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Thank you so much! aCONTENTS Syllabus Unit I. AUDITING Unit Il. CORPORATE GOVERNANCE, Unit Ill, MAJOR CORPORATE GOVERNANCE FAILURES Unit IV. BUSINESS ETHICS Unit V. CORPORATE SOCIAL RESPONSIBILITY Question Papers with Answers (iii) (i) 49 121 w 137 onwardsSYLLABUS B.Com. (Hons.) CBCS AUDITING AND CORPORATE GOVERNANCE Duration: 3 hours Objective: To provide knowledge of auditing principles, procedures and techniques in accordance with current legal requirements and professional standards. UNIT I— AUDITING Basic Principles and Techniques; Classification of Audit, Audit Planning, Internal Control—Internal Check and Internal Audit; Audit Procedure— Vouching and Verification of Assets & Liabilities; Company Auditor— Qualifications and disqualifications, Appointment, Rotation, Removal, Remuneration, Rights and Duties; Auditor's Report—Contents and Types, Liabilities of Statutory Auditors under the Companies Act 2013 Special Areas of Audit: Cost audit, Tax audit and Management audit; Recent Trends in Auditing: Basic considerations of audit in EDP Environment; Relevant Auditing and Assurance Standards (AASs). UNIT II—CORPORATE GOVERNANCE Meaning, Theories, Models and Benefits of Corporate Governance: Politics and Governance; Board Committees and their Functions; Insider Trading; Rating Agencies; Green Governance/E-governance; Clause 49 of Listing Agreement; Corporate Governance in Public Sector Undertakings; Corporate Funding of Political Parties; Class Action; Whistle Blowing; Shareholders Activism. UNIT II[—MAJOR CORPORATE GOVERNANCE FAILURES BCCI (UK), Enron (USA), World.Com (USA), Andersen worldwide (USA), Vivendi (France), Harshad Mehta Scam, Satyam Computer Services Ltd., and Kingfisher Airlines; Common Governance Problems Noticed in various Corporate Failures; Codes and Standards on Corporate Governance; Initiatives in India. UNIT IV—BUSINESS ETHICS Morality and Ethics; Business Values and Ethics; Various Approaches to Business Ethics; Ethical Governance; Corporate Ethics; CSR—Extension of Business Ethics; Benefits of Adopting Ethics in Business; Ethics Programme; Code of Ethics; Ethics Committee. UNIT 5: CORPORATE SOCIAL RESPONSIBILITY (CSR) Corporate Philanthropy, Meaning of CSR, CSR and CR, CSR and Corporate Sustainability, CSR and Business Ethics, CSR and Corporate Governance, Environmental Aspect of CSR, CSR provision under the Companies Act 2013, CSR Committees, CSR Models, Drivers of CSR Codes and Standards on CSR, Global Reporting Initiatives, ISO 26000. ao00 (i)Auditing Auditing—Principles, Techniques, Types of Auditing, Audit Planning Q. 1. Explain the basic principles in auditing of financial statements. Ans. Auditing is independent examination of financial statements of any entity with a view to establish their reliability and the reliability of results drawn there from. The basic objective of financial audit is to enable an auditor to express an opinion on the financial statements whether the final accounts give a true and fair view of the concern. The following are the basic principles in Auditing of financial statements: 1. Integrity, Objectivity and Independence. The auditor should be straight- forward, honest and sincere in his approach to his professional work. He must be fair and must not allow prejudice or bias to override his objectivity. He should maintain an impartial attitude and appear to be free of any interest which might be regarded as being incompatible with integrity and objectivity. 2. Confidentiality. The auditor should respect the confidentiality of information acquired during the course of his work and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose. Confidential information acquired as a result of professional and business relationship must not be used for the personal advantage of members or third parties. 3, Skills and Competence. Audit should be performed and the report should be prepared with due professional care by persons who have adequate training, experience and competence in auditing. The auditor requires specialised skills and competence which are acquired through a combination of general education, technical knowledge and formal courses concluded by a qualifying examination recognized for this purpose and practical experience under proper supervision. In addition, the auditor should be aware of developments including pronouncements of ICAI on accounting and auditing matters, and relevant regulations and statutory requirements. 4. Work performed by others. When the auditor delegates work to the assistants, he will continue to be responsible for forming and expressing his opinion on the financial information. However, he will be entitled to rely on the work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. 5. Documentation. The auditor should properly document matters which are important in providing evidence that the audit was carried out in accordance with the basic principles. 