Anda di halaman 1dari 34

Prapared by Prashant Parmar B.COM.

+=+=+=+=+=+=+=+=+=+ Auditors qualifications, appointment, rights and
duties etc. Q. 1 Describe the provisions of Indian Companies Act, 1956 regarding
qualifications and disqualifications of a company (Sau. Uni. 2003, 2008, 2009) OR
Describe provisions made for the appointment, re-appointment, qualifications,
disqualifications, remuneration and removal of auditor according to the Companies
Act. (Sau. Uni. 2004, 2005) OR Describe the provisions of companies Act, 1956 for
qualification, disqualifications and removal of the auditor. (Sau. Uni. 87, 89, 92,
2000, 2002, B.U.2005) OR Describe the provisions of Companies Act, 1956,
concerning the qualifications, disqualifications, appointment and re-appointment of
the company auditor. (Sau. Uni. 94, 97, 99, 2007, 2010) OR Write Short Notes :
(1) Qualifications of Auditor. (Sau. Uni. 96, 2001) (2) Auditors appointment and reappointment. (Sau. Uni. 96) Ans. Let us examine the provisions of Companies Act
regarding the auditor in following order : 1. Qualifications and disqualifications of
auditor 2. Appointment and re-appointment of auditor 3. Auditors remuneration 4.
Removal of the auditor I. Qualifications and disqualifications of company auditor : 1.
Auditors qualifications : According to section-226 of Companies Act, person or firm
having the following qualification can be appointed as an auditor : (1) Person who is
the member of Institute of Chartered Accountant. (2) Any firm whose all the
partners are serving as chartered accountants in India. (3) A person holding a
certificate under the restricted auditors certificate (part B. state) rules, 1956 can be
appointed as an auditor. 2. Disqualifications of an auditor : According to section226(3) of Companies Act, the following person cannot be appointed as an auditor :
(1) Any registered institute. e.g. Company; (2) Any salaried officer or employee of
the company (3) Officer of the company, partner of an employee or any person who
is serving there; (4) A person who is indebted to the company for an amount
exceeding Rs.1,000 or who has provided any security in connection with the
indebtedness of any thid CHAPTER: 1 COMPANY AUDIT - 1Prapared by Prashant
+=+=+=+=+=+=+=+=+=+ person (party) to the company for an amount
exceeding Rs.1000 cannot be appointed as an auditor. (5) According to section226(4) of Companies Act, if a person is disqualified with relation to either a holding
company or its sub - Sidiary Company, he shall be disqualified for being an auditor
of the first company. If an auditor becomes the subject to any of the disqualification
mentioned above, after his appointment, he shall be deemed to have left his rank
(position) as an auditor. Besides provisions of Companies Act, auditor can be
disqualified according to the disqualifications shown in section-8 of Charter
Accountants Act, 1949. II. Appointment and Re-appointment of auditor : Every
company has to appoint an auditor for auditing their accounts. Following provisions
have been made regarding appointment of an auditor according to section-224 of
the Companies Act in different circumstances. 1. First Appointment : The board of

directors appoints the first auditor of the company within one month of the
registration of the company, which continues till the end of the first annual general
meeting of the company. If the board of directors does not appoint the first auditor
of the company in this way, the first auditor of the company is appointed in the
annual general meeting of the company. 2. Appointment every year : Every year,
Company appoints the auditor in the annual general meeting by share holders. The
auditor appointed this way holds office till the completion of next annual general
meeting. The auditor has to be intimated about his appointment within seven days
after the resolution about the appointment has been passed in the annual general
meeting. And after getting this information the auditor has to inform the registrar of
companies in writing in a prescribed form whether he has accepted or refused the
appointment within thirty days. This provision is also applicable in the case of
reappointment of an auditor according to the amendment of 1974 in the Companies
Act. 3. Re-appointment : Only the auditor who has been appointed by the company
should be reappointed in the annual general meeting. Of course, reappointment is
not done under following circumstances : (1) If auditor is not qualified for
reappointment. (2) If a resolution has been passed to appoint another person
instead of him or resolution has been passed that the same auditor should not be
reappointed. (3) If auditor has given a notice in writing to the company about his
unwillingness for his own reappointment. (4) If the notice about the resolution of
other auditors appointment instead of the current auditor has been received by the
company but because of death, insanity, inability or disqualification of such person,
the resolution cannot be proceeded with. 4. Appointment by the Central
Government : When the appointment of re- appointment of an auditor is not
possible at annual general meeting of the company, the Central Government
appoints the auditor. In this case, the company has to inform the Central
Government withinPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ the seven days of completion of annual general
meeting of the company that the auditor is not appointed or re- appointed. 5.
Appointment of an auditor of Government Company or Corporation : In the
Corporation, government companies which are established by the laws of State
Government or Central Government in which the government has the right for more
than 50%, the appointment of an auditor of such companies is done by the Central
Government on the advice of the Comptroller and Auditor General of India. e.g. Life
Insurance Corporation, General Insurance Corporation etc. 6. Appointment by a
Special Resolution : According to the amendment in Companies Act of 1974, a new
section- 224 (1) (A) is included. As informed in it, the auditor can be appointed or
reappointed by the special resolution passed in the annual general meeting of the
company in the following circumstances : (1) The company whose 25% or more of
subscribed capital is held by public financial institution, the Central Government or
the State Government; (2) The company whose 25% or more of Capital is held by
such financial or any other institution established under the State Act and 51% of
subscribed capital is held by the State Government; (3) The company whose 25% or

more subscribed capital is held by nationalized bank or general insurance company.

If the auditor has been appointed without passing any special resolution by the
company, it will be considered that the auditor has not been appointed at all and
later, the Central Government will get the right of appointing the auditor. 7.
Appointment to fill the casual vacancy : If there is any casual vacancy of an auditor
because of death, insanity, insolvency, the board of directors can appoint another
auditor, but it the current auditor has resigned and there is any vacancy, the board
of directors cannot appoint any other auditor. General meeting possesses tors
cannot appoint any other auditor. General meeting possesses the right to fill the
casual vancancy that is caused by the resignation of an auditor. Auditor appointed
for such casual vacancy will held the office till the completion of next annual
general meeting. According to the amendment of 1974, auditor can undertake the
audit of 20 companies with pain-up share capital of less than Rs.25 lakhs rupees,
including 10 companies with paid-up share capital of more than Rs.25 lakhs. III.
Auditors Remuneration : If the auditor has been appointed by the board of
directors, his remuneration too will be decided by the board of directors. If the
auditor has been appointed by the annual general meeting, his remuneration will be
decided by the annual general meeting itself. If auditor has been appointed by the
Central Government, the Central Government will decide his remuneration too. In
short, one who appoints will decide the remuneration too but the remuneration is
paid by the company. The amount given to the auditor as reimbursement of
expenses is included in the remuneration of the auditor. According to the provisions
of Companies Act, remuneration paid to the auditor should be shown separately and
it is to be shown in the profit and loss account of the company. IV. Removal of
auditor :Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ The first auditor appointed by the board of directors
can be removed by the resolution of general meeting of the company and another
auditor can be appointed in his place. The first auditor appointed by the Board of
Directors continues to hold his office till the conclusion of the first annual general
meeting of the company. But if the auditor is to be removed before the expiry of his
term, he can be removed by the resolution of the general meeting of the company
and for the appointment of another auditor in his place, any member of the
company has to give a notice seven days prior to the date of general meeting. It is
not necessary to get the permission of Central Government for this. For the removal
of auditor who has been appointed by the other way, means appointed by annual
general meeting, Central Government etc., it is necessary to get the permission of
Central Government in advance and its resolution has to be passed in the general
meeting of the company. According to the provisions of Companies Act, if other
auditor is appointed in place of retired auditor, resolution has to be passed in the
general meeting of the company. According to the provisions of Companies Act, if
other auditor is appointed in place of retired auditor, resolution has to be passed in
the general meeting of the company. If such resolution has passed by any share
holder, notice regarding this should be sent to the company before 14 days.

Company will send this notice to all shareholders and retiring auditors. The auditor
has right to show his opinion in writing to the company. If auditor sends his opinion
to the written opinion to the company, the company has to send this to all
shareholders but if such opinion cannot be sent to the shareholders because of late
receiving or because of any other reason, auditor will be given the right to read this
opinion in the general meeting. If the company or shareholders feel that such
written report is false or auditor makes false representation of his report, the court
will not permit to read that statement. Q. 2 According to the provisions of
Companies Act, 1956 (1) Describe rights of an auditor (Sau. Uni. 80, 86, 95, 97,
2000, 2002, 2006, 2008) (2) Describe the duties of company auditor (Sau. Uni. 83,
86, 95, 97, 08, 2009, 2011) Ans. With the purpose that auditor can fulfil his duties
properly and with the intention of protecting their welfare as the representative of
shareholders, company auditor has been given certain rights according to the
provisions of Companies Act. Besides this, certain duties have been decided for the
Company Auditor which are as follows: Auditors Rights : Auditor has been given
some important rights so that he can fulfill his duties honestly and faithfully. These
rights can be described as follows : 1. Right to verify books of accounts and
documents : According to the provisions of Companies Act, the auditor has the right
too check the accounting books during the working hours. Which are kept at the
head office of the company or at any other place and their vouchers and account
registers which are sent to the head office by the branch at any time. All books of
accounts which are kept legally like cost accounting books, accounting registers like
legal register, memorandum, articles, minutes, stock register and vouchersPrapared
by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ like contract, bills, invoices, receipts, etc. can be
included in the accounting books. Auditor can check such books of accounts,
vouchers, etc. at any time during the working hours of the office. Of course, it is
found generally that auditor comes to verify accounts at the previously decided
time by the auditor and the client. But it is true that auditor should arrange surprise
visit without informing the client and check the securities, cash on hand etc. 2.
Right to obtain information Explanation: Auditor has the right to get all the
necessary information and explanation which are required for the verification of
accounts. He can obtain this explanation from the management of the company,
responsible officers and employees of the company. If the auditor is denied this
necessary information and explanation, the auditor should make a remark about
this clearly in his report. 3. Rights regarding general meeting : If audited accounts
are to be presented, auditor has the right to receive a notice of general meeting and
remain present in the general meeting. It is not inevitable for auditor to remain
present in the general meeting. It is the auditors right, not duty. Of course, if the
auditor has criticized the accounts in his reports, it is desirable that he remains
present in the meeting and give explanation clearly to the shareholders. Though
auditor remains present in the meeting, it is not compulsory for the auditor to give
any answer of the question asked by the chairman. When the notice about the

appointment of new auditor in place of current auditor is given to each member, the
auditor has a right to receive such notice and to present his opinion in writing to the
company. But there is a condition that such report should not be reformative. 4.
Right to improve the wrong presentation regarding accounts in the meeting : If the
auditor feels that the statement of accounts presented by the management is
wrong, fraudulent or illusive, auditor has the right to improve (verify) it. But
anything that has been left out in the report cannot free the auditor from his
responsibility with the help of oral explanation. 5. Right to get the advice, service of
experts : The auditor has a right to get the advice of experts regarding technical
matters of Law and business. But the auditor has to present his own opinion in the
report according to the case of London and General Bank Ltd. 6. Right to get
remuneration: Generally, authority who appoints the auditor decides the
remuneration of the auditor. The auditor has right to receive such remuneration. It
has been stated in the case of Homer V/s. Kwitter that auditor is appointed on an
annual remuneration and if he is removed during the current year, the auditor has
the right to receive the full amount of remuneration. 7. Right to receive legal
expenses: According to the provisions of Companies Act, if civil or criminal case
have been filed against the auditor, he has the right to receive legal expense for the
defence. Not only this, he has a right to recover such legal expense from the assets
of the company. (But the condition is that the judgement of the case should be in
favour of the auditor and auditor is declared to be innocent or the justice believes
that the auditor has behaved honestly.) 8. Right to visit the branch and verify the
accounts:Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ When other auditor has been appointed for the
audit of accounts in the branch, if the auditor feels necessary, he can visit the
branch and verify the accounts. 9. Special Right of an auditor (Lien): If the auditor
has worked as an accountant, he gets special right (lien) on books of accounts but if
he has worked just as an auditor, he does not get any special right on books of
accounts. Duties of an Auditor: Auditor is the protector of the interests of
shareholders. Certain duties have been decided to protect the interests of
shareholders. Let us discuss such duties from three different view points: I. Duties of
an auditor according to Companies Act. II. Duties of an auditor according to judicial
decision. III. Professional Ethics. I. Auditors duties according to Companies Act :
Auditors duties to shareholders according to Companies Act are as follows: 1. To
present Audit report: According to section 227 of the Companies Act, it is the
preliminary duty of an auditor that he should present the report before shareholders
after verification of accounts of the company. Though the auditor is appointed by
any authority, the auditor has to address his report to the shareholders and present
it to them. Only in special audit, auditor has to give his report addressing the
Central Government. According to the judicial decision, in case of Allen Craig & Co.,
it is not auditors duty to send audit report to each and every shareholder. Once he
submits such a report to the company secretary, his duty is considered to be
fulfilled. During his verification of accounts, if the auditor finds any defect, illegal act

or breach of the provisions of Companies Act, he has to point it out and guide them
about its improvement. Even then, if the error is not corrected or if it is neglected,
auditor should clearly mention that matter in his report. According to Section 227
(1) of the Companies Act, it is the auditors duty to verify the following matters: (1)
It should be verified that conditions about the loan and security of the company are
not harmful to shareholders. And it should be verified that they have received
enough security against the loan or not ? (2) It should be verified that the
transactions written in the books of company by adjustment entry are not harmful
to the interest of the company. (3) If any company except that of investing or
banking company has invested in shares, debentures and securities and sold them
at lower price than its purchase price, it should be checked in depth and minutely.
(4) It should be verified that lended money or loan of the company has not been
shown as deposit. (5) It should be verified that any type of personal expenses have
not been posted as revenue expenditure. Examining the books of accounts of the
company minutely, auditor should find out whether the accounts present true and
fair economic condition of the company or not ? Before giving his opinion about it,
he should show enough care and skill. As stated in the case of Controller of
insurance v/s. H.C. Das, AuditorPrapared by Prashant Parmar B.COM. (SEM-VI)
+=+=+=+=+=+=+=+=+=+ should not depend only on the certificate of the
management and officers of the company. 2. Certification to be given for statutory
report : According to section 165 of Companies Act, the company has to hold a
statutory meeting within six months after registration of the company in which
statutory report is to be presented. The auditor has to give a certificate for the
following matters in this statutory report. (1) Number and types of shares issued by
the company. (2) Total amount of cash received by the company for allocated
shares. (3) Statement of receipts payments of cash till that date. 3. When the
prospectus is issued: The company who has been running business and when it is
sues the prospectus, the information and detail of profit-loss account of the last five
years, amount of dividend distributed every year during the last five years and the
auditors report for assets and liabilities of the company should be included in the
prospectus. 4. When special auditor is appointed : To verify companys accounts and
management, Central Government appoints special auditor. At that time, it is
auditors duty to offer necessary and possible help to such auditor-inspector. II.
Auditors duties according to judicial decisions : Auditors duties to shareholders
according to judicial decision can be shown as under: 1. To exercise reasonable careskill : According to the statement of the Justice Lipse in the judicial decision of
Kingston Cotton mills case, auditor should exercise reasonable care and skill while
doing his duty. Of course, what is reasonable care-skill can be decided on the basis
of particular circumstances of respective case. 2. To verify important documents : In
the judicial decision of Leeds Estate Building and Investment Society Ltd. Vs.
Shepherd case, the judge Shri Sterling ruled that the auditor should be familiar with
the articles or the company. No excuse regarding auditors ignorance about the

existence of articles is accfeptable. 3. To verify the truthfulness of transactions :

According to the judicial decision of Registrar of Companies Mumbai V/s. P.M. hedge
case, auditor should not check only the accounts from the arithmetical view but he
has to inquire into transactions in depth and should verify the truthfulness and
authenticity of transactions. 4. To verify the assets : In the judgement of London Oil
Storage Co. Vs. Sear Hasluck & Co. the judge Shri Alverstone has ruled that, it was
auditors duty to verify the existence of all assets shown in the balance sheet. It the
auditor fails to do his duty, auditor is liable to submit the loss suffered by the client.
As shown in the case of city Equitable insurance Co. Ltd. Auditor should physically
verify the assets and investments. 5. Disclose true economic condition : In the case
of London and General Bank Ltd., the judge Shri Lindle has stated that it was not the
auditors duty to give advice to the trader but to disclose the true economic
condition of the company. III. Auditors duties according to professional ethics
(duites towards institute):Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ According to the Chartered Accountants Act, the
auditors duties to his profession ethics are as below: 1. Regarding the acceptance
of appointment or re-appointment: If he is appointed in place of retiring auditor,
auditor should inform the retiring auditor in writing before he accepts the
appointment. Moreover, he should accept the appointment or re-appointment after
following the provisions of sections 224 and 225 of Companies Act. 2. Regarding the
rejection of less fees : Appointment cannot be accepted on lower fees in place of
any other Chartered Accountant. 3. Regarding signing the report : A person who is
the member or a partner of Institute of Chartered Accountant of India can sign the
annual accounts. Any other person should not be allowed to sign on the annual
report. 4. Regarding not getting work through advertisement : Through
advertisements or circulars auditors work cannot be obtained. 5. Regarding not
getting work by giving commission : He cannot pay commission, brokerage or pay
fees out of profit of business to get any work of audit. Of course, there is nothing
wrong if he gives the share of profit to the partner of the firm after his retirement or
death as per agreement. Liabilities of Auditor Q. 3 Discuss auditors liabilities to
negligence according to the Companies Act. (Sau. Uni. 81, 84 , 86 , 92 , 94 , 99
, 2001, 2004, 2005, 2007, 2010, 2011) Discuss auditors Civil liabilities according
to the Companies Act. (Sau. Uni. 81 , 84 , 86 , 92 , 94) Write Short Notes :
Auditors liability to negligence (Sau. Uni. 89) Discuss in brief : Auditors liability to
misfeasance (Sau. Uni. 89) Ans. Auditors Liability : Auditor of a private institute is
not appointed under any Law. He is appointed by an agreement with the client. So,
his liabilities are decided on the basis of instructions given by the client. It is
advisable for the auditor of private institute to get instructions of the client in
writing so that there will be no confusion regarding the work done by him in future.
Company auditing is different from this. He is appointed according to the Indian
Companies Act of 1956 and his liabilities are showed in the law. His liabilities can be
described under two heads : 1. Civil Liability : (A) Liability arising from negligence

(B) Liability arising from misfeasance (A) Auditors civil liability regarding negligence
: As auditor is appointed by the company, it becomes auditors duty to protect the
interest of the company. Moreover, as auditor represents shareholders, it becomes
prime and sacred duty of an auditor to maintain the trust of shareholders. In order
to fulfil his duty faithfully auditor should use care skill. Of course, it is difficult to
define fair care skill and it is again difficult to define it or measure it. It can be
decided on the basis of form, type of the case or condition.Prapared by Prashant
+=+=+=+=+=+=+=+=+=+ If the auditor fails to do his duties, he should be
ready to suffer its results. It means, he should pay for the losses suffered by the
client. Here, it should be remembered that auditor has to pay for the losses of the
client only if the loss occurs because of his negligence to his duties. But if he owner
has not suffered any losses because of auditors negligence or auditor had not been
negligent and yet the client had suffered, in that case the auditor is not liable to pay
for it. This can be easily understood with the help of following manner. Loss without
negligence An auditor is not liable for Negligence without loss Moreover, if the client
has really suffered losses because of the negligence of the auditor, only the
company has the right to file a suit for the recovery of damages, individual
shareholders cannot claim. Of course, if the company is making losses, its liquidator
can file such suit. Following cases regarding this are famous : (1) Leeds Estate
Building and Investment Co. vs. Shaepherds (1887) (2) The Irish woolen Co. vs.
Tyson and Brothers (1900) (3) London Oil storage Co. vs. Seer Hasluck and Co.
(1904) (4) Registrar of Companies (Mumbai) vs. Hedge (1954) Q.4 Discuss auditors
liabilities to misfeasance as per Companies Act. (Sau. Uni. 81, 84 , 86 , 92 , 94 ,
South G.U. 2001, 2004, B.U.2004) Ans . As Auditor is considered liable for
negligence, in the same way, he can be found liable for misfeasance also. As the
representative of shareholders, auditor should protect the interests of shareholders
and for this auditor should take proper care and use his skill and expertise. Even
then, if auditor does not follow his duty properly, means if he commits misfeasance,
auditor is liable for this. If company has suffered any loss because, of auditors
misfeasance or breach of trust, auditor should pay the damages. When company
becomes insolvent as per the provisions of Companys Act, court feels that founders
of the company, management or officers (including auditor) have misused the
money of the Company or kept it in unauthorized manner with them or they have
committed misfeasance or breach of trust. In that case the court can order such
founders, management or officers to pay for the loss company has suffer because of
their breach of trust and misfeasance by holding them liable. Even then, if the suit
is filed in the court against any officer of the company (including auditor) for
negligence, misfeasance etc. and if the court feels during the hearing of the case
that (1) He may be liable or not; or (2) They had acted fairly an honestly; or (3) On
overall consideration of all the circumstances of case and circumstances under
which he was appointed, if he is found worth absolving from the allegations, the
court gives total or partial freedom under certain conditions. When auditor gets the

idea that a case is going to be filed against him for negligence, breach of trust or
misfeasance, before the case is filed, auditor can make himself free from such
liability by sending an application to the court and if the court finds it proper, it can
make the auditor free from such responsibility.Prapared by Prashant Parmar B.COM.
+=+=+=+=+=+=+=+=+=+ According to the provisions of Companies Act, any
company cannot keep the auditor free from liability of negligence, breach of trust or
misfeasance by its articles or agreement. If there has been any provision or
agreement has been made, as it is against Companies Act, it is considered null and
void. Yet, in certain circumstances civil or criminal liability of auditor is created,
company can give relief to the auditor under the following conditions : (1)
Judgement should be in favour of the auditor; or (2) Auditor should have been
declared innocent; or (3) The court must have given relief the auditor according to
the provisions of Section-633 of Companies Act. If auditor has made any false
statements in the prospectus inviting the public to invest in shares or debentures,
as an expert, auditor is considered liable for it. Moreover, if any person has
purchased share, debenture on the basis of such false statements and if he has
suffered loss, auditor is liable to pay for it. But if auditor withdraws his statements
before the issue of prospectus is out, he becomes free from the liability. Famous
cases regarding this are given bellow : (1) London and General Bank Ltd. (2)
Kingston Cotton Mills Company Ltd. (3) The City Equitable Fire Insurance Company
Ltd. (4) The Westminster Road Construction and Engineering Company Ltd. Q.5
Discuss adutiors criminal liabilities under the Indian Companies Act. (Sau. Uni. 81,
83 , 89 , 92 , 93 , 96 , 98, 2006) Write Short Notes : Auditors Criminal liability.
(Sau. Uni. 96) Ans. Criminal liabilities : Auditor is an officer of the company and if
he breaks the provisions of law. It is known as criminal liability of the auditor. For
this, auditor is liable to fine or punishment. Regarding auditors criminal liability,
various provisions of Companies Act are as follows: According to Section-63 of
Companies Act, if a prospectus is issued by the company containing false
statement, every person including auditor who authorized the issue of such
provisions in section 68 of the Companies Act, to punish him. Contrary to the
provisions of Section-233 of Companies Act, if any auditor gives report or certifies
documents of the company, auditor or any other person who has signed the report
or any one who was certified documents does this intentionally, he is liable for fine
upto Rs.1000. According to Section-240 of Companies Act, the auditor should help
the inspector appointed by the Central Government. If auditor does not help him, he
is liable to be punished with imprisonment of six months and or with fine of
Rs.2000. According to Section-242 of Companies Act, the Central Government take
necessary steps on the basis of the report by the inspector and if the suit has been
filed against the person related to the company, if the auditor does not help, it is
treated similar to contempt of court and the auditor will be held liable to
punishment. According to Section-477 of Companies Act, a Private Court can
examine the auditor when the company is making loss and the important

documents which are with the auditor should be submitted to the court if necessary.
If the auditor does not remain present in the court, he can be arrested.Prapared by
Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ According to Section-478 of Companies Act, the
auditor of the company can be investigated by the High Court on the basis of official
liquidators application. Its remark will be made and the auditor should sign on it. In
the civil or criminal procedure of an auditor, such entry can be used as an evidence.
According to Section-539 of Companies Act, if the auditor makes any false or
fraudulent entry in the account books of the company, register or tears, destroys,
alters or tampers with it, the auditor is liable for the punishment upto seven years
imprisonment and or fine. Q.6 Discuss auditors liability to the third party. Describe
judicial decisions of any two cases related to it. (Sau. Uni. 83, 93 , 95 , 96)
Discuss auditors liability under the titles shown below : (1) Liability to the third
party Write Short Notes : Auditors liability to the third party (Sau. Uni. 93, 95)
Ans. Auditors Liability to the third party : Generally, the auditor is appointed by the
company. So, the relationship between the company and auditor is established
according to the agreement. Therefore, auditor is aware of the fact, that if he fails to
do his duty, he is liable to pay for the loss suffered by the client; but the question
arises here is that, whether other persons of the society connected with the
financial interest of the company like creditors, debenture holders etc. can consider
the auditor liable for his work or not ? If any third party takes any decision keeping
in mind the accounts certified by the auditor, trusting his report and if the annual
accounts prove to be wrong and as there is no reference to the wrong accounts in
the report of the auditor, if the third party incurs any loss, can the auditor be
considered liable to pay for the losses ? In binary circumstances, the answers to
these questions are into negative because auditors appointment, remuneration,
removal etc. are not decided by the third party. Generally, an agreement is made
between the company and the auditor. Company appoints the auditor. It pays
remuneration. Therefore, uditor is accountable to the company and not the third
party. Yet it is not totally true. In certain situations, auditor is liable to even the third
party. Let us clarify this matter by referring to various judgements. It was decided in
the case of Lelievere & Dennes vs. Gold that auditor had nothing to do with the third
party because he is never appointed by the auditor. In case of Calender vs. Crane
Christmas and Co. Ltd., the justice had stated in his judgement that auditor is not
responsible for any loss suffered by third parties through reliance on accounts
already audited by him even if the negligence is proved. This is because there is not
relation of any kind between the auditor and the third party through agreement. But
in case of Hedley Byrne and Co. vs. Heller and Partners, giving judgement, House of
Lords of England informed that auditor cannot escape from his liability if the third
party suffers any loss by relying on the report of the auditor and takes any
important decision based on it. Based on this judgement, Institution of Accountants
of England published one statement Auditors liability to the third party. Following

recommendations have been mode :Prapared by Prashant Parmar B.COM. (SEM-VI)

+=+=+=+=+=+=+=+=+=+ (1) If the auditor has prepared accounts, registers,
reports with negligence and if they are prepared keeping in view certain
transactions with the third party and if actions are to be taken on the basis of it by
the third party, then the third party can get the compensation for the losses shown
by the auditor. (2) If any shareholder decides individually to invest in the company
on the basis of certified accounts or auditors reports, auditor is not liable to that
shareholder individually. (3) If the accountant knows that his accounts will be based
for the estimatin of taxes and yet if any negligence is showed, the auditor is not
liable for it. Of course, in the case of Commissioner of Income Tax (Madras) Vs. G. M.
Dandekar in India, Justice Shri Ayyar stated that auditor is not responsible to
income-tax department for the correctness of the accounts. In case of Ultramares
Corporation Bank Vs. Touche, Niven & Co. (U.S.A.) Ultramres Corporation Bank had
granted loan to Touche, Niven & Co. relying on the audited accounts of the
company. In fact, accounts did not present the true and fair condition of the
company, as a result, Ultramares Corporation Bank was not in a position to recover
the money of loan. So, the bank filed a suit against the auditor of the company for
the compensation of damages. Of course, the settlement was done outside the
court before the court announced judicial decision. According to the opinions
presented in the magazine Accountant published in England, as there is no
relation between be held liable otherwise difficult situation may arise. If the readers
of the newspapers, magazines act on the basis of the information published in it and
incur losses, the owner of the newspapers and magazines cannot be held liable. In
order to consider auditor liable, it should be proved that following four conditions
showed in case Derry Vs. Peek have been followed: (1) The third party depends on
the statement which was signed by an auditor was in fact false. (2) One who made
statement knew that statement was wrong or he had showed total negligence to
know the truthfulness or he had remained ignorant intentionally. (3) The statement
was with the knowledge and intention that the third party would act upon it, trusting
its correctness. (4) The third party had acted on the basis of such statement and
they had incurred losses. If the conditions shown above are applicable, auditor is
liable to compensate, the losses incurred by the third party. It should be
remembered that towards the third party, auditor has a moral liability. They will act
depending on his reports so, if auditor has made false or misguiding statements and
the third party suffers loss, it is auditors moral liability. According to Indian
Companies Act, if there is any misguiding statement in the magazine and auditor
has given his permission, auditor is liable to pay for the gamage suffered by the
person who has invested money depending on it. But it should be remembered that
the auditor should be honest. While auditing, he should use fair skill, vigilance and
expertise. It is necessary that auditor is honest and gives his report after proper
verification of accounts. Auditor has moral liability too. The third party deals with
the company thinking that accounts which have been verified by the qualified

auditor are correct. In this situation, auditor should take care of the interest of third
parties.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ Report of Auditor Q. 1 Explain the importance of
audit report. (Sau. Uni. 91, 2008, 2009) Explain the importance of company audit
and describe the types of reports. (Sau. Uni. 90, 91, 95, 2006) Write Short Notes
: (1) Types of Audit Reports (Sau. Uni. 90, 95) (2) Auditors Qualified Report (Sau.
Uni. 2000, 2001) Ans. Audit report is the presentation of collected and considered
facts. It is prepared in such a way that those people who do not have information
about the matter of the report can be informed clearly in brief. According to Section
227 (2) of Companies Act, it is auditors duty to verify the accounts of the company
carefully and give a report about whether the accounts present true and fair
condition of the Company or not ? Auditor is the representative of shareholders;
therefore it is his moral duty to take care of shareholders interest. Generally,
shareholders do not know the real condition of the company. They are not capable
for it. So, auditor should verify whether the money of shareholders is properly
managed ? that money is not used illegally or for personal purpose, the
management is done according this. He should minutely verify the accounts of that
company. Finally, he has to present in his report before shareholders whether the
profit-loss account and balance sheet of the company gives true and fair economic
condition of the company. Let the auditor not add any new information in the
presented accounts but the real importance lies in giving the report after verifying
the truthfulness and clarity. In the case of London and General Bank, justice had
stated the auditor was liable for not giving proper report to the shareholders.
Auditors report proves very useful to those who have lent money to the company,
banks who have sanctioned loans for short or long term and finance company.
CHAPTER: 2 COMPANY AUDIT - 2Prapared by Prashant Parmar B.COM. (SEM-VI)
+=+=+=+=+=+=+=+=+=+ It helps shareholders, debenture holders, depositors
to know the true financial condition of the company before deciding their financial
investments. While assessing Sales Tax, duty, custom, income tax etc., audited
accounts help income tax officers by providing faith and trust and truth. As a result
assessment of tax takes place easily and quickly. Auditor report is useful to know
that the public money is not misused and wasted. Thus, auditors report is very
important from various points of view to shareholders, debenture holders,
depositors, bank, other investors, creditors, bankers, income tax officer, public,
government etc. Types of audit reports: There are two types of reports : 1. Clean
Report 2. Qualified Report 1. Clean Report: If no defect, illegal act, frauds are
detected during the verification of the accounts of the company and if profit and
loss account in the annual account of the company presents true and fair profit or
loss and balance sheet shows true and fair economic condition as of the date and
auditor presents whatever report are called clean report. Clean report is also called

report without defect or routine report or regular report. 2. Qualified Audit Report:
During the verification of the accounts of the company, any defect, illegal act,
frauds, breach of provision of law is detected and the profit loss account does not
show true and reasonable profit or loss of the concluding year and balance sheet
does not show the true and fair economic condition as of that date, when auditor
gives report about it is called qualified audit report. This type of audit is also called
improved report or limited report. In the following circumstances, the auditor should
give qualified report: (1) When accounts, financial registers etc. are not prepared
according to the accepted principles of Accounting. (2) When it is not possible to
verify accounts according to accepted principles of auditing. (3) Where the auditor
is not given enough books of accounts, certificates, vouchers and necessary
information and explanations. (4) When Account books are not maintained as per
the provisions of Companies Act. (5) When profit-loss account and balance sheet,
profit-loss allocation accounts have not been prepared as per Companies Act. (6)
Including management, if any person has committed breach of provisions of
articles, memorandum, provision of Companies Act, qualified report should be
given. If auditor ascertains that companys balance sheet does not present true and
fair economic condition of company and profit-loss account does not present true
and fair financial picture, in circumstances like (i) More or insufficient provision of
depreciation on fixed assets. (ii) If there is an adverse effect on profit-loss account
because of change in the method of depreciation. (iii) More or insufficient provision
for bad debts, bad-debt reserve has been made. (iv) Assets shown in the balance
sheet are assessed at low price or more price etc. Auditor should present qualified
report.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ Q. 2 Explain the works true and fair used in the
audit report. (Sau. Uni. 88, 93 , 95 , 96, South G.U.2003) Write Short Notes :
Concept of True and Fairness. (Sau. Uni. 91, 94 , 97 , 98 , 99, 2001, 2003,
2005, 2007, 2010) Ans. After verifying accounts of the company, he has to give a
report whether the accounts of the company present true and fair economic
condition of the company or not ? In that case, it is necessary to understand what
the meaning of words is true and fair. It can be said that the accounts of the
company show true and fair economic condition of the company only when
accounts have been prepared according to the accounting principles and accounting
methods, capital and revenue transactions have been allocated properly,
information is given according to the second part of residual-6 of Companies Act,
total information is given as per provisions of law and shown in law. All the assets
and liabilities of the company shown in the balance sheet of the annual accounts
are presented properly, means no assets or liabilities of the company have been
left, or have not been shown were wrongly, its valuation has been done according to
the accepted principles, there is provision for depreciation on fixed assets,
contingent liability is shown with provision regarding it. Thus, if the real condition of
assets and liabilities is shown in the balance sheet, it is called true and fair
condition. We can say that fair and true profit is shown in profit-loss account only

when profit has been calculated after adjusting in necessary from according to
Companies Act and Profit-Loss account has been prepared according to the
principles of accounting and provision of Companies Act. Account of allocation of
profit-loss should have been prepared properly; necessary amount should have
been carried to the reserve account, provision for depreciation, bad debt reserve,
reserve discount, tax reserve etc. should have been properly arranged. If profit and
loss account has been affected due to change in the methods of depreciation, along
with above, it is to be seen whether the entries related to pre-paid expenses, bill
receivable, bills payable or income received have been properly posted or not. The
presentation done through accounts on the circumstances discussed above is true,
transparent and fair and at that time auditors certificate regarding accounts will
present true and fair economic condition in its real sense. The use of words true
and fair started with the implementation of Companies Act in 1956. Before that,
words true and correct were used. These words were used since the
implementation of Companies Act of 1913. The meaning of true and correct is
that the basis on which the annual accounts have been prepared matches with the
books of accounts. In this sense. Annual accounts show true and correct condition of
the company. True and fair words are used in this extensive sense. The meaning
of true and fair is extensive. Annual accounts are true only with reference to
books of accounts. Not only are these accounting books also truly transparent.
Transactions in it are regarding business. They are authentic, true and written truly.
In this sense, fairness of transactions is presented by words true and fair. Q. 3
Explain words True and Fair used in the audit report of auditor to be presented
with the balance sheet. (with changes Sau. Uni. 96, 2007, 2011)Prapared by
Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ Ans. In Ans 12(B), we have already discussed the
meaning of words True and Fair. So, now let us prepare a clean report. Clean
report of the auditor To Shareholders of maha gujarat Co.Ltd., We have verified the
attached balance sheet of Maha Gujarat Co. Ltd. Dated 31-3-2009 and the profit and
loss account for the year ended on that date and report that : 1. We have obtained
all the information and explanations which to the best of our knowledge and belief
where necessary for the purpose of out audit. 2. In our opinion proper books of
accounts as required by law have been maintained by the company so far as seen
from our verification of the books. 3. The balance sheet and Profit-Loss Account of
the company showed in the report are in agreement with the books of account. 4. In
our opinion and to the best of our information and according to the explanations
given to us, the accounts, including remarks thereon give the information required
by the Companies Act, 1956 in the manner required and (1) The balance sheet of
the company shows true and fair economic condition as on 31-3-2011; and (2) Profit
and Loss Account shows true and fair profit for the year ended on the date.
Signature : Naresh Narayan Modi (Partner) Karnavati Modi & Co. Date : 15-6-2011
Chartered Accountants Q. 4 Prepare a report of a company by an auditor having
three defects. ( Sau. Uni. 93, 97 , 99 , 02 , 03 , 04 , 05 , 2010) Ans. Here is the

specimen of a qualified audit report: Auditors qualified report : Specimen To The

Shareholders of Gyayak Company Ltd. We have verified the attached balance sheet
of Gyayak Company Ltd. As on 31-3-2010 and also the profit and loss account of the
company, for the year ended on that date annyexed there to and present the
report that: 1. We have been provided all the necessary information and
explanations required for the purpose of our audit. 2. In our opinion proper books of
accounts as required by law have been maintained by the company which is so
found out from our verification. 3. The profit and loss account and balance sheet are
in agreement with the books of accounts. 4. In our opinion and to the best of our
information and explanations given to us, the accounts, including remarks on it, are
as per the Companies Act, 1956 in the manner as it is required and (1) The balance
sheet of the company presents true and fair state of companys affairs on 31-32011.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ (2) Profit and Loss Account gives true and fair profit
for the year ended on that date. (i) In our opinion, the provision for depreiation on
Fixed assets is as less as Rs.1,80,000. (ii) There has been change in the method of
valuation of closing stock, due to which the profit of the company is calculated more
by Rs.1,75,000. (iii) The loan granted to the management worth Rs.1,80,000 is
contrary to the section-295 of Companies Act. (iv) Sales Tax has been assessed
Rs.1,60,000 regarding which there is no provision in the accounts. Signature :
P.P.Parmatma Prakash (Partner) Rajkot Atma & Company Date : 10-6-2011 Chartered
Accountants Divisible profit and dividend Q.1 Discuss the factors affecting divisible
profit. (Sau. Uni. 2007, 2008, 2009, 2011) Discuss in brief the factors affecting
true profit. (Sau. Uni. 93, 2003) What is divisible profit? Which points should be
kept in mind while determining it ? (Sau. Uni. 86, 87, 99, 2002, 2004) What is
divisible profit? Which points will you keep in mind while determining it? Explain in
regard to the judgement. (Sau. Uni. 2005) Explain the guideline principles for
calculating divisible profit. (Sau. Uni. 90, 94) Write Short Notes : Divisible Profit
(Sau. Uni. 89, 90, 95, 2001, 2003) Ans. What is divisible profit ? Divisible profit
means the profit that can be legally allocated among shareholders in the form of
dividend. In section 205 of Companies Act, clarification regarding the meaning of
divisible profit has been made. According to section 205 of Companies Act. (1)
Company cannot announce or allocate dividend for any financial year except, (a)
Out of the profits of the company are from the current year or out of the
accumulated balance of profits of the earlier years remaining undistributed after
provision for depreciation is made or (b) out of the money provided by the Central
or Sate Government for the payment of dividend by the Central of State
Government for the payment of dividend in pursuance of guarantee given by such
Governments. In cases other than guaranty of the government, company cannot
allocate dividend from any other funds except profit. Dividend can be distributed
CHAPTER: 3 COMPANY AUDIT - 3Prapared by Prashant Parmar B.COM. (SEM-VI)

+=+=+=+=+=+=+=+=+=+ out of profit only. Of course, there is no binding of
law that interest should be paid out of the profit earned from business. It can be
from capital profit or revenue profit. There is one exception to this principle and it
has been described in section-208 of Companies Act. According to the provisions of
this section, if capital has been accumulated by issuing shares and if this capital is
used in the activity of such construction in which a lot of time passes for this
construction activity to become more profitable, company can allocate interest from
the capital even if it doesnt have profit. Of course, for this, permission of the
Central Government should be taken and the conditions enforced by this section
has to be followed. To decide the divisible profit of the company, following principles
should be kept in mind : 1. Accepted principles of Accounting: According to the
accounting principles, while deciding divisible profit, difference between the
beginning of the accounting year and closing assets and credit and capital and
liabilities should be worked out. It there are more assets, profit is calculated but if
there are less assets, it is considered as loss. According to the accounting principles,
it is not at all proper (fair) to allocate dividend from capital profit. Even in the
current year, before distributing dividend from the profit if there is any loss of the
last year, it should be adjusted and it would be proper and advisable to distribute
dividend from the remaining profit. Not only this, it is advisable to allocate dividend
only after taking a certain amount of profit to the reserve account. 2. Provisions of
Memorandum and articles: For the allocation of divisible profit, management has to
obey the provisions of Memorandum and articles that allocation of profit also affects
third parties. Therefore, if in the distribution of dividend, capital is returned, it is
contrary to principles of law, so, according to the provisions of memorandum and
articles, management can recommend the allocation of dividend from divisible profit
after deducting reserve and provisions. But if dividend is distributed form capital, it
is called breach of trust, so, management has to return it. (K. Madhav Vs. Popular
Bank, 1970) It has been said in various judgments that provisions of articles should
be followed completely. Any work contrary to it will be considered illegal. 3.
Provisions of Law: In order to decide divisible profit, it is inevitable to abide by law.
After the amendments of 1960 and 1974 in the Companies Act of 1956, legal
condition became absolutely clear. According to sections 205 and 350 of Companies
Act, after deciding divisible profit, dividend can be allocated from it. 4. Judgements:
Jugements can prove a guideline to decide divisible profit and distributing dividend
from it : Practical points to be considered while deciding divisible profit: It is
necessary to keep in mind certain practical points given below while deciding
divisible profit. (1) Depreciation: While deciding divisible profit, it is necessary to
have provision of depreciation of assets according to section 205 of Companies Act.
If there is no provision for depreciation, accounts will not show true and fair
economic condition and once the life of assets is over, in order to get new asset in
Place of that, replacing the asset is not possible because of lack of financial funds.
Of course,Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING

+=+=+=+=+=+=+=+=+=+ Central Government can permit any public

company to distribute a dividend without having provision for depreciation in public
interest. Here is the example of one judgement regarding this: Lee Vs. New Chatel
Asphalt Co. Ltd. (2) Capital profit: In business, capital profit is different from current
profit. The profit earned from regular activities is common or revenue profit.
Dividend can be allocated from it, but dividend cannot be allocated out of capital
profit. Received premium while issuing shares debentures, amount of forfeiture,
profit received from the sale of fixed assets, profit before the registration of the
company etc. are examples of capital profit. Generally, dividend cant be distributed
from capital profit but if such profit has been really received, and if there is
provision for articles on assets and if any such profit remains after re-valuation of
liability, dividend can be allocated from capital profit. Here is the example of a
judgement regarding this: Foster Vs. New Trinided Lake Asphalt Co. Ltd. (3) Capital
Loss: Capital loss is different from the ordinary or revenue loss in business. Discount
on share-debenture, premium loss in the sale of fixed assets etc. are examples of
capital loss. On the basis of certain judgments, it can be said that even without
adjusting capital loss, company can allocate dividend from the current profit but
without adjusting capital loss, dividend cannot be distributed from capital profit.
Here is the reference to a judgment regarding it : Bolton Vs. Natal Land and
Colonization Co. Ltd. (4) Past Loss, Past Profit: According to principles, before
allocating dividend to shareholders, past loss should be adjusted. It has been
informed in section-205 of Companies Act that without adjusting past loss, dividend
cannot be distributed. But certain judgments have been given contrary to these
provisions of Companies Act. Foreign judgments which are contrary to the provision
of Indian Companies Act are not binding in India. Like past loss, if there is profit of
the past year and if the company has suffered loss in the current year, before
distributing dividend from the profit of the past year current loss should be adjusted.
Here is the example of such judgment regarding this: Stapley Vs. Reid Bros. Ltd. (5)
Transfer to reserves: According to Table A, Management can transfer any amount
of profit to reserves for future problem. Such amount can be invested in the
company or other outside companies. Management can transfer certain amount of
the profit to reserves instead of distributing it as dividend. According to the
amendment of Companies Act, from the profit of that year out of which dividend is
to be distributed, the percentage decided by the Central Government but not more
than 10% of profit has to be transferred to reserves before the company announces
dividend. Q. 2 What is dividend? Who can declare the dividend? As an auditor of a
public limited company, directors ask for your advice regarding recommendation of
interim dividend. Which points will you keep in mind while advising them ? (Sau.
Uni. 81, 83) Directors of public limited company where you have been appointed
as an auditor, ask for your advice regarding the announcement of interim dividend.
Discuss the steps you would suggest to be followed before announcing this decision.
(Sau. Uni. 97)Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING

+=+=+=+=+=+=+=+=+=+ When the directors ask for your advice regarding

announcement of interim dividend verifying which points, you will advise them?
(G.U.) How will you audit the interim dividend ? (Sau. Uni. 95, South G.U. 90)
Describe auditors duties regarding dividend. (Sau. Uni. 95) Write Short Notes :
Interim Dividend (Sau. Uni. 85, 97, 98, 2003, 2005, 2008, 2009, 2010) Ans. What
is dividend? Dividend is the profit distributed among shareholders according to the
proportion of share. If Company earns profit and the part of profit which is
distributed among shareholders is called dividend. Every share-holder has a right to
receive his share the profit of the company. Of course, it is decided by articles to
what proportions can the dividend be demanded only after it has been announced
in the general meeting of the company. This means up to when the dividend is not
announced in the general meeting, no shareholder can demand dividend. There are
mainly two types of dividends: 1. Interim Dividend 2. Final Dividend. Let us verify
the provisions of Companies Act regarding the announcement of both types of
dividend. Provisions of Companies Act, Regarding the announcement of dividend: It
is the basic principle of Companies Act to pay dividend from the profit. Dividend
cannot be paid out from capital and dividend should be paid on cash. The
announcement of dividend shows that company has earned profit. After deducting
depreciation, dividend can be paid from the profit. After the announcement of
dividend in the general meeting, dividend should be paid out to the shareholders
within 42 days. 1. Regarding Interim Dividend: The dividend which is declared in the
middle of the year before the final dividend is called interim dividend. If there is
provision in the articles, interim dividend can be announced. For this resolution of
the board of directors is necessary. The permission of general meeting is not
necessary for announcement of interim dividend. 2. Regarding final dividend:
Dividend that id declared at the end of the accounting year is called final dividend.
At the end of the year, annual accounts of the company are prepared and dividend
is announced after calculating net profit. The Board of Directors has authority to
recommend dividend and general meeting has the authority to announce dividend
on the basis of the recommendation. Guidance to the management regarding the
announcement of interim dividend: As an auditor of the company, while guiding the
management regarding the announcement of interim dividend, following points
should be kept in mind: (1) It should be verified whether the management has
authority to declare dividend according to the company articles or not ! If it doesnt
possess such authority, it should be obtained. If table-A has been adopted, there
must be provision regarding this in it. (2) After preparing interim accounts of the
company, profit of the period should be calculated, while calculating such profit,
depreciation, bad debts, bad debts reserve, interest adjustments should be kept in
enough for the announcement of interim dividend? If the management wants to use
the amount of the profit in development activities, and if sufficient possibility
ofPrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ profit is not seen in the time afterwards, it is not

advisable to announce interim dividend. (3) If interim dividend has been announced
in the past years, its rate, accounts of that time, economic situation of business at
that time etc. should be taken into consideration so that while taking the decisions
in present, past experiences will provide proper guidance. (4) The profit during the
remaining period of the year should be estimated too. There would be no question if
the condition of interim is going to prevail all the year. But suppose if the business is
seasonal like warm (woolen) cloth, raincoat, umbrella, fire crackers etc. and after
preparing interim accounts and the business season comes in other times, there
would be no business. So, the earning of all 12 months is already included in the
interim calculation of profit. Therefore, there is no question of earning profit during
that time. Instead earned profit will be used for expenses. So, in these
circumstances recommendation of distributing interim dividend will prove a danger
and fatal! (5) While estimating future profit factors like orders in hand, production
capacity, prices of goods, labor, government policy etc. will affect the profit. If such
effect is inconvenient, no possibility of profit is seen, and a difficult situation arises.
Management and auditor of the company are considered liable for this. Precise
Estimates of the companys business potential and future profit in the remaining
period of the financial year should be ascertained. It cannot be considered fair to
allocate interim dividend if the company is likely to face any economic liabilities in
future. (6) Before announcing the rate of interim dividend, rate of final dividend
should be considered. Generally, rate of final dividend is more than that of the rate
of interim dividend. Auditor should see to it that if the rate of final dividend does not
increase, at least it should be maintained. There is a danger of losing reputation if
the final rate reduces. The graph of reputation of the company in the minds of
shareholders and investors would go down too. There will be inconvenient reactions
of this on share market. (7) In the provisions of Companies Act, we have shown that
dividend should be allocated in cash only. Therefore, the companys cash liquidity
has to be checked. Even if the profit earned by the company is good but it is
invested in the business the company does not have enough cash for the
distribution of dividend and it has announced interim dividend, assets of the
company will have to be sold at a very low price. Existence of business might be
endangered. (8) It should be verified whether the work of distributing interim
dividend is ultra virus or not. (9) On the basis of the statement of inward and
outward cash,
cash is seen and if the management decides to distribute interim dividend on the
basis of such increase of cash, but this is a serious mistake. Auditor should explain
management the difference between cashbook and profit loss account.
Sometimes, it happens that seeing cashbook, cash in hand appears more but profit
loss account may show loss! On the contrary, seeing cashbook, cash in hand
appears to be less but profit loss account shows more profit! Therefore, it is not
proper to take the decision of allocation of interim dividend on the basis of cash on
hand. Even if profit loss account does not show profit, there can be more cash on
hand in the following circumstances:Prapared by Prashant Parmar B.COM. (SEM-VI)

+=+=+=+=+=+=+=+=+=+ (i) Assets of company have been sold and cash has
been received but later, that amount has not been invested in the purchase of other
asset or other investments. (ii) Even if the purchases of goods is done on cash basis,
if such purchase has been due on credit in the current year and its amount has not
been paid. (iii) Company has received cash by issuing debentures but it has not
been invested in any other form. (iv) If company has borrowed money order to
follow the plans of development in future, but that money has not been used still. In
the contrary situation, though the profit loss account shows profit, there is no cash
in hand. (10) The profit loss account shows profit but if necessary entries like
depreciation, bad debt reserve, interest etc have not been posted, as a result profit
seems possible but in fact, there may not be profit. In these circumstances, the
decision of declaring interim dividend cannot be considered proper. Audit of
Computerised Accounts Q.1 What is Computerized Account ? Explain its importance.
(Sau. Uni. 2010) What is electronic data processing ? Discuss its characteristics.
Explain importance of computerized Accounting System. (Sau. Uni. 2008, 2009)
Write Short Notes : Audit of EDP (Sau. Uni. 99, 2003, 2005, 2007, 2008) Ans. For
auditor, it is very necessary to understand the specialties of electronic data
processing (EDP) because it is prepared in various ways in comparison to accounts
manually prepared by human beings. Therefore, auditor should be aware about it
from general viewpoint as well as its special techniques and other important
information about it. Important specialties of EDP are as follows: (1) Organizational
Structure : With the adoption of EDP, the number of employees reduces a lot.
Organisational structure will become small. The format of organization system will
change. Staff control will also change. Duties of employees will also change. Certain
information recorded individually as a result of special knowledge of that individual
employee might also be connected with the process in adding information. When
internal process and reports are also connected, it is in such condition that there are
errors or frauds in that programme or information storage or process can be easily
detected. (2) Lack of Documents giving information: CHAPTER: 4 COMPANY AUDIT
- 4Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ In the accounting system depending on human
beings, the accountant notes accounts in the books on the basis of documental
evidences. E.g. vouchers invoice, receipt, bill etc. while in electronic data process of
accounts, such documents is many times not available for noting. That entry is done
directly on computer e.g. calculation of sales order received from the customer,
discount given to him, interest etc. is done directly on computer. (3) Lack of visible
audit trail: In human based method, the noting of accounting procedure is carried
according to some order. e.g. transactions, its entry, posting, balance sheet, annual
accounting, etc are directly dealt with. In data process stystem simultaneously as
the effects are automatically given according to the computer system. All the

information is stored in the machine code. Once the time is over, that information
cannot be even seen. (4) Lack of visible report: In various mechanical accounting
methods, some printed reports are received. While in certain methods, printed
reports are not available. Lot of information is stored in the machine which can be
read only through computer. (5) Information and process can be easily known: In
mechanical accounting methods, with the help of computer, information retrieval
and processes become easy and quick. Therefore, if effective internal check has not
been arranged by the unit, there is a possibility of tempering, with the information.
If an unauthorized person gets its information, there can be many frauds and
misappropriations with the information available in it as well as its process. (6)
Constant Procedure: Mechanical procedure is more trustworthy than the procedure
depending on human beings. It works constantly according to the pre-set
programme. On the contrary, if a wrong programme is fed, it works continuously
according to that programme as a result errors are continued. (7) Programme
Check: In mechanical method, much of control process is liked with programme and
this process is arranged in such a way that it can be rarely seen. Suppose an
unauthorized person tries to add or get information, computer will demand
password. Many such checks have been arranged like limitation of printing the copy
of report, specific verification on information etc. (8) Every side of a transaction and
its information gives its effects in the mechanical file: In mechanical accounting
method, if you enter one transaction, instantly it affects to related all places e.g. If
goods is received, effect of this transaction is seen in purchase account, in the
account of goods supplier, in stock account and in cash or bank account. If any
wrong entry is done, many wrong entries will be passed under different account
heads. (9) Medium for information and programme storage: Vast information and
numerous computer programmes are stored in the small and portable, fixed storage
media like CD and floppy etc. Of course, there is a risk of theft of these media. It
may be lost or destroyed in accident. (10) Use of Code: In order to clarify name and
details of cmputerised methods, code number is used at a large scale. Auditor
should know about all these. It can create problems many times particularly, in the
beginning stage, as there is lack of detailed description, it is specially difficult to
understand different transactions.Prapared by Prashant Parmar B.COM. (SEM-VI)
+=+=+=+=+=+=+=+=+=+ Q. 2 Discuss internal control in computerized
accounting. What is common EDP control? Describe in detail. (Sau. Uni. 2006)
Control over the use of computer. (Sau. Uni. 2000, 2002) Ans. In computerized
accounting system, control is necessary for the proper maintenance of information.
Of course, in certain methods, internal control has been properly arranged. The
principles of control which are applied in the method depending on human beings
are applicable to computerized accounting method also. Like planning of
organization, entrusting power and method of clarification, allocation of duties etc.
are some of the examples. Moreover, some special controls are necessary in
computerized accounting method. In internal control process, human based process

and programme based process, both are used in data processing which is divided
into two parts: (1) General control in computerized accounting system (2) Control
over processing in data processing Object of general data processing is to create a
format for General Control system. For general control in data processing allocation
of duties, maintenance of software, control over development process, control over
the use of stationery, control over data entry and programme, file control, ancillary
arrangement for security, etc. are included. (1) Allocation of duties and
responsibilities: Generally, data processing section is very small. There will be less
employees in it. So, it is necessary to allocate every employees duties and
responsibilities clearly. In possible responsibility of designing system, responsibility
of processing, exerting and maintaining responsibility, of maintaining information
and its storage should be allocated to different people, otherwise because of less
number of people, possibility of frauds and misappropriation increases. For clear
allocation of duties and responsibility, organization of computerized accounting
system department is arranged. Let us examine it. Frauds or misappropriation are
committed by unauthorized person or many times by the computer operator also.
Therefore at the same time, arrangement for personal verification should be done.
(2) Control for development and maintenance of software: It is necessary to have
specific control for development and maintenance of software. If application
software or system software is to be developed or used, it should be done through
an authorized and efficient person. Documents which are required for the
development of the latest process should be clear. If possible, it should be human
based. The construction of the method should start with input, through master file,
it should pass through process and reach output. The whole process starting from
input to output should be clear. For programming, proper documentation should be
followed. Information for it should be given while programming. There should be a
detailed description of control process in programming. There should be details for
operation. List of instructions of programming should be ready for proper
verification of information should be done. There should be a complete control over
programme by system and proper care should be taken so that unauthorized person
will not be able to play mischief with programme in any circumstances. After
authorized verification of programme. Its analysis should be checked, one copy of it
should be stored at some other place and if there is any necessity of change in the
original programme, it should be done by data processing manager only. Thus
beforePrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ using the system practically, should be verified
completely, and in the same way, before its application, responsibility of authorized
person should be fixed. (3) Control over operator: Certain controls depend on the
utility of human beings and preparation. Man is useful in time table and operating
instructions. Operating logs are possible after personal verification at certain time
intervals. Duties of operator should be order wise and as far as possible, there
should be at least two operators. (4) Routine errors: If process is properly followed,
errors can be avoided, Errors should be corrected under the observation of

supervisor. Auditor should also verify errors. Indicators showing errors make internal
check more powerful. Auditor should also pay attention to such errors which were
not detected at first sight. (5) Control over stationery: There should be a proper
process to obtain stationery, particularly so, when stationery is related to pay order,
cheque etc. specific procedure is required for control. (6) Control on data entry and
programme: A specific arrangement should be made to see that only an authorized
person can feed the transactions into computer as well as only an authorized person
should be able to make use of the software and only that specific person should
have the authority to do so. (7) Control and maintenance of data files: It is
necessary to have an extra arrangement for the maintenance and storage of data
because many times by accident data gets destroyed or lost. C.D., magnetic tape
etc. can be destroyed by fire and also data in it might be destroyed or damaged. So,
storage system should be properly arranged. Many times it is possible that stored
information (data) gets deleted because of operators mistake. So, to avoid such
errors, floppy and disc should be labeled properly. Computer centre should have
proper arrangement for storing data. Documents and files should be properly
stored, so that even if data is lost and destroyed by accident, it becomes possible to
get original data again, therefore, original data, documents of sources should be
stored outside the computer centre. Generally, file is stored in three copies in floppy
or disc. This is known as son, father and grandfather concept. This means today,
data is entered and copied in the disc. Next day, the data is added in the copied
disc and other opy of copied disc is made. Thus, data is preserved in three
generations. This means, if the data of the first second and third day is destroyed, it
can be obtained immediately and used also. (8) Control over embezzlement in data
processing system: Data processing method possesses vast electronic and
mechanical thought and error or misappropriation is possible in any part as a result
of which process appears to be full of mistakes and method took full of
misappropriation. Certain steps for control are taken in the method which can be
divided into 5 points Useless or similar words, copying, eco. Verification,
verification of instrument etc. Useless word is joined with data item so that errors
can be defected. It is related with basic features of data and development. In copy
process, same data is processed again and it is verified by comparison with original
process. In eco. Verification, checking is done on the input and output plans. In the
same way instrument is verified too. (9) Protection and safety:Prapared by Prashant
+=+=+=+=+=+=+=+=+=+ Data processing equipments must be properly
insured. Not only hardware but important documents and data can be damaged by
accident or error of man. Such unplanned arrangement is damaging to the firm.
Many times careless employees also damage data and programme files. So, proper
arrangement for their safety must be verified. Verification & Evaluation of Assets
and Liabilities Q.1 What is verification of assets? How does it differ from vouching?
(Sau. Uni. 94, 97, 98, 99, 2005, 2007, 2008, 2009, 2011) What is verification of
assets? How does it differ from vouching? What are the duties of auditor regarding

verification of assets ? (Sau. Uni. 92, 2000) What is verification of assets?

Describe auditors duties regarding it. (B.U. 2004) Explain the meaning of
verification of assets. Describe the points to be kept in mind by the auditor while
verifying and evaluating assets. (Sau. Uni. 90, Oct. 98) Differentiate: Verification
and Vouching. (Sau. Uni. 95, 96, 2001) Ans. 1. Meaning of verification and
valuation of assets and liabilities: Careful verification means checking the following
points: Whether the assets shown in the balance sheet really exist or not. The
assets are in the name or the unit or in the name of any person? Whether any
liability is there on it or not ? Whether its valuation has been done as per the
accepted principles or not ? In brief examining existence, possession, ownership,
valuation and liability of CHAPTER: 5 COMPANY AUDIT - 5Prapared by Prashant
+=+=+=+=+=+=+=+=+=+ assets is called verification. Now, let us examine
various definitions regarding verification given by famous writers. According to the
definition of verification given by Shri. J. Prakash, Verification means such a
procedure in which auditor is satisfied about the existence, ownership, valuation
and authenticity of assets shown in the balance sheet after the real verification.
According to the opinion of Spicer and Pegler, Verification means verification of the
valuation, ownership and rights, existence and possession of assets and if there is
any liabilities on assets. In verification, vouching of assets and existence,
ownership of assets are verified. Moreover, verification includes valuation. On the
basis of definitions given above, here are the characteristics of verification : In
verification of assets, assurance of the following is included Existence and
possession of assets; Ownership and rights of assets; Valuation of assets; and If
there is any liability on assets? 2. Points to be considered during the verification of
assets and liabilities: While carrying out verification of assets and liabilities,
following directive principles of verification should be considered: (1) If the assets
shown in the balance sheet are purchased in the previous years, then it should be
verified on the basis of last years balance sheet. But if the assets have been
purchased during the current year, deep examination is necessary. It should be
checked whether asset has been purchased for the purpose of business? Also
authority of purchasing, copy of resolution, have been purchased after the proper
process ? Purchase bill, payment receipt etc. details should be checked minutely. (2)
If any asset has been sold out or discarded during the year, authority regarding it,
copy of resolution, proper proceeds, sales-figures, profit or loss due to sales, entries
of these etc. should be examined in detail. (3) During the verification of assets,
types of assets should be considered. In comparison to current assets, verification of
fixed assets is easier but current assets are changeable. So, it can be converted in
cash. As it is not fixed, it goes on changing now and then. So, more care should be
taken in its verification. Generally, in rare cases, auditor comes for verifying
accounts at the end of the year means on the date of preparation of balancesheet
but once the annual accounts are ready, a convenient date for both the parties is

fixed and auditor comes for verification and there would be a difference between
the current assets of that date and current date of balance sheet. Naturally, stock
has been used, debtors are reduced, cash is increased or opposite condition
prevails. This means current assets showed in the balance sheet on the date does
not match with the current date showed on the date of account checking by the
auditor. From the date of balance sheet to the date of checking of accounts, it
should be checked how much balance is left on the basis of transactions in the
books. Moreover, it is necessary to be careful concerning movable assets e.g. when
cash has been paid at different places, when auditor goes to calculate cash at other
place after getting cash figures from one place, meanwhile it is possible that he
used amount to fill up the difference in cash from the earlier calculated amount. In
the same way, if any asset hasPrapared by Prashant Parmar B.COM. (SEM-VI)
+=+=+=+=+=+=+=+=+=+ been mortgaged, effort is made to show that there
are no liabilitie4s on assets by releasing those mortgaged assets with the help of
assets that have been verified by the auditor. In order to prevent this type of frauds,
current assets and movable assets should be verified together. (4) Physical
verification of assets should be done according to the register of fixed assets. It
would become difficult for the auditor to check technical type of assets because we
cannot expect knowledge about technical aspects from auditor regarding different
subjects. So, for such matters, auditor should depend on the certificate of the
responsible officer. If there is any doubt regarding this, auditor should ask for the
advice of an expert and then give his own opinion. (5) According to the provisions of
Companies Act, it is necessary to have provision for depreciation on the fixed
assets. Before allocating dividend, company should arrange for the provision of
depreciation according to the section 205 and section 350 of Companies Act.
Auditor should specially examine this. (6) It should be carefully verified whether
valuation of assets has been done according to the accepted principles of valuation
or not ? Moreover, it should be checked that without reason, there is no change in
the method of valuation. (7) Immovable assets should be showed under the
following heads under partI, of schedule-VI of Companies Act: (i) Goodwill (ii) Land
(iii) Building (iv) Leasehold assets (v) Railway- siding (vi) Machinery and Plant (vii)
Furniture-fixture (viii) Asset development expenditure (ix) Patent, trademarks,
patterns copy-right (x) Live Stock (xi) Vehicles. (8) If any assets have been
mortgaged, certificate of the ownership should be verified. (9) It should be verified
that the allocation of capital and revenue expenditure has been properly allotted or
not ! 3. Auditors duties concerning verification : Auditor should check the accounts
very carefully and skillfully as per the study of accepted principles and objects of
verification presented above. Following brief details will be useful : (1) When new
assets are purchased for business, it should be checked that it has been purchased
for business purpose authentically after following proper procedure. (2) If assets
have been purchased previously, balance showed in the last years balance sheet
and if any expense has been incorrect for improvements, it should be verified with

the balance of asset shown in the current balance sheet. (3) Physical existence and
possession of asset should be verified. (4) The ownership of assets is that of the
institute or not? Should be verified. (5) It should be ascertained whether the
valuation has been carried out according to the accepted principles of valuation or
not. (6) Is there is any liability or if the asset is mortgaged, it should be verified. (7)
It should be carefully verified whether the allocation of capital and revenue
expenditure has been done properly or not? (8) It should be verified whether the
assets are properly shown in the balance- sheet according to provisions of
Companies Act.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ (9) Like assets, Liabilities to should be properly
checked. Auditor has to follow his duty very carefully and minutely. If he shows
carelessness or negligence, he is held responsible. Many Judgments have been
passed showing auditors responsibility. A few interesting references are presented
below. In the case of London Oil Storage Co. Ltd. V/s. Seer Hasluck & Co., the auditor
was careless in the verification of assets. Auditor had failed to verify the cash on
hand. Cash on hand shown in the balance-sheet was 796 Pounds, while actually
cash on hand was only 30 Pounds. While announcing the judgment of this case,
Justice Mr. Alverstone said that it was the duty of an auditor to verify the assets
shown in the balance sheet. If auditor failed in his duty, he will be considered liable
for any damage suffered by the client. In the case of City Equitable Insurance
Company Ltd., the company did not possess the documents of securities. The
auditor did not verify the security physically. In fact, these documents were with the
broker of the company named Mr. Elis and he had received money for his personal
objective on security documents. As a result, the company suffered losses later n. In
this case, Justice Mr. Roman had specifically motioned that if the securities of the
company are found in the possession of such a person, generally who is not
entrusted with the responsibility of securities of the company and if the auditor
himself has not personally verified it and did not submit a report in this regard, then
his work cannot be forgiven. Vouching and Verification: (How do vouching and
verification differ?) As vouching and verification both are the processes of
examining accounts, there is possibility of misunderstanding them as synonyms of
each other. But difference is seen among them. As the scopes of vouching and
verification are not the same, it is necessary to understand the difference between
them. There are differences between vouching and verification from the view point
of definition, time, scope, valuation, working method, phase etc. These differences
can be clarified by the following table: Verification Vouching 1. Definition :
Verification means checking with regards to existence of assets and liabilities, as
well as possession, ownership, valuation and liability. 1. Vouching means verifying
an entry in the book of account with supporting documentary evidences to see
whether production and expenditure concerning business are authorized and
ascertain proofs available etc. 2. Time : Verification is done only after accounts are
completed and the balance sheet has been prepared. 2. Vouching can be done at
any time during the year. 3. Scope : Verification of assets in done every year. 3.

Vouching of assets is undertaken once during the lifetime of the asset in the year of
its purchase. 4. Working Method : Auditor himself does the auditing as it is most
important highly technical matter. 4. Comparatively vouching is easy, so that coworkers can do that.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ 5. Valuation : In verification, it is necessary to
valuate assets. 5. In vouching, valuation of assets is not necessary. 6. Stage :
Verification is the next step after vouching has been completed. So, verification is
the last step. 6. Vouching is the first stage (step) of audit work. In verification,
vouching is included. Q. 2 Verify any four of the following: (1) Investments (Sau. Uni.
82, 89, 2001, 2008, 2011, G.U. 89, 2005, B.U. 2004, 2005) (2) Closing Stock (Sau.
Uni. 98, 2001, 2005, 2008, 2011, B.U. 94, 97) (3) Unsecured Loan (Sau. Uni. 97,
98, 2008) (4) Furniture (Sau. Uni. 2008, B.U. 94, 2004) (5) Forfeited shares (Sau.
Uni. 87, 91, 94, 97, 98, 2000, 2002, 2003, 2005) (6) Goodwill (Sau. Uni. 91, 94,
97, 98, 2002, 2003, 2005, 2011, South G.U. 2002, 2003, G.U. 89, 2004, 2005) (7)
Bank Overdraft (Sau. Uni. 2008) (8) Creditors (Sau. Uni. 83, 99, 2003, B.U. 97)
Ans. Verify any four of the following: 1. Investments: When an institute has invested
in large number, there should be an investment register so that details like different
investments such as shares, debentures, types of other securities, institute who
issues, date of purchase, price, rate of interest, rate of dividend received interest
dividend, receivable interest etc. can be obtained immediately. Like investment
book, the ledger too should be kept. If possible, verification of investments should
be completed in a single sitting. In case, it is not possible, investments should be
kept with the institute so that chances of illegal acts can be reduced. Certificates of
investments should be checked by the auditor himself. Finding the order (sequence)
of those certificates, it should be confirmed whether the share certificates are in the
name of company or not ? According to the section 49 of Companies Act (1956),
except exceptions, share certificates should be in the name of company only.
Auditor should verify that there is no breach of provisions of law. At the end of the
accounting year, responsible officers of the company should prepare the list of
investments. Auditor should verify this list carefully. He should verify whether the
certificates are in the name of company or not according to the investment note? In
the case of City Equitable Fire Insurance Company, the justice stated, that if the
investment documents are kept in the custody of such a person who is authorized to
keep it and the auditor himself does not verify it, then the Auditor is held
responsible. If shares, debentures or securities are kept in the bank, a certificate
regarding it should be obtained from the bank. The date of issue of that certificate
should be specifically verified. It should be checked whether any liability has been
raised on such investments. If a company has purchased shares at the closing of
that years accounts but has not received the share certificates, its details should be
verified on thePrapared by Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ basis of the figures of broker. And if the amount has
been paid for those shares, its entry in the book and counterfoils of the cheque book

should be verified. If the company has applied for new shares and received the
shares but certificates are not given till the total amount is paid. In these
circumstances, it should be ascertained after examining share permission letter,
receipt paid for shares, counterfoils etc. If the share certificate is for more than one
share and some of the shares out of them have been sold out, a share certificate for
transfer should be sent and if it has been sent, a certificate of remaining shares
with the company should be received and verified. Investments are mainly of two
types: Registered and bearer, Registered shares, stocks or debentures can be
verified easily because they are transferred in the name of the customer. Of course,
auditor should check whether they have been transferred in the name of the
company. Bearer bond and share warrant are neither in the name of the company
nor any person. For its transfer or change, no procedure is to be followed and
therefore, its verification should be done carefully. In order to valuate investments,
first of all the purpose of investments should be verified. It should be checked with
which purpose the investment has been made ? Has it has been invested with the
purpose of earning interest or to earn profit by purchase-sale ? If its an investment
company, its intention is to get interest by investing No question of depreciation
arises here. If there is provision for re-valuation in the articles, it should be executed
accordingly. If other companies whose object in long-term investments may not be
getting interest but to sell off or purchase new shares from the market as per the
price fluctuation. Hence, for them it is a floating asset. Therefore, concerning such
companies, the lesser price out of cost price or market price of investments should
be assessed. In order to decide the cost price of investments, auditor should verify
the sale figure of broker. If any unit or person has been given shares for their
services or sales of asset, it becomes difficult to evaluate the price. In these
circumstances, value of investments can be assessed by deciding the price of
services or business. Even then the market price of investment should always be
taken into consideration. If the underwriting agent purchases shares according to
his agreement, the amount that comes after deducting the receivable underwriting
brokerage from the price given by him should be considered as cost price. Even if
the market price reduces for a short period in comparison to the cost price of
investments, they should be shown in the balance sheet at the cost price. If the
market price reduces for a long period, the amount worth reduced prices should be
adjusted in the profit and loss account and investment fluctuation fund should be
created and it should be shown in the balance sheet after subtracting it from the
value of investments. The auditor should see the prices issued by the share market
in order to know the market price of investments. Shares listed in the share market
and unlisted shares should be shown separately in the balance sheet. Balance sheet
of those shares which are not sold or bought in the market should be examined to
decide the price of shares and the prices which are printed in other publications
should be taken care of. If purchase of investment is with or without interest, capital
of interest and revenue has been allocated properly or not should be
verified.Prapared by Prashant Parmar B.COM. (SEM-VI) AUDITING

+=+=+=+=+=+=+=+=+=+ If the company has received bonus shares or rights

shares, they should be verified. Even while valuation, it should be carefully verified
at the time of assessment. For this, the permission letters, reports which have been
received from the company should be kept with. If the total amount has not been
submitted on the shares purchased by the company, the remaining unpaid amount
should be shown in the balance sheet on the capital debt side under the head of
contingent liability in the inner column. As shown in the schedule 6 of part I of
Companies Act provision, details of investment should be shown separately. 2.
Closing Stock: The unsold goods stock in hand at the end of the accounting year is
valued and shown in the annual accounts. The valuation of stock directly affects the
profit. If stock is valuated at a higher price, more profit will be seen. If stock is
valued at loss price, less profit will be seen. Thus, for showing less or more profit,
stock is very useful to the management. Before verifying the goods stock, auditor
should see whether there is stock register for goods stock or not? Moreover, is there
an efficient internal check or not ? If necessary , it can be ascertained with the help
of test checking method. He should verify whether there are entries of purchase till
last date, sale, return etc. in the stock register or not? Auditor or his representative
should remain present while calculating goods stock. Generally, in the calculation of
stock, the arrangement is done in such a way that one employee calculates,
another one notes it down, the column of price is kept blank, later it is filled and
other calculation is followed. Of course, it is necessary during this procedure the
auditors representative should remain present. While verifying goods, auditor
should remain careful that he should not calculate the total stock in possession but
he should calculate only the goods for which invoice has been received and its entry
has been made e.g. (1) Goods have been purchased, and received but because of
lack of invoice, its entry has not been done, it should be seen that the goods are not
calculated by mistake and included in the stock. (2) Sold goods have been returned
but upto when the note of goods returned has not been prepared, it should not be
included in the stock. (3) The invoice of the goods after sales has been sent but
purchaser has not been dispatched the goods, in that case, it should not be included
in stock. (4) If purchased goods are to be returned, the entry of purchase return is
also ready but if goods have not been returned, it cannot be included in the stock.
(5) Goods have been received for the sale on commission but it is still lying unsold,
it cannot be included in the stock. (6) The goods bought from other institute on the
basis of sell or return but if it is not chosen, it should be seen that these goods are
not included in the stock. But if such goods are included in the stock, stock will
appear more than what it really is and so, its price will appear more. As a result,
profit will appear more. 3. Unsecured Loan: It has to be verified while checking the
unsecured loan whether the secured loan and unsecured loans are separately
shown in the balance sheet. Ancillary proofs like agreement of unsecured loancredit, resolution of the manager, correspondence etc. should be verified. The
conditions of repayment of interest and loan amount should also be verified. It
should be ensured that therePrapared by Prashant Parmar B.COM. (SEM-VI)

+=+=+=+=+=+=+=+=+=+ is no difference between the balance amount to be
paid as per the balance sheet and the balance of payment to be made as per the
records of the creditors. 4. Furniture: In furniture fixtures and fittings, chairs, tables,
racks, benches, electric fittings etc. can be included. Like machinery register, there
should be one register for furniture too. In transaction, it is called dead stock
register in which details regarding furniture, fixtures, fittings like type, purchase
date, price, expenses regarding purchase, estimated durability (life), rate of
depreciation etc. are shown. By fixing a strip of oil paint or metal on furniture should
be marked with number on it of that existence and possession can be verified. If it is
the purchase of current year, it should be vouched. If there is any balance of
previous year, it should be compared with the last years balance sheet. The note of
decrease or increase of the current year should be checked. If the furniture has
been made by self, the expense for the raw material etc. and capital revenue
expenditure should be allocated and taken in the account of furniture fittings and it
should be verified. In case of furniture manufacturing as profession, it should be
checked whether the cost price amount has been entered in the account of
purchase A/c. or not? Counting the reparing expense, maintenance expense as
revenue expenditure, it should be posted in the profit and loss account. Valuation of
the furniture fixtures fittings should be shown in the balance sheet according to
Depreciation after Cost. As the life of this type of assets is different, different rates
of depreciation will be applied to it. Moreover, for hotel/restaurant, varied rates of
depreciation of furniture have been prescribed. Is there provision of depreciation
accordingly or not should be verified. If furniture has been purchased on installment
system, capital revenue allocation of the amount paid as the interest and cost price
in the installment should be verified. The conditions for agreement of installment
system should be verified. The conditions for agreement of installment system
should be verified. If there is any liability of any type on furniture, fixtures and
fittings, it is necessary to verify it. 5. Forfeited Shares: The share holder who falls to
pay the amount of installment within the prescribed time limit, company gives him
the notice to pay the amount of installment with interest. Even then, if the share
holder fails to pay the remaining amount, the management of the company, using
the power of forfeiture of shares empowered by the company articles, forfeits his
shares. The management should use this power in the best interest and the welfare
of the company. Regarding forfeiture, following are the provisions as per Table-A:
(1) First of all, the company should issue a notice to the share holder for paying the
amount with interest. (2) If the share holder does not pay the amount of installment
even after such notice of 14 days, his shares are forfeited. (3) The resolution of
forfeiture of shares is passed in the board meeting. Share holders name is removed
from the membership register and he is informed about it. (4) Forfeited shares can
be reallocated or the board of director would dispose it off in whatever way they feel
proper. Regarding the forfeiture of shares, auditor should see why the shares were
forfeited ? Only when the installment of share has not been paid, shares can be
forfeited. Auditor should see whether the articles have empowered the

management or the court have given the power of forfeiture or not?Prapared by

Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ The auditor should check the resolution of
management regarding forfeiture and reissuing the shares, process according to the
provision of articles, notice of 14 days, its proper note in accounting book,
necessary change in the membership register etc. Forfeited shares can be reissued
but it should not be less than amount received previously. But, if it is issued in
higher price, additional amount should be debited to the account of reserve capital,
Auditor should verify all these matters. 6. Goodwill: This is a type of intangible asset
in fixed assets. Goodwill means reputation. In other words, Goodwill means the
value of the reputation of a firm in the form of money. The firm dealing in similar
business but doing more profit is supposed to have goodwill. This means, Goodwill
depends on the capacity of getting more profit for any firm. In business, goodwill
can occur in two ways one is while purchasing business and the other is during the
entry or retirement of a partner in the firm. While purchasing any business, the
amount to be paid as a price for receiving net assets is called goodwill in business.
Goodwill should be verified when a partner joins or retires from a partnership firm.
Goodwill should be estimated in cost price. On goodwill, no depreciation is implied
as it is done in case of land. In the principles of valuation of fixed assets, these two
are exceptions. Valuation of goodwill is done through various methods like arbitrary
valuation, on the basis of total income, on the basis of average profit, on the basis
of super profit etc. Auditor should check the agreement of purchase of business in
order to ascertain whether the value of goodwill has been properly estimated or
not? It should be decide whether the standard is fair if the business is a running
business and its goodwill has been estimated on the basis of profit. Goodwill is an
intangible asset. It is very difficult to decide the value to be received by selling it.
Another specialty of goodwill is that its value does not reduce with the passing of
the generally, but increases. The valuation of goodwill depends on specialty of
business, capacity to early, special license or quota, future of business and persons
related with business. Therefore, it becomes difficult to check and do valuation of
these things. By estimating less price of goodwill, additional amount cannot be
taken to the profit and loss account. If it has been done so, auditor should refer to it
in his report. As far as possible, amount of goodwill should be adjusted step by step.
Some institutes present big expenses as goodwill in the balance sheet. The
responsible officer of the institute should prepare a certificate regarding its fairness.
If the current expenses are large and if they have been shown as goodwill, it is
unforgivable. The auditor has to mention this in his report. As goodwill is an
intangible asset there is no question of liability on it. 7. Bank Overdraft: The excess
amount withdrawn from the bank than the actual balance in the bank is called
overdraft. For overdraft, arrangement in any manner with the bank can also be
made. While verifying the bank overdraft bank passbook as well as the bank
correspondence should be verified. If any security is made for the overdraft, a
certificate to that effect should be obtained from the bank. 8. Creditors: Generally,

debts concerning goods services are included in creditors. The total of accounts of
such creditors is shown as creditors in the balance sheet. At the end of accounting
year, creditors register should be prepared. It should bearPrapared by Prashant
+=+=+=+=+=+=+=+=+=+ the signature of responsible officer. Amount of
creditors, ledger of creditors should be compared with the register of creditors. The
balance of creditors of goods purchased on credit should be compared with
purchase note, purchase ledger; goods return note, bills payable book, cash book
etc. Particularly, note of purchase and return transactions of the opening and ending
month of the accounting year, goods outward and goods inward books, receipt book
should be verified carefully. It should be ascertained whether there is provision for
necessary reserved discount on creditors or not ? if any long outstanding balance is
found in the ledger, it should be verified that the amount payable to the creditors
has been withdrawn but instead of paying to the creditors, it has been embezzled.
There should be a system of receiving confirmation letters from the creditors about
the balance of certain time intervals so that it any fraud has been committed in the
dealings with creditors, it would be immediately detected. Q. 3 What is contingent
liability ? Give three examples of contingent liability and describe how will you
check the type and ratio of the contingent liability you have described ? (Sau. Uni.
84, 88, 99, 2002) Write short note: Contingent liability (Sau. Uni. 84, 88, 99,
98, 2002, 2007, 2008, 2010) Ans. 1. What is Contingent liability? Some liabilities
are certain while certain debts or liabilities are contingent or improbable or
accidental. Conversion (or not), of contingent liability into payable liabilities
depends on certain events which may or may not take place. It is auditors duty to
see whether specific or contingent liabilities have been shown in the balance sheet
of the company or not ? Contingent liability is not certain and it is also not sure will
it become payable or not? And yet it is necessary to show it in the balance sheet
because if the financial condition of any company is very sound and the prices of its
shares in the market are high, purchasers buy shares depending on the balance
sheet of the company. In these circumstances, if cases are filed or claims for losses
are filed against the company in the court of law, if they lose the case and have to
pay a large amount of claim, company will be placed in a difficult situation. Prices of
share of the Company will go down. As a result, share purchasers may face a great
loss as they are unaware about the contingent debt. To avoid this condition, total
fixed and contingent liabilities should be shown in the balance sheet. Moreover,
some companies have provision for reserve against such contingent debts. 2.
Examples of Contingent Liabilities: (1) Cases (claim) for losses in the court against
company in which there is possibility of payment for the loss. (2) Discounted bills
where there is possibility of dishonored bills. As a result, that amount has to be paid.
(3) When the company has purchased partly paid-up shares of another company,
the unpaid installments on shares are to be paid in future when it is demanded by
the company. (4) The total amount of unpaid dividend of previous years on
cumulative preference shares which are issued by the company and to be paid in

future. (5) When the company has made contracts in advance and if there is any
possibility of losses or there is possibility of arising new liabilitiesPrapared by
Prashant Parmar B.COM. (SEM-VI) AUDITING
+=+=+=+=+=+=+=+=+=+ (6) When the company has given the guarantee for
any person or institute and if such a person or institute fails to return the amount,
the amount is treated as contingent liability. Thus, there can be various kinds of
contingent liabilities. In certain cases, the amount of debts is fixed while in other
cases, it is not possible to say how much amount will it be, e.g. the amount to be
paid for the debts on partly-paid shares is not fixed while in the claim against the
company for the breach of patent, trade mark, etc., it cannot be said what will be
the judgment in the court ? So, in such cases, liability is contingent. At the same
time, the amount of payment will be improbable means uncertain. 3. Decide the
type and proportion of contingent liabilities as an auditor: (1) Liability regarding not
discounted but yet not matured bills receivable: Amount of bills receivable
discounted in the bank is certain and fixed. So, this is the contingent liability of the
fixed amount. Its proportion can be known on the basis of the proportion of
discounting of bills receivable. (2) Liability regarding unpaid installments on shares :
The amount of contingent liability is fixed and proportion of amount can be known
on the basis of how many shares has it been invested? (3) Liability of remaining
dividend on cumulative preference shares: The rate of dividend on such type of
preference shares is fixed and therefore, the fixed amount of contingent liability can
be known and dividend for how long is unpaid can be known on the basis of that
time duration. (4) Claims against the company which have not been accepted by
the company: The amount of this type of liability is fixed if the amount of claim is
certain and the proportion of amount can be known on the basis of number of
claims in the court. (5) Guarantee given by the management to bank regarding
loan: The amount and proportion of contingent liability can be known on the basis of
the amount of guarantee by the company on behalf of the management. 4. Points to
be considered by the auditor regarding contingent liability: According to the
provisions of the Companies Act, it is compulsory to present the details and amount
of the contingent liability in the balance sheet of the company. So, the auditor
should check whether the provisions of Companies Act have been followed or not ?
Contingent liability should be shown on the capital liability side in the balance sheet
at last in the inner column under the head of contingent liability. That amount
should not be taken in the total of balance sheet. Auditor should collect a written
statement regarding contingent liability from the responsible officer of the company.
He should ascertain whether the contingent is proper and has it been shown in the
balance sheet ? If there is any possibility of loss to the company regarding
contingent liability, it is advisable to have provision for reserve concerning it. Q. 4
Differentiate : Evaluation and Verification of assets (Sau. Uni. 94, 97, 98, 2001,
2002, 2003, 2005, 2006, 2007, South G.U. 90, 2001) Write note : Evaluation of
assets Ans. Show difference :Prapared by Prashant Parmar B.COM. (SEM-VI)

+=+=+=+=+=+=+=+=+=+ Verification and valuation of assets Verification
and valuation of assets: As we have already considered previously, verification
means to check the existence of asset, its ownership, its possession, valuation and
if there is any liability on asset etc. This process of examination is called verification,
while valuation means not only statistical calculation of different assets but to
evaluate different assets on the basis of accepted principles for the purpose of
balance sheet. In a way, valuation is a part of verification and yet the difference
between the two can be stated as follows: No. Points Verification Valuation 1.
Definition: Verification means examining the existence and possession of assets and
liabilities shown in the balance-sheet ownership rights, with or without liabilities.
Valuation means valuating assets in concern with its utility. Thus, valuation means
the process of estimation of assets as per the accepted principles of valuation. 2.
Scope: Scope of verification is vast. In verification, existence, ownership,
possession, valuation, liabilities etc. are checked. Scope of valuation is limited. In
this valuation, verification of price of assets, and analytical checking are included. 3.
Responsibil ity: Auditor is responsible for the verification of assets-liabilities shown
in the balance sheet. He cannot reduce liabilities by obtaining any certificate
regarding this. While valuating assets and liabilities shown in the balance sheet,
certificate of responsible officer can be obtained and can depend on it. 4. Objects:
Object of verification is to check and ascertain existence; possession, valuation,
liabilities of assets. Object of valuation is to check the value of assets and its
analytical checking. 5. Process: In the process of verification of assets, types of
assets should be kept in mind. There is no specific procedure for verification. In
valuation of assets, various values of assets like original price, market price etc. and
classification of assets and principles of valuation should be kept in mind. 6.
Expansive meaning: The scope of verification is large. Verification includes
valuation. Vouching is also included in verification. Valuation has a limited scope.
Verification cannot be included in valuation.