This document provides an overview of auditing and corporate governance for a B.Com module. It discusses the historical reasons for the development of professional auditing and defines auditing. Key differences between auditing and bookkeeping and between auditing and accounting are outlined. The primary and subsidiary objectives of an audit are described. The document also covers audit techniques, planning, standards, and the roles and qualifications of professional auditors.
This document provides an overview of auditing and corporate governance for a B.Com module. It discusses the historical reasons for the development of professional auditing and defines auditing. Key differences between auditing and bookkeeping and between auditing and accounting are outlined. The primary and subsidiary objectives of an audit are described. The document also covers audit techniques, planning, standards, and the roles and qualifications of professional auditors.
This document provides an overview of auditing and corporate governance for a B.Com module. It discusses the historical reasons for the development of professional auditing and defines auditing. Key differences between auditing and bookkeeping and between auditing and accounting are outlined. The primary and subsidiary objectives of an audit are described. The document also covers audit techniques, planning, standards, and the roles and qualifications of professional auditors.
Module I Reasons for the development of professional audit 1. Renaissance 2. Introduction of double entry. 3. Industrial revolution. 4. Introduction of statutory audit. 5. Companies act, 1956. 6. International standard for accounting and auditing. 7. Court judgements 8. Computer accounting. 9. Auditing practices. 10 SEBI Act 11. Corporate governance. 12. Emergence of multinational companies. 13. Globalization. 14. Nano technology. 15. Independence of auditor. 16. Removal of restrictions on taking up audit work in US. 17. Right to information Act. 18. The companies Act, 2013. Auditing The international auditing practice committee defines, “the independent examination of an entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to expressing an opinion thereon.” Difference between audit and book keeping Auditing Book keeping It is verification of accuracy of entries It is the art of recording daily made in the books of accounts. transactions in the books of accounts. It is done by auditors. It is done by book keepers. It is retrospective. It is of the current period. It is analytical in approach. It is constructive in approach. Auditors are outsiders. Book keepers are paid employees. It is at the completion of year. It is a continuous process. Difference between auditing and accountancy Auditing Accounting Where accounting ends, auditing Where book keeping ends. Accounting begins. begins. It is done by auditor. It is done by accountant. Auditor is an independent person. Accountant is a permanent employee. An auditor is remunerated in the form An accountant is remunerated in the of professional fee. form of salary. Auditing was a luxury concept. Accounting is a necessity. Objects of audit Primary object To ensure the accounts reveal a true and fair view of business and its transactions. Subsidiary objects a. Detection and prevention of errors. b. Detection and prevention of frauds. A) Detection and prevention of errors Errors in accounting are a) Errors of omission Errors of omission arises when a transaction is wholly or partly omitted being properly recorded in the books. b) Errors of commission It arises when a transaction has been recorded and wrongly entered in the original entry ledger due to negligence. c) Compensating error A compensating error is one which is counter balanced by another error. d) Errors of principles It arises when entries are recorded by violating fundamental principles of accounting. B) Detection and prevention of frauds Fraud means false representation or making a wrong entry intentionally to defraud somebody. Types of fraud Misappropriation of cash. Computer related fraud. Functions of audit 1. To ascertain system of accounting of the organization. 2. To examine arithmetic accuracy of records. 3. To assess the quality of internal controls. 4. To verify physical assets and inventory. 5. To make recommendations for improvement. 6. To determine compliances with policies and procedures. Advantages of auditing Advantages to the business 1. Helps in detecting and preventing errors. 2. Helps in detecting and preventing frauds. 3. It ensure accuracy of books of accounts. 4. It ensure authenticity and reliability of final accounts. 5. It can enjoy reputation and goodwill of business. Advantages to the owner 1. Sole trade can rely on the audited financial statement. 2. Auditing assure proper maintenance of accounts of joint stock company. 3. It helps valuation of assets in admission, retirement, and death of a partner. 4. Auditor helps the management to improve functioning of business. Advantages to the Society 1. Audited statement of accounts is more reliable to creditors. 2. Income tax authority consider audited accounts to be reliable. 3. Audited accounts of company create a confidence in the mind of investors. 4. Easily calculate purchase consideration on the basis of audited accounts. Disadvantages / Limitations of auditing 1. It is costly. 2. Loss of initiative. 3. It is mechanical. 4. Possibility of alteration. 5. Impossibility of checking all transactions. 6. Unsuitable for small concern. 7. Rely on experts. Auditor as a watch dog not a bloodhound An auditor is appointed by the shareholders in case of a limited company. He is expected to play the role of watch dog for shareholders. His duty is verification not detection. If he finds something suspicious he should raise to the shareholders. In case of frauds and errors the auditor has the duty of reasonable care only. Watch dog concept limit the scope of the audit, that it is merely verification of accounts and does not deeply cover the object of detection and prevention of fraud. Investigation Investigation means an act of detailed examination of books and accounts and financial position of a business firm. Objects/ purpose of investigation 1. When the proprietor suspects fraud. 2. When a person intend to purchase business. 3. When a person wishes to purchase share of a company. 4. When a person wishes to lend money to a business. 5. It maybe conducted on behalf of income tax authority. Difference between auditing and investigation Auditing Investigation The purpose of audit is to determine The purpose of investigation varies true and fair view. from business to business. The audit relates to checking of all Investigation relates to critical books and records. checking of particular records. Auditing is compulsory. Investigation is not compulsory. The auditing is conducted before the The investigation is conducted after investigation of accounts. the auditing of accounts. The person who conduct auditing is The person who conduct called auditor. investigation called investigator. The Qualification of auditor is There is no specific qualification for chartered accountant. investigator. It has a narrow scope. It has a wide scope. Auditing is done at the end of the Investigation can done over a period financial year. of years. Qualities and qualification of a professional auditor Professional qualification The auditor must pass Chartered Accountant examination conducted by ICAI. Professional qualities Knowledge of theory and practice of accountancy Knowledge of commercial law Knowledge of techniques of audit Knowledge of management accounting Knowledge of cost accounting Knowledge of economics Knowledge of mathematics and statistics Knowledge of industrial management Personal qualities Honesty Ability to work hard Impartial Courage and ability Ability to communicate Commonsense Ability to maintain secrets Cautious and vigilant Ability to trace fact and figures Tactful Inquisitive Audit assurance standard Auditing standards means the measure and quality of audit performed by an auditor. General auditing standards Personal standards Standards of field work Standards of reporting Technical standard and Planning and supervision Conformity with accepted proficiency accounting principles Independence in Evaluation of internal Consistency in application of mental attitude control accounting principles Due professional care Sufficient competent Adequacy of information evidence disclosure Basic principles of auditing Basic principles of auditing are the set of rules according to which the books of accounts of a firm should be audited. Integrity, Objectivity and independence Confidentiality Skills and competence Documentation Planning of audit Audit evidence Accounting system and internal control Audit conclusion and reporting General basic principles of auditing Principles of objectivity Principles of materiality Principles of independence Principles of full disclosure Principles of professional ethics Basic concepts of auditing Evidence Due audit care Fare Presentation Independence Ethical conduct Audit techniques Audit techniques are the devices, which are adopted in applying the basic principles and auditing standards. Important audit techniques 1. Vouching 2. Confirmation 3. Reconciliation 4. Analysis of financial statements 5. Physical examination 6. Test checking 7. Scanning 8. Verification of the posting 9. Enquiry Audit planning Pre-arranging and coordinating the work of audit of a client is called audit planning. Preliminary steps involved in audit planning Letter of appointment Letter of engagement Study nature, scope, duties Acquire knowledge about business and its nature Verification of legal documents He should obtain the list of all books maintained in the office. If it is not a new audit Examine the accounting system Internal check system Duties of the members of the client staff List of principal officials Instruction to the client Preparation of an audit program System audit Distribution of audit work Preparation and submission of audit report Audit note book It is a register or dairy maintained by audit clerk during the course of audit. It is also called audit memorandum. Advantages of audit note book 1. It helps to prepare audit report. 2. It is a tool for measuring efficiency of an audit. 3. It is a guide for subsequent audit. 4. It is an evidence for future. 5. It avoid repetition of work. Disadvantages of audit note book 1. It create misunderstanding between client and audit staff. 2. It create faultfinding attitude in the mind of audit staff. 3. If it is not properly maintained it considered as evidence for auditors negligence. Audit working papers Audit working papers are the documents which record during the course of audit. It is also called audit files. Content of audit working paper 1. The trail balance 2. Schedule of debtors and creditors 3. Schedule of investment 4. Depreciation statement 5. Bank reconciliation statement 6. A draft of final account Advantages/aim/purpose of audit working papers 1. It is necessary for audit report. 2. It is a guide for subsequent audit. 3. It is a valuable documentary evidence. 4. It helps in coordinating audit work. 5. It helps in controlling audit work. 6. It is a historical record of work done. Types of audit working papers/ files 1. Permanent file It is a permanent audit file of the client. It gives brief history of previous audit of the client. 2. Annual file Annual file contains details of the current years audit program. It is also called current files. Audit programme It is a written and predetermined plan of action for conducting an audit. Types of audit programme 1. Fixed audit programme It is a pre-planned and detailed programme of audit. It is also called fixed or pre-determined audit programme. 2. Flexible audit programme An audit programme that can be changed as per the need, time, nature of business and auditing standard is called flexible audit programme. Advantages and disadvantages of audit programme Advantages Disadvantages It defines duties of clerk clearly Out of date and useless It defends the auditor Unable to cover all the point To assess the cost of audit Hurry in completion Timely completion of audit Not suitable for all types of firms It helps to new audit staff No chance to use intelligence Effective control over audit staff Rigidity Tick mark Tick marks are the symbols used during the course of audit, which indicates how much of audit works are done. Test checking It means to select and examine a representative sample from a large number of similar items. Routine checking The process of checking posting, casting balancing in ledger and subsidiary books are done in a routine manner are called routine checking. Surprise check It is a technique used by an auditor. He pays surprise visit to the client office and make surprise checking on certain important items. Audit classification Audit on the basis of organizational structure Audit on the basis of degree of independence Audit on the basis of conduct of audit Audit on the basis of specific objectives New generation audits I. Audit on the basis of organization structure Statutory audit It is a legally required audit to present the fair picture of the financial health of the organisation. It is a compulsory audit. Following are the undertakings in which statutory audit is compulsory a) Joint stock companies b) Banking companies c) Insurance companies d) Cooperative societies e) Public charitable companies Private audit Private audit refers to the audit of accounts of private business enterprises. It is not compulsory audit. It includes a) Sole trader b) Partnership c) Private individual Difference between company and partnership audit Company Audit Partnership audit It is compulsory It is not compulsory Auditor is appointed by members Auditor is appointed by partners The power, duties and rights of Defined as per agreement. auditor defined in companies act. It is done year after year. It is done at discretion of partners. The auditor must be qualified u/s 226 Auditor need not hold those of companies act. qualifications. Auditor reports to the members. Auditor reports to the partners. Government audit It means audit of accounts of government department and offices, government companies and government statutory corporations. Objectives of government audit To ensure every payment is made as per rules. To ensure expenditure sanctioned by competent authority. To ensure payment made to the right person. To verify payment made is duly entered in proper books. To verify system of granting travel allowances to employees. To verify system of granting daily allowances to employees. To ensure expenditure is classified into capital and revenue. To verify existence of stock and store. Difference between government & private (commercial) audit Government Audit Private Audit It is compulsory. It is optional. It is a continuous audit. It is done periodically. Audit for govt. departments. Audit for commercial concerns. Conducted by CAG of India. Conducted by professional auditors. II. Audit on the basis of degree of independence 1. Independent audit It is also called external audit. The audit of account of the firm is conducted by independent professionally qualified auditors. 2. Internal audit It is an independent review of operation and other records of the firm. III Audit on the basis of conduct of audit 1. Continuous audit It is a statutory audit. This audit is done by professionally qualified auditors. It is a detailed examination of all transactions. Advantages and disadvantages of continuous audit Advantages of continues audit Disadvantages of continues audit Detailed checking Alteration of figures Up to date accounting records Involves much time Efficient audit Expensive Greater moral check Dislocation of client work Preparation of interim audit Losing the thread of the work Early finalization of accounts Mechanical Suggestion from auditor 2. Final audit The final audit take place only after the end of the trading period. All the transactions for the whole year completely recorded and balanced. Advantages and disadvantages of final audit Advantages of final audit Disadvantages of final audit Less audit cost Suitable for small firms only Take only reasonable time More depend ontest checking Not mechanical Errors and fraud remains Not require large audit staff Unhealthy delay in report time No dislocation in the work of Does not help preparation of client interim accounts 3. Balance sheet audit It is a type of audit. In this type auditor verify balance sheet items such as capital, liabilities, reserves, Provisions, assets and other items given in the balance sheet. 4. Interim audit It is a type of audit conducted in between two annual meetings. Advantages of interim audit 1. Easy to find out interim results. 2. It helps to declare interim dividend. 3. Errors and frauds are quickly detected. 4. It imposes moral check as the client staff. 5. Final audit can be completed quickly. Disadvantages of interim audit 1. More expensive. 2. Dislocation of work of client staff. 3. It required more detailed and exhaustive checking. 4. It creates additional work of audit. 5. It is easy to alter already audited figures. 6. Suitable for large firms only. 5. Occasional audit If the sole trader or partners conduct an audit for a specific object on special occasion such audit are called occasional audit. 6. Partial audit It is a type of audit, which is carried out in respect of specified aspect of books of accounts of the business. 7. Standard audit It is a type of audit rarely conducted in business firms. Under this type certain items in the accounts are thoroughly scrutinized and analyzed. IV. Audit based on special objectives 1. Management audit It is the systematic evaluation of the performance of management of an enterprise. It is the critical review of all aspects and process of management. 2. Cost audit Cost audit is the verification of the correctness of cost records with a view to ascertain the cost of product. 3. Cash audit It is a type of audit under which only cash transactions are audited. 4. Special audit It is a type of audit conducted by the central government for some special objectives. The person who conduct special audit is called special auditor. 5. Operation audit It is a part of management audit. It is usually conducted by external auditor known as management consulting services. 6. Efficiency audit It is a type of audit conducted for the purpose of increasing efficiency of the firm. It is an aid to management. 7. Detailed audit It referred as continuous audit, running audit or complete audit. Under this type of audit, the auditor checks detail all books of accounts with regular intervals. 8. Propriety audit It is a part of management audit. It is treated as high form of audit. 9. Performance audit It is a part of management audit. In this type of audit, auditor evaluate the performance of the firm. 10. Regulatory audit It is conducted by private business firm. The main object is to see whether every transaction is approved and sanctioned by competent authority. 11. Vouch and post audit It is a diversion of detailed audit. It is a detailed examination of all transaction by auditor with the preparation of original entry till it has been posted. V. New Generation audit (Recent trends in auditing) 1. Inflation audit It is the audit related to inflation accounting. The accounting effect of change in prices is known as inflation accounting. 2. Human resource audit It is the process of evaluating human resources programs and practices. 3. Social audit It is the way of measuring, understanding and reporting an organization’s social and ethical performance. 4. Energy audit It is an inspection survey and analysis of energy flows for energy conservation. 5. Peer review It is a supervision audit. It is an audit of auditor’s performance. 6. Forensic audit It is a detailed examination and evaluation of financial and non-financial records to collect evidences that can be used in a court of law. 7. Environment audit It is a type of audit which provides an assessment of environmental performance of a business or organisation. Module II Audit procedures Vouching It means a careful examination of the original documentary evidence such as invoice, receipts, minutes, contracts etc. Objectives of vouching 1. To ensure transactions pertain to the business only. 2. To detection and prevention of errors and frauds. 3. It pertains to the year under audit. 4. The transactions are properly authorized and are genuine. 5. No transaction has been omitted in the books. Vouchers Vouchers is documentary evidence, in support of transactions in the books of accounts. Types of vouchers 1. Primary vouchers Primary vouchers are original vouchers. They are written or printed, or typed evidence in original. Example: Cash memos, Invoices. Pay in slip 2. Secondary vouchers When original voucher is not available copy of the original evidences are produced in support or subsidiary evidence such vouchers are called secondary or collateral vouchers. Example: Bank reconciliation statement, copy of sales memo. Essentials of valid voucher 1. The authority of the voucher. 2. The authenticity of the voucher. 3. The genuineness of the voucher. 4. The accuracy of the voucher. 5. The correctness of the voucher. 6. Proper classification of accounts in to capital and revenue. While examine the vouchers following points must be paid special attention 1. All the vouchers are consecutively numbered and arrange serially. 2. He should examine the date of the vouchers. 3. He should see that information in the voucher is fully self- explanatory. 4. He should see that voucher is related to business in the name of the firm. 5. He should see that each voucher is original in face. 6. He should accept voucher in printed form. 7. He should not accept voucher in over writing or erasure. 8. He should complete vouching work in a one siting. 9. He should not take help of client staff for vouching. 10. He should see that every voucher is passed in the order by responsible officer. Vouching of cash book Vouching of cash book means checking of cash receipts and cash payments with supporting documents. Vouching of receipt side/ Debit side of the cash book Cash receipts Supporting vouchers Opening balance Previous years audited balance sheet Cash sales Cash memos with summary of salesman Receipts from debtors Counterfoils, pay in slip Receipts from B/R Debtors explanation for outstanding debt Bills discounted Cashbook, passbook, bills receivables book Sales of fixed assets Auctioneers note, sales deed Loans received Legal provisions, loan agreement Interest on bank deposit Bank passbook with bank advice Insurance claim money Correspondence insurance claim Receipts from Hire Purchase agreement, counterfoils of agreement purchase Subscription received Register of subscription, counterfoil receipt Commission received Agreement between client and party, cash book counterfoils Vouching of payment side/credit side of cash book Cash receipts Supporting vouchers Bank overdraft Previous years audited balance sheet Cash purchases Cash memo, invoice, good in work book Payment to creditors Receipts issued by creditors, goods inward register, invoice minutes book Payment of wages Wage sheet, wage record, time and piece work card or record Payment of salary Salary register, attendance book, appointment letter, agreement minutes Directors fee Articles of association, minutes of general meeting, receipts issued by directors Travelers commission Sales order register, bills and receipts, agreement Bills payable Bills payable book, bank pass book Insurance claim money Correspondence insurance claim Loans advanced Loan agreement, receipts given by borrower, security and title deeds Purchase of investment Breakers note, cheque book, passbook, letter of allotment Purchase of plant and Invoice and receipts machinery Patent and copyright Receipts, agreement, agents account Advertising Budgets, receipts Interest on loan Interest register and pass book Dividend paid Dividend warrant, passbook Rate and tax Bills receipts issued by municipal authority Petty cash book Voucher, postage register, stationary register, petty cash requisition Auditors fee Receipts issued by the auditor Teaming and lading/ lapping It is a method of committing fraud in connection with the receipts of cash from debtors. Vouching of purchase ledger The auditor has to check and verify the following in case of purchase ledger: Record of all purchase orders. Verification of quantity, price and payment terms of purchase invoice. Verification about goods are actually received. Verification about proper recording of purchase bill. Auditor should verify statement of accounts of suppliers. Vouching of purchase return book The auditor needs to verify following points in case of vouching of purchase return books: He should compare credit notes with purchase return book. He should examine goods outward book. He should check entries in the purchase returns journal. He should check heavy returns at the start or end of the year. He should check the totals and postings to purchase returns and suppliers accounts. Vouching of credit sales or sales book The auditor should vouch credit sales in the following manner: He should apply test check. He should check some invoices with orders and outward entries. He should confirm sales of capital items not included in the sales. He should confirm trade discount allowed is not included in sales ac. He should send accounts statements to customers. He should confirm goods on consignment is not included in sales. He should check cancelled invoice against duplicate invoice copy. Vouching of sales returns The auditor should vouch sales return in the following manner: He should vouch sales returns entries with stock register. He should verify the copy of the credit note issued to customer. He should check posting from sales returns book to customer ledger. He should verify customer returns at the start and end of the year. Verification of assets and liabilities It means examination of establishing truth as existence, ownership, possession and valuation of assets and liabilities in the balance sheet. Difference between vouching and verification Vouching Verification It examine all the business It examine assets and liabilities transactions recorded in the original appearing in the balance sheet. entry. It is based on documentary evidence. It is based on both physical and documentary evidence. Work done by junior staff. Work done by auditor himself. It is not include valuation of assets It include valuation of assets. It is continuous and throughout the It is one at the end of the year. year. It take place first. It take place after vouching. Objectives of verification of assets and liabilities 1. To ensure assets and liabilities shown in the balance sheet actually exist. 2. To satisfy that auditor assets and liabilities are properly valued. 3. To ensure that assets are actually the properties of business. 4. To ensure liabilities are actually held. 5. To verify that they are free from any mortgage. 6. To see that assets and liabilities are properly classified. 7. To detect fraud and check arithmetical accuracy of posting. Verification of various types of assets Cash in hand Auditor use cash weighing machine to count cash. He should count cash, stamps, IOU in hand. He should check remittance from branches. He should check purpose of holding large cash balances. Documentary evidences should be verified in case of cash in transit. Cash at bank Auditor should verify pass book with cash book. He should compare pass book with BRS. He should obtain certificate regarding bank balances. He should see outstanding cheque are genuine. Loans advanced He should examine loans granted through loan agreements. He should see that loan amounts are confirmed by the borrower He should examine the mortgage deal. He should determine adequacy of security offered. He should see there is no change in loan agreement terms. Bills receivable He should get a list of total bills receivable. He should see that bills are properly drawn, accepted. He should see that bills are subsequently matured. He should enquire from the bank regarding bills sent for collection. Debtors He should obtain duly certified list of debtors. He should scrutinize accuracy of debtors list. He should verify actual existence of debtors. Sales ledger balance should be checked with debtor’s ledger. He should see debtors shown on balance sheet are recovered. He should see adequate provision made for bad debt. Stock in trade (Inventory) Auditor should examine internal check system in operation. He should check stock sheet with stock register. He should examine management control of issue of stock. He should check totals, balances and extensions of stock sheets. He should check physical existence of stock in hand. Free hold property He should verify legal existence of title deeds relating to land. He must verify both ownership and possession of the client. He should compare ledger account with balance sheet. He should verify deed, purchase agreement, lease agreement etc. He should examine brokers notes, auctioneers accounts etc. Plant and machinery He should obtain schedule of plant and machinery certified by responsible officer. He should verify adequacy of depreciation. He should see same method of depreciation follow year after year. Motor vehicle He should verify vehicle are registered in the name of client. He should get schedule of all motor vehicles owned by the company. He should see that adequate depreciation is provided for vehicles. He should see that vehicles are shown in balance sheet separately at cost less depreciation. Copyright He should verify copy right agreement. He should obtain schedule of copyright. He should see that copyright are shown in balance sheet separately at cost less depreciation. Goodwill He should verify purchases agreement to ascertain value of goodwill. He should see written off in accordance with resolution of board. Loose tools He should obtain loose tools register. He should verify receipts of issue of loos tools. He should see that loos tools are shown in balance sheet separately at cost less depreciation. Live stock He should obtained schedule of livestock. He should compare livestock register with schedule. He should verify livestock are revalued annually. Verification of various types of liabilities Sundry creditors He should obtain schedule of creditors from management. He should compare creditor amount with balance of creditor ledger. He should verify purchase and purchase return book. He should verify goods inward book. Bills payable He should verify bills payable from bills payable book. He should examine the bills payable retired under rebate. Bank overdraft He should verify overdraft agreement with bank. He should check the pass book and cash book. He should verify whether overdraft is secured or unsecured. Loans He should verify loan agreement. He should see that loans and advances shown in balance sheet. He should verify whether loan is secured or unsecured. Debentures He should verify memorandum and articles of the company. He should verify debenture trust deed. He should obtain a certificate from debenture holders to verify amount of debenture issued. Valuation of assets and liabilities It means estimation of various assets and liabilities. It is the duty of the auditor to confirm assets and liabilities appear in the balance sheet in fair value. Valuation of different assets Fixed assets They are acquired for permanent use of business. The utility of this asset is for long period. Eg: Plant, machinery, land, building, motor vehicle, furniture etc. Fixed asset valued at cost less than reasonable depreciation. Provision for depreciation on fixed asset is necessary. Current assets They are acquired for resale or converting them into cash. They are purchased for a short period. Eg: Stock, debtors, bills receivables, cash in hand, cash in bank Cash and bank balance no valuation required Debtors are valued at book value. Provisions for bad and doubtful debts proceed for book debt. Raw material valued in FIFO and LIFO method. Closing stock valued at cost or market price, whichever is lower. Intangible assets Intangible assets are those assets which cannot be seen or touched. They are not visible in physical form. Eg: Goodwill, copyright, patent, trademark. These assets are shown at cost price. These assets treated as fixed assets for the purpose of valuation. Wasting assets Wasting assets are fixed in nature which are depleted gradually in process of earning income. Eh: Mines, quarries, oil wells, etc. Wasting assets are shown in original cost in balance sheet Provision is made for depreciation and depletion. Fictitious assets Fictitious assets are huge revenue expenditure that has been capitalized with the object of spreading amount to number of years. Eg: Special advertisement cost, preliminary expenses, debenture discount. These have no exchange value Every year, a portion of these expenditure are written off in P&L ac. Valuation of different liabilities Current liabilities These are the liabilities of the business, which are short term liabilities. They are settled with a period of one year. Eg: Creditors, Bills payable, outstanding expenses. Fixed Liabilities These are the liabilities of the business, which are long term liabilities. They are to be settled in long term basis. Eg; long term loans, long term deposits accepted. Contingent liabilities These are liabilities which are not actual liabilities, but which may become an actual liability on happening or non-happening of a future event. Contingent liabilities A contingent liability is one, which is not a real liability but it will became an actual liability on happening or non-happening of an event. Characteristics of contingent liability Uncertain Conditional It involves additional expenditure Actual liability on happening of an event It may be a past or possible future act Difference between verification and valuation Verification Valuation Verification includes valuation. Valuation is a part of verification. Auditor verify existence of assets. Ensure value of assets shown in the balance sheet are correct. It is done by the auditor. It is done by management team. It is made at the end of the year. It is made throughout the year. It is the final work. It is the initial work. The auditor is guarantee in the case of In this case there is no such guarantee. verification. Window dressing It means manipulation done by the management of the company in the financial statements in order to present more favorable picture of the company. Window dressing done through following ways Increase the inventory value. Postponement of purchase of fixed assets. Selling a fixed asset or cash. Paying of current liabilities. Considering short term liabilities as long term. Module III Internal control Internal control It is an overall control system of the internal management. In this system number of checks and control exercised in the business to ensure its efficient and profitable working of the firm. Internal audit It is an independent review of operation and other records of the firm. Objectives of internal audit 1. To ensure efficient conduct of business. 2. It is an independent review of operational performance. 3. Completeness and accuracy of final accounts. 4. To keep control overall activities of the organization. 5. To verify organizations policies and procedures. 6. To keep a checks on errors. Features of internal audit 1. It is compulsory. 2. It is continuous audit. 3. It is suitable for large business organizations. 4. It is generally conducted by own employees of the firm. 5. Its object is vary from business to business. 6. It is conducted to ascertain internal control system. Advantages / Merits / Benefits of internal audit 1. Helps to identify accounting errors. 2. It makewinds final audit easier. 3. It helps to maintain better management. 4. It promotes proper use of resources. 5. It increases efficiency of the firm Disadvantages / Demerits of internal audit 1. It is not useful for external reporting 2. It is not suitable for small firms. 3. It is expensive. 4. It is time consuming. 5. It involves chances of errors. Difference between internal check and internal audit Internal check Internal audit The work of one clerk is The work of one clerk checked by automatically checked by another another after the former has at the same time. completed the work. It minimize errors and frauds. It detect errors and frauds. No separate staff appointed. Specially appointed. It is for internal management. It is for top management. It is treated as an instant audit It treated management audit. It is a continues process. It is done periodically. Difference between internal audit and independent audit Internal audit Independent audit Appointed by management. Appointed by shareholders. Compulsory. Compulsory by statute. No professional qualifications Professional qualifications required. required. Continuous audit. Independent after a period. Dependent on management. Independent on management Report to management. Report to shareholders. Scope of audit determined by Scope is determined by statute. management. Internal check Internal check simply refers to an arrangement of transactional work amongst the members of the staff. Objectives of internal check 1. It is the division of work among the staff. 2. It prevent errors and frauds. 3. Errors and frauds are automatically discovered. 4. Work of one staff automatically checked by another. 5. No staff allowed to do any single work. Advantages of internal check Advantages to the owners 1. It provide accurate and reliable accounting records. 2. It leads to better efficiency and economy in operation. Advantages to the business 1. Division of work 2. Early detection of errors and frauds 3. Preparation of final accounts 4. Fixation of responsibility 5. Makes audit work easy Advantages to the auditor 1. No need for detailed checking 2. Rely on test checking Disadvantages/ limitations of internal check 1. Not suitable for all firms 2. Sacrifice the quality of work 3. Tends to slacken efforts 4. It create chaos and disorder 5. Risky for auditor Fundamental principles of internal check Essentials of good internal check system/ How to plan a good internal check system? / Principles of internal check system 1. The system should be practical and simple. 2. The system should be economical. 3. The system should be carefully designed and suitable to nature of business. 4. Careful selection and proper training should be provided. 5. Division of work among staff should be allowed. 6. Rotation of employees should be made. 7. Proper register should be provides. 8. Annual stock verification should be done. 9. The internal check system should be flexible. 10.Budgetary control system should be established. Internal check regarding cash transactions Cash receipts There should be separate cashier to deal with cash receipts. Cash received should be entered through a rough cash book. All receipts should be banked daily. BRS should prepared to reconcile cash and bank transactions. All unused receipt book should be kept by responsible officer There should be separate arrangement for custody of B/R. All cash receipts should be acknowledge by printed receipts. Cash payments There should be a separate paying cashier. He should not have access to the ledgers. In case of petty transactions, impressed system is followed. Petty cash payment must made to the petty cashier only. All payments Is to be made by proper authority. Acknowledgement shall be obtained for all payments made. All cancelled cheques must be destroyed Unused cheque book should be kept under lock and key. Petty cash Separate person appointed for dealing petty cash payments. Petty cash book should kept on impressed system. Petty cash book maintained on analytical form. No petty cash payments made without proper voucher. Petty cashier should not give any amount other than imprest system. All vouchers must be properly filed and kept under the custody of petty cashier. Cash sales a) Sales over the counter Separate salesman should be appointed for each counter. A specific number may be allotted for every salesman. Different numbers should be used for different counters. Each salesman should be provided with sales memo book. Sales memo provided different counters of different colors. The sales memo prepared by the counter sales man should be checked by another officials. Total amount of cash sales should be entered in the general cash book. b) Sales by travelling agent He should not allowed to collect cash from customers. He should not allowed to meet any expense in connection with sales. Final receipts of cash collected should issue by head office. The head office should be informed about balance over due by customers. Reminder to the customer should be sent by head office. He should be instructed to submit periodical statements of sales. He should not be allowed to continue work for a long period in the same area. c) Postal sales/ sales under mail order business There should be separate section in sales department to deal with postal transactions. Separate VPP register should be maintained. Proper records should be maintained for goods returned by customers. Total amount received in a day should deposited into bank. A proper officer should check VPP register frequently. Order received for postal sales should be properly filed. d) Online trading Auditor verify the list of all. Close examination of credit money register. Verify amount of e-money received. Internal check regarding wages a) Maintenance of wage records Time recording clock Piece work records Overtime records Pass out records b) Preparation of wage sheet Basis of preparation Separate sheet Checking the wage sheet Signature Approval and wage payment c) Payment of wages The approved wage sheet should be passed to the cashier. The cashier should withdraw the sum shown under net wage column. All workers receive wages to present personally. A list of casual workers should be prepared. Payment of wage made in the presence of work managers. Special arrangement made for absent employees. Internal check regarding purchase Requisition Inviting tenders Placing purchase order Receipt of goods Invoice Making payments Internal check regarding purchase return A separate return outward book is maintained. Record return of goods to supplier’s in return outward book. A statement should prepared by stores department for goods return. Purchase department should check goods and prepare advice notice. All incoming credit notes should be numbered and stamped. Responsible officer should examine the credit note. Internal check regarding credit sales There should a separate department to deals with credit sales. All orders received should be numbered. All orders received should record orders receivable book. Separate record is maintained for different orders. Credit sales is allowed only for minimum period. A copy of cash order should be send to dispatch section. The entries should be made in sales day book. Sales day book should be checked by responsible officer. Internal check regarding sales return All goods returned should be recorded in goods inward book. All sales return are approved by responsible officer. Credit note should be prepared and signed by responsible officer. The details of credit note should be entered in sales returns book. Internal check regarding stores a) General principles regarding stores Store department should be located in convenient place. The facilities in the store should be sufficient. A system of code number should be implemented. Admission of staff should be restricted and controlled. Purchase function and store keeping should be separate. Physical verification at the end of year should compulsory. b) Receipts of stores On receipt of goods the store keeper should prepare a goods received note in triplicate. One copy to purchase department, one copy to accounts department and third copy store department itself. The goods received should be stored in allotted place. All details about store item should be noted in bin card. c) Issue of stores Issue of stores should be made only against the requisition slip from concerned department. The department head should signed the requisition slip. Different colors of requisition slip to different department. An official clerk should be in charge of issue of stores. Gate pass should be issued only for authorized persons. d) Preservation of stores Separate place provided for each type of store items. A system of separate numbering bincard should be adopted. The store should be frequently checked by responsible officer. Physical stores verification conducted at the end of the year. Stock taking should be conducted at the end of the year. e) Recording and maintenances of stores record Separate accounts provided for maintaining accounts. Bin card should be checked and compare time to time. Stores ledger also maintained by accounts department. Rights and powers of an auditor 1. Right to access books of accounts and vouchers. 2. Right to visit branches. 3. Right to obtain information and explanation. 4. Right to correct wrong statement. 5. Right to have legal and technical advice. 6. Right to be indemnified. 7. Right to receive remuneration. 8. Right to sign the audit report. 9. Right to receive notice and attend general meeting. Duties of an auditor Statutory duties 1. Duty to make enquires. 2. Duty to report on accounts audited by him. 3. Duty to report for prospectus. 4. Duty to certify declaration of clarity. 5. Duty to assist inspectors. 6. Duty to assist public prosecutors. 7. Duty according to the direction of central government. Duties arising out of common law 1. To ascertain unutilized capacities of the industry. 2. Extent of over stocking stores. 3. Position of current assets. Duties arising out of professional etiquette 1. Auditor should carry his duty to public interest. 2. Auditor must be honest, competent and independent. 3. He should disclose all material facts related to firm. 4. He should strictly follow rules formulated by ICAI. Duties imposed by court 1. It is the duty of the auditor to check stock properly. 2. He should perform his duties with proper care and skill. 3. He should examine the terms of debenture trust deed. 4. He should physically count cash on the last day of financial year. Liabilities of an auditor Civil liability 1. Liability for negligence 2. Liability for misfeasance Liabilities under companies Act 1. Liabilities for misstatement in the prospectus 2. Untrue statement in prospectus 3. Failure to assist investigation 4. Failure to return property, books or papers 5. Penalty for falsification of assets 6. Penalty for deliberate act of commission or omission Criminal liability 1. Falsification of any books or material 2. Liability for frauds Audit report It is a written document which present the purpose, scope and result of the audit. Qualities of a good audit report/ Characteristics 1. It should be based on fact. 2. It should not be brief and not lengthy. 3. It should be free from mistakes. 4. It should express the opinion of the auditor. 5. It should exhibit true financial position of the company. 6. It should reflect the result of the audit. Content of audit report If Identification of financial statement being audited. If proper books of account have been kept. If accounts of branches have been audited. If balance sheet are in agreement with books of accounts. If any other statement included as required by government. Certificate of corporate governance. Types of audit report 1. Clean report If the auditor satisfy the affair of the company and the fairness of the final accounts of the company, the auditor issue clean report. It is also called positive, unqualified and conventional report. 2. Qualified report If the auditor does not satisfy the affair of the company and the fairness of the final accounts of the company, the auditor issue qualified report. It is also called negative report. Audit certificate It is a certificate of truth of the statement that the auditor makes. It is a written confirmation of the accuracy of affairs of the company. Difference between audit report and audit certificate Audit report Audit certificate It is an expression of opinion of financial It is a certificate of truth. statements. It is based on facts, estimates and It based on fact, figures supported by assumptions. documentary evidence. It is only a test not guarantee. It is a guarantee of truth. The scope of report is large. The scope is limited. Audit committee Audit committee is an independent committee formed with the board of directors of the company to oversee financial reporting and disclosure. Role of auditor in audit committee Implementation of accounting policies and practices. To make suggestion for strengthening internal control system. Provide requirements and issue certificate of governance. Assisting management for better standard of governance. Tax audit Tax audit refers to verification of books of accounts maintained by a tax payer. The purpose of tax audit is to validate income tax computation made by the tax payer. Objectives of Tax Audit To ensure books of account of the assessee are properly maintained. To assist assessing officer in computing total income of the assessee. To enable proper assessment of tax by the department to reflect through income of the tax payer. To ensure assessment are made simpler and faster. To facilitate administration of tax law by a proper presentation of accounts. Management audit It is the systematic evaluation of the performance of management of an enterprise. It is the critical review of all aspects and process of management. Objectives of management audit 1. To ensure smooth running of business. 2. To identify overall objectives of organization. 3. To ensure optimum utilization of human resources. 4. To ensure proper utilization of physical facilities. 5. To assist all level of management. 6. To pinpoint deficiencies in functional areas. 7. To suggest improved methods for managerial operations. Features of management audit 1. It is purely voluntary in nature. 2. It is performed on continuous basis. 3. No professional qualification required for management auditor. 4. The management auditor submit report to management. 5. It is performed for a specific purpose. 6. Approach of management audit objective and constructive. Advantages of management audit 1. It help management to achieve target. 2. It is a good tool for management control. 3. It ensure optimum utilization of men and material. 4. It identify overall objectives of the enterprise. 5. It ensure coordination among different departments. 6. It ensure smooth running of business. 7. It pinpoint deficiencies in functional areas. Limitations/ disadvantages/ criticism of management audit 1. It is a costly affair. 2. It is expensive, so no suitable for small firms. 3. It does not have a well-defined scope. 4. It locks management in taking risky decisions. Difference between financial audit and management audit Statutory audit Management audit Compulsory Not compulsory Appointed by shareholders Appointed by management Conducted by qualified chartered Conducted by a team of management accountants experts It review historical records It concerned with past and future activities Report submitted to the shareholders Report submitted to the management Accountable to shareholders Answerable to management Difference between cost audit and management audit Cost audit Management audit Compulsory audit Not compulsory Conducted by qualified chartered Conducted by a team of management accountants or cost accountant experts Limited scope Wider scope It covers period of one year It covers more than one year Report submitted to government Report submitted to management Qualities of a management auditor 1. He should have knowledge in management. 2. He should have knowledge in accounting. 3. He should have knowledge in marketing. 4. He should have knowledge in economics. 5. He should have knowledge in various tax laws. 6. He should have ability to hard work 7. He should be impartial. 8. He should have courage and ability to discharge duties. Module IV Conceptual framework of corporate governance Corporate governance Corporate governance may be defined as a broad range of policies and ethical practices which are adopted by an organization in its dealings with the stakeholders. Importance of corporate governance 1. Protect stakeholders. 2. Attract investors. 3. Promotes accountability. 4. Mitigate risk. 5. Ensure compliance. 6. Improve efficiency. 7. Ensure corporate social responsibility. Benefits of corporate governance Benefits to society It avoids banking crises and economic stability Provide larger and liquid capital market More inflow of fund It eliminates corruption Development of better corporate strategy Improvement of management Benefits to corporations It avoids fraud It follows law and regulation It improves rating grade It improves the competitive advantages Shareholders interest will be taken care Theories of corporate governance 1. Agency theory Agency theory defines the relationship between the principals and agents. Here the principle is the shareholder and agent is the board of directors. 2. Stewardship theory Under this theory manager act as a steward. Steward protect and maximizes shareholders wealth through firm performance. The role of management is to facilitate and explore. 3. Stakeholders theory This theory incorporated the accountability of management to a board range of stakeholders. According to this theory stakeholders are eligible for fair return from the organization. 4. Resource dependency theory This theory focuses on the role of board of directors in providing access to resources needed by the firm. Hence, the owners have to appoint resourceful directors into the board. Models of corporate governance 1. The American Model It is a rule based model. This model gave emphasize on interest of shareholders, management and directors. It is also known as Anglo- Saxson model. In this model the chairman and CEO of the company will be one and the same. 2. United kingdom Model It is a principle based model. This model is mandatory to follow code of governance. There is a clear separation between chairman and CEO. Self-regulation and compliance is voluntary in this model. It is also called commonwealth model. 3. Continental European Model It is a rule based model. It is very common in European countries. It is a two tier model. One is management board dominated by top management and the other is supervisory board dominated by employees. 4. Japanese business network model It is popularly known as Keiretsu. In this model financial institution plays an important role in governance mechanism. This model follow stakeholders approach. Investors does not have a crucial role in this model. 5. Asian family based model a. Overseas Chinese model: They follow a paternalistic style of management. In this model, families own the equity stake of the company. The board plays only a supportive role in decision making. b. Chaebol model In this South Korean model, power is vested with a family. They will have great influence in government. The board have limited role in the affairs of the business. The number of family members always exceeds the independent directors. Board Committee Board committee is a committee identified or formed by the board with the objective of supporting the board work. a. Audit committee It is the one of the standing committee formulated by the board. Functions of audit committee Appointment and removal of external auditor Observing of internal audit policies and its implementation. Connecting link between internal and external auditor. Proper financial reporting. Performing internal control. Compliances with law and procedures. b. Nomination and remuneration committee It is the standing committee of the board. The main objective is to review the composition of full board and check the expertise of the board. Functions of nomination committee Identify the qualified person to be a director. Appointing and removal of a board member. Director’s performance evaluation. Setting standards. Succession planning. c. Stakeholders relationship committee It is established in accordance with company’s constitution to ensure statutory fiduciary and regulatory responsibilities. d. Corporate social responsibility committee It is a committee to ensure corporate responsibility practices in an organisation. Insider trading It is an unlawful act when the insiders are using the unpublished information’s for their self-benefits. Reason for controlling insider trading To protect the interest of investors To protect reputation of the company To maintain confidence in the stock market To maintain stability in the financial system Credit Rating Credit rating is an opinion of a particular credit agency regarding the ability and willingness of an entity. Rating agencies These are the independent financial service agency which provides different types of rating to the organization. Corporate governance rating It is the evaluation or assessment of the system through which an organization is managed. Global rating agencies Moody’s Investors service It is a credit rating agency in New York to provide credit services across the globe and also to provide financial analysis. Standard and Poor’s (S&P) S&P global is one of the global financial service agency provides various financial services to the global capital market. Fitch Rating It is an international credit rating agency at New York. It provides all the rating services that generally done by any credit rating agencies. National Rating Agencies CRISIL CRISIL is the first credit rating agency in India established in 1987. It provides independent rating services to corporate instruments. CARE CARE rating is considered to be the second largest credit rating agency in India. It provide independent rating regarding quality and the extent to which they have adopted the corporate governance. ICRA ICRA is a leading credit rating agency. It provides various grading services of financial instruments and assess corporate governance practices. E-governance It is the usage of information and communication technology by the government to provide and facilitate government services, exchange of information, communication transaction etc. Green governance It is a systematic life cycle approach for ensuring the sustainability of the business. Objectives of green governance To ensure sustainable development To control the human intervention To permit the companies for online complains To conserve non- renewable natural resources Features of green governance Separate board committee Distinct corporate governance code Appointment of independent directors Reporting of disclosure Green governance initiative in India E-certification of forms by professional E-voting Video conferencing facility for shareholders Video conferencing facility for directors Online application and online fee payment Issue of e-certificate by using digital signature Clause 49 listing agreement The clause 49 has laid down seven conditions that are furnished by the listed companies in order to ensure their listing in the official list of stock exchanges. Provisions under clause 49 agreement Board of directors Audit committee Subsidiary companies Disclosures CEO/CFO certifications Report on corporate governance Compliance Shareholders activism It is simply refers to shareholders intervention in the affairs of the company. Reasons for shareholders activism 1. Self-dealing 2. Fragile management 3. Lack of transparency Objectives of shareholders activism 1. To act as monitor of management 2. To protect the interest of the shareholders 3. To ensure accountability and transparency Class action suit It is the law suit against the company or individual against by plaintiff. Whistleblowing It is the act of reporting malpractices within an organization to the internal or external parties. Module V Major corporate governance failures Major corporate governance failure BCCI (UK) Maxwell communication Enron USA Satyam computers services ltd Tata finance King fisher airlines BCCI (UK) Bank of credit and commerce international was an international bank established in 1972 by Agha Hasan Abedi, a Pakistani financier. The bank was established with the objectives of serving the need of the Asian and third world countries. Reason for BCCI failure Lack of vigilance by the regulators Supremacy of the promoter Lack of attention of auditors Laziness of the board Maxwell communication Maxwell communication Ltd was a renowned British media company. It was established in 1964. Reason for Maxwell communication failure Concentrated ownership Inefficient board Unethical usage of professional standards High rate of borrowing Lack of transparency in transfer of assets Issues in audit Enron USA Enron scandal was the largest of all corporate accounting scandal which has surprised the entire corporate world. The company was specialized in natural gas, electricity marketing, energy and other physical commodities. Reason for Enron USA failure Misleading accounting policies and practices Hides huge amount of debts Satyam Computers Services Ltd. Satyam computers was one of the largest software development and Consultancy Company in India. It was incorporated in 1987 as a private sector company. Reasons for Satyam Computers failure Misrepresentation of facts. Embezzlement of fund. Insider trading Accounting malpractices Lack of vigilance by auditors. Tata Finance It is one of the company operated and owned by Tata group, India’s largest and most social responsible business group. It was incorporated as a private limited company in 1984, later converted into public limited company. Reason for Tata Finance failure Poor investment policies by the management. Insider trading by the company executives. Backdated sales Concealment of material facts. Kingfisher Airlines Kingfisher airlines was a privately owned airlines company in India. This company played a significant role in Indian aviation industry. It was the second largest company in Indian aviation industry. Reason for Kingfisher Airlines Failure Luxurious service in flight travel High fuel prices Adverse government policy by taxation. Competition from other airlines. Corporate governance problems/ Reasons for corporate governance failure Regulators mistake Supremacy of the CEO Lack of vigilance by auditors Incompetent board Misleading accounting policies Insider trading Poor investment policies Exorbitant rate of interest Concentrated ownership Cadbury Report on Corporate Governance The Cadbury report is published in December 1992. Adrian Cadbury is the chairman of Cadbury committee. The major recommendations of Cadbury reports are as follows: A single person should not be vested with the decision making power. The non-executive directors should act independently. A majority of directors should be independent non-executive directors. The term of the directors can be extended beyond three years only after the prior approval of the shareholders. The remuneration of the directors should be both fair and competitive. Codes and standards of corporate governance Board composition Board development Remuneration Accountability Audit Shareholders relations PREPARED BY JUBAIR MAJEED RAHUL MURALI