12 SHIVA DELHI UNIVERSITY SERIES 6. Planning. The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. Plans should be based on knowledge of the client’s business. Q. 2. Define auditing. Discuss in brief the objectives of auditing. (2008) Or “Detection and prevention of errors and frauds is the main objective of auditing’. Explain the duties of an auditor in this regard. Or Explain briefly different types of errors and frauds which are likely to be detected by an auditor. (2016) ‘Ans. Auditing is the checking of the transactions of the business with its Books of Accounts and evidences with a view to find out the arithmetical accuracy of the accounts, the correctness and truthfulness of the transactions recorded in the Books and their results thereon. According to Spicer and Pegler, “An audit may be said to be such an examination of the Books, Accounts and Vouchers of a business which will enable the auditor to satisfy himself that the Balance Sheet is properly drawn up so as to give a true and fair view of the state of affairs of the business and whether the Profit & Loss Account gives a true and fair view of the Profit or Loss for the financial period according to the best of his information and the explanation given to him and as shown by the Books, and if not, in what respects he is not satisfied.” According to F.R.M. De Paula, “An audit denotes the examination of a Balance Sheet and Profit & Loss Account prepared by others together with the Books, Accounts and Vouchers relating thereto in such a manner that the auditor must satisfy himself and honestly report that in his opinion such Balance Sheet is properly drawn up so as to exhibit a true and correct view of the state of affairs of the particular concern according to the information and explanations given to him and as shown by the Books.” A more comprehensive definition of auditing has been given by Robert E. Schlosser in the following words : “Auditing is a systematic examination of financial statements, records and related operations to determine adherence to generally accepted accounting principles, management policies or stated requirements.” Features of auditing: (i) The audit is a systematic examination of the Books, Accounts, Documents and Vouchers of a business (ii) The purpose of the examination of Books etc. is to ascertain how far they present a true and correct view of the state of affairs of a particular concern, (iii) The auditor has to satisfy himself that the Books have been drawn up properly and they give a true and fair view of the state of affairs. (iv) Audit conducted in a haphazard manner does not serve the desired purpose, (v) The report of the auditor pertains to a particular financial period. Objects of an audit: Objects of an audit may be: I. Main and Il. Subsidiary. I. Main object. The main object of the audit is to find out whether the accounts of a particular concern show a true and fair view of the earnings and financial state of affairs.UNIT I-AUDITING 3 According to R. Rober Coomber, “The main purpose of an audit today is the verification of financial statements, usually a Balance Sheet and Profit & Loss Account in the light of certain accounting principles to establish whether or not it is a true statement and correctly drawn up.” The main object of auditing is to form an independent judgement and opinion about the reliability of accounting records and true and fair view of financial state of affairs and working results. Il. Subsidiary or Ancillary objects: 1, Detection and prevention of errors. 2. Detection and prevention of frauds. 1. Detection of errors. Detection of errors is an important subsidiary object of auditing. Errors may arise at different stages in book-keeping records. Most of the errors are of innocent nature but sometimes they are deliberately committed to cover some dishonest transactions. Classification of errors: The errors may be of the following types: (i) Clerical or Technical errors. The errors, which may occur because of the carelessness of the staff, are known as clerical errors. These errors may be of the following types: (a) Errors of omission. Under errors of omission, a transaction is omitted both on debit and credit side. This does not affect the Trial Balance. For example, Goods purchased from Mohan worth %9,500. The entry is not recorded in the Books of Accounts at all. It means neither ‘Purchase Account’ is debited nor ‘Mohan’s Account’ has been credited. It is very difficult for the auditor to detect such errors. () Errors of commission. Under errors of commission, the posting is wrongly made, e.g. the posting of %2,500 to the credit of Uday instead of the credit of Vijay. This error has no effect on the agreement of Trial Balance. (0) Compensating errors. If two or more errors are counter-balanced, (ie., are set off by each another) they will not affect the agreement of the Trial Balance. For example, if the Purchase Book is overcast by %3,000 and the Sales Book is also overcast by %3,000, they will not affect the agreement of the Trial Balance. Similarly, if the Wages Account is undercast by %500 and the Salaries Account is overcast by %500, the Trial Balance shall remain unaffected by such errors. (d) Errors of duplication. Errors of duplication occur if the same transaction has been recorded twice in the Books of original entry and also posted twice in the ledger. For example, sales worth %6,000 may be recorded twice in the accounts. This will not affect the agreement of Trial Balance. It is very difficult for an auditor to trace this kind of errors. (ii) Exrors of principle. The errors, which may occur because of ignorance of the principles of accounts by the staff, are called errors of principle. Under errors of principle, the posting of revenue expenses to a capital account or vice-versa does not affect the agreement of Trial Balance. For4 SHIVA DELHI UNIVERSITY SERIES instance, if furniture purchased is debited to Purchase Account, an error of principle is committed and it does not affect the Trial Balance. The auditor has to be very careful about such types of errors. ‘The detection of errors is an important part of auditor's duties since it involves the accuracy of the accounts and statements. The auditor has always to be very careful about these errors. Although the auditor's duty is confined to intelligent and careful enquiry only, yet he must exercise reasonable care and skill in connection with the detection of errors. It is clearly stated that “an auditor is a watch-dog and not a blood-hound”. The auditor is not expected to assume the role of a detective or a blood-hound in this regard. 2. Detection of frauds. Detection of frauds is also an important subsidiary object of auditing. The fraud must be detected in early stages otherwise it becomes difficult to detect. Frauds connected with the accounts may take place either: (i) by the misappropriation of cash or goods or (ii) by manipulation (falsification) of accounts. (i) Misappropriation of cash. The misappropriation of cash takes place by ‘commission of receipts’ and by ‘inclusion of fictitious payments’. Some examples of misappropriation of cash are given below: (a) Cash sales may not be recorded. (b) Record of credit sales may be omitted. (6) Showing payments against purchases never made. () Cash received from sale by V.P.P. or Sale or Return may be pocketed. (ii) Misappropriation of goods. The misappropriation of goods may take place in case of goods which are more valuable and less bulky. It is not easy to detect them. A continuous vigilance is always to be maintained over the issue of materials, records of sales, purchases and stock (iti) Manipulation of accounts. It is generally perpetrated by the Directors, Managers or other responsible officials of the concern. Some of the examples of manipulation of accounts are given below: (a) Recording fictitious purchases or sales (6) Creation or utilisation of secret reserves (6) Charging more or less amount of depreciation (a) Charging more or less amount of provisions (c) Omitting to record various expenses () Under-valuation or over-valuation of stock or other assets or liabilities. (iv) Prevention of errors and frauds. Besides the detection of different types of errors and frauds, an auditor is also expected to prevent them (a) It is not possible for an auditor to prevent errors and frauds completely, but he can put a moral check upon the staff by detecting, them. The staff would always be alert and would not carry on any dishonest transaction as they will be afraid of their detection by the auditor. (b) The auditor should make a detailed study, analysis and evaluationUNIT I—AUDITING 5 of the Internal Control System of the concern and find out its weak points and offer his suggestions for making improvements in the management and internal control of the enterprise so that the chances of occurrence of errors and frauds may be minimised. (0) The auditor can help in detecting errors and frauds by way of careful and detailed checking, whenever necessary. (@) The auditor may assist the management in setting right or dispensing with the dishonest employees so that there may be minimum chances for errors and frauds to occur. Q. 3. What are the different techniques used by an auditor in auditing of financial statements? Ans. Auditing technique is defined as any technique used by auditors to determine deviations from actual accounting and controls established by a business organization as well as uncovering problems in established processes and controls. Auditing techniques are used to aid the organizations by uncovering errors in business practices and providing solutions and means of correction. Some businesses use irregular accounting, methods to hide certain monetary transactions and non-compliant behaviour which can be uncovered by the use of varied auditing techniques. Kinds of audit techniques: 1. Vouching and Verification. Vouching is the process of recognising obligation and authorizing cash disbursements. It deals with the examination of profit and loss items. For example, the auditor comes across an entry ‘that a company has made payment for a particular object’. To ensure this, he needs to “find evidence” by vouching the documents like invoice, official receipt, bank statement etc. Verification is concerned with reviewing, inspecting and checking to ensure that the documents conform to specific requirements. In this procedure, the auditor inspects the actual assets of the company to make sure that they tally with the written records. It is a substantive audit procedure which deals with examination of balance sheet transactions/items whether the assets or liabilities are properly stated. Vouching is the substantive testing/examination of transactions at their point of origin whereas Verification usually deals with the final balances in the final accounts. 2. Observation. Observation consists of looking at a process or procedure being performed by others. It includes observation of the counting of inventories by the entity’s personnel and observation of the performance of control activities. Observation provides audit evidence about the performance of a process or procedure. 3. Documentation. The form and content of audit documentation should be designed to meet the circumstances of the particular audit. The information contained in audit documentation constitutes the principal records of the work that the auditors have performed in accordance with the standards. The quantity, type and content of audit documentation are a matter of the auditor's professional judgment. The audit documenta-tion therefore is not restricted to being only on papers, but can also be on electronic media. There are many factors that determine the form and content of documentation for a particular6 SHIVA DELHI UNIVERSITY SERIES engagement such as nature of the engagement, nature of the business activity of the client, status of the client, reporting format, Relevant legislations applicable to the client, records maintained by the client, Internal controls in operation, quality of audit assistants etc. 4. Inquiry. Inquiry involves seeking information from knowledgeable persons inside or outside the entity. It involves obtaining written confirmation from a third party, typically, although not exclusively, in relation to an account balance in which the third party has an interest. 5. External Confirmation. External confirmations involve seeking information from external sources such as bank audit letters or circularisation of receivables. Confirmations are best used where there is a knowledgeable party, independent of the entity and where alternative reliable evidence is not readily available. The most knowledgeable parties are those in a commercial relationship with the entity holding reciprocal information as to entity’s balances. These include debtors, creditors, banks, lenders, borrowers and custodians of entity assets such as stocks and securities. 6. Recalculation. Recalculation involves checking the arithmetic accuracy of the client's records. Auditors generally recalculate a company’s accounting reports or documents as part of the audit process. These procedures apply to the financial statements, reconciliations, cost reports and other documents. Auditors use these technical procedures to ensure that the company is accurately applying, basic accounting principles to its financial transactions. 7. Reperformance. Reperformance is the auditor's independent tests of client’s accounting procedures or controls that were originally done as part of the entity’s accounting and internal control system. This involves reperforming, various reconciliations at interim periods to check that controls have been operating effectively. For example, reperforming a bank reconciliation statement; making limited tests to ascertain that the information in the sales journal has been included for the proper customer and at the correct amount in the subsidiary accounts receivable records and is accurately summarized in the general ledger. 8. Analytical procedures. Analytical procedures consist of comparing items. For example, current year’s financial information with prior year’s financial information and analysing predictable relationships among the various items of financial statements. It can also be used to help identify any unusual trends or characteristics within the financial statements. Audit Evidence will depend on a number of factors, such as—risk assessment, nature of the accounting and internal control systems, materiality, etc. Q. 4. What are the different classes of an audit? Ans. Classification of audit: A. Classification on the basis of organisational structure: 1. Statutory audit 2. Private audit 3. Government audit 4, Internal audit 1. Statutory audit: (i) Audit of Companies (ii) Audit of Trusts (iii) Audit of Cooperative SocietiesUNIT I—AUDITING 7 (iv) Audit of Societies registered under Societies’ Registration Act (0) Audit of Electricity Companies. 2. Private audit: (i) Audit of accounts of a Sole trader (ii) Audit of accounts of a Partnership firm (iii) Audit of accounts of other individuals and institutions (e.g., clubs etc.). 3. Government audit: (i) Government Departments (i) Statutory Corporation (iii) Government Companies. 4. Internal audit is an audit conducted by an internal auditor appointed by the management of the enterprise with a view to highlight the working and weak areas of the organisation. B. From practical point of view: (i) Continuous audit (i) Annual/periodical/final audit (iii) Balance Sheet audit (iv) Partial audit (2) Interim audit (vi) Complete audit (vif) Cash audit (vif) Cost audit (ix) Tax audit (x) Management audit. Q. 5. Write notes on the following: (2016) (a) Statutory audit (b) Interim audit (0) Private audit (d) Periodical audit ‘Ans. (a) Statutory audit. Where the audit of an enterprise is made compulsory by law, it is called Statutory audit. The appointment of auditors, qualification, disqualification, remuneration, rights, duties, liabilities etc. are all mentioned in the relevant statute. The companies/undertakings are compulsorily required to conduct their statutory audit and it is not optional in nature. The entities which are required to undertake this audit, are: * Joint Stock Companies under Companies Act, 2013 * Insurance Companies under Insurance Act, 1938 * Banking Companies under Banking Regulation Act, 1949 * Cooperative Societies under Cooperative Societies’ Act, 1912 * Public and Charitable trusts under respective statutes * Electricity Supply Companies under Electricity (Supply) Act, 1948. Important features of statutory audit: First, Since this audit has been prescribed by law, the shareholders/owners of the enterprise concerned cannot make it optional even by their unanimous votes. Secondly, Statutory audit is conducted by a person properly qualified and competent under the law applicable to the enterprise. For example, In India, only a chartered accountant holding certificate of public practice of accountancy, can be an independent auditor. Moreover, he must not suffer from any of the disqualifications laid down in the law to preserve and protect his independence. Thirdly, The rights, duties and liabilities of an independent auditor are governed by law. They cannot be curtailed by the shareholders/owners of the enterprise. Lastly, A statutory audit cannot be partial or incomplete in any respect.8 SHIVA DELHI UNIVERSITY SERIES (b) Interim audit. It is conducted in between two annual audits. Its object is to enable the company to declare an interim dividend. It involves a complete examination and review of the accounts and records of the business up to the date of the interim audit. Thus interim audit may be conducted for a quarter or six months Purpose: * It helps in quick detection and rectification of errors and frauds. * It facilitates early completion of the annual audit. * It is helpful in the case of a business where interim figures have to be published. * Tt exercises an effective moral check on the staff of the enterprise. (c) Private audit. Where audit in the case of an enterprise is not compulsory by law, though it is opted by the enterprise, it is called Private audit. In such a case, people get their accounts audited by a qualified auditor (especially when the audit is not mandatory) on account of the following benefits: (i) Audit serves as an assurance to the owners that the accounts of business transactions are being properly maintained and that there are no frauds and errors committed by the employees of the enterprise. (ii) Audited accounts are on the reliable basis for assessment of tax liability under Income Tax Law, Wealth Tax Law, Sales Tax Law etc. as the tax authorities readily believe them. (iii) Audited accounts facilitate the settlement of claims and disputes. (iv) Audited accounts facilitate the process of raising loans and advances from financiers. (v) Audited accounts provide a reliable index to its profitability and financial soundness in case of its purchase or sale as a going concern. (vi) To see if the payment has been made to an individual against some account under the rules and if it is to be recoverable, it has been recorded in the account prescribed. (vi) While vouching receipts, it is to be ensured that such receipts are against payments which have already been made and are recoverable as such. ‘They are also recorded in the prescribed accounts. (viii) Verify the existence and valuation of stores and the stock. (ix) Ensure that a proper system of stock-taking has been adopted. (x) If the accounts have been prepared on uniform basis, account of one year can be compared with the other years and if there is any discrepancy, the cause may be enquired into. After going through above benefits, we can say that every unit should go for audit. It is a necessity and not a luxury. (d) Periodical audit. In case of this type of audit, the auditor begins the audit work of the organisation at the end of a period, say, an accounting year. According to De Paula, Periodical audit is one where the auditor does not attend until the completion and closure of the financial accounts by the undertaking/ client had done and the auditor takes the audit-work as a whole and the checking is done at one time. Q. 6. Define continuous audit. To what class of business is it applicable? What are its merits and demerits? Explain.UNIT I—AUDITING 9 Or “Continuous Audit is double-edged weapon”. Comment. (2015, 2008) Or Why is continuous Audit called a double edged weapon. (2013) Ans. Continuous audit. According to Spicer and Pegler, “A continuous audit is one where the auditor's staff is occupied continuously on the accounts the whole year round, or where the auditor attends at intervals, fixed or otherwise, during the whole of the financial year.” According to R.C. Williams, “A continuous audit is one where the auditor or his staff is constantly engaged in checking the accounts during the whole period or where the auditor or his staff attends at intervals, fixed or otherwise, during the whole of the trading period.” In other words, a continuous audit involves a detailed examination of all the transactions by the auditor attending at regular intervals during the whole of the trading period. At the end of the year he checks the Profit & Loss A/c and the Balance Sheet. In small concerns continuous audit is not much suitable as its accounts can be audited at the end of the financial year without much loss of time as the number of transactions is not very large. Applicability of continuous audit: It becomes absolutely essential to have continuous audit in the following cases * Where the business is large and the number of transactions is also very large. + Where there is no satisfactory system of internal audit or internal check. + Where it is necessary to present the final accounts just at the close of financial year, e.g., Banks. * Where statements of accounts are required to be presented to the management either at regular or irregular time intervals. “Continuous audit is a double-edged weapon” as it has both advantages and disadvantages. Advantages of Continuous audit: (i) The first advantage of continuous audit is that under this system a detailed examination of accounts is possible as the auditor gets one complete financial year for the purpose. (ii) The errors can be detected and rectified soon. (iti) The opportunities for complicated frauds are lessened and they can be detected before they attain larger proportions. (iv) The regular supervision by the auditor brings increased efficiency and accuracy in the accounts of the concern. (2) In the process of continuous audit each and every person of the deputed staff in the particular concern is kept fully busy. (vi) The proprietor of the concern may get any desired information duly verified at any time without any difficulty. (vii) It is more convenient for the auditor also as he is able to make easy arrangements for his work. (viii) Continuous audit creates a moral check upon the client's staff. (ix) Continuous audit can be completed quickly and final accounts can be presented sooner.10 SHIVA DELHI UNIVERSITY SERIES Disadvantages of Continuous audit: (i) Tampering with figures. In a continuous audit, auditor does not go over the accounts which he has examined at his last visit. This may tempt the dishonest clerk to tamper with the accounts or figures examined by the auditor in the previous visit in order to commit or hide a fraud. (ii) Interruption of client's work. In a continuous audit the auditor visits the client's office at regular or irregular intervals to check the accounts and records. This may cause unwelcome dislocation in the client's work. (iii) Expensive. A continuous audit is an expensive form of audit, in that the more the visits by the auditor, so much higher will be his fee. (iv) Missing link. It may be difficult for the auditor to remember every piece of work that he had left undone during his last visit. The loss of link in his work may be inevitable because of the interval between the two visits, as a result of which some important queries may remain unanswered and some vital points may go unexplained (v) Dependence on auditors. Frequent visits by the auditor or his staff may induce the client’s employees to depend upon him even for minor things For example, the client's staff may not exert much to locate an error in the hope that this will in any case be discovered by the auditor during his next visit. (vi) Possible collusion between client's staff and auditor's staff. Frequent interaction of the staff of the client with that of the auditor may provide scope of unhealthy relationship between the two. They might collude to perpetuate a fraud. Inspite of the disadvantages, which are only a few, and measures that can be taken to overcome them, Continuous Audit is beneficial for large business houses. Q. 7. What is an internal audit? Distinguish between an internal audit and a statutory audit? Ans. Internal audit is the independent appraisal of activity within an organisation for the review of accounting, financial and other business practices as a protective and constructive arm of management. According to Howard F Stettler, ‘Internal audit is the audit of company affairs and activities from within’ Difference between Internal audit and Statutory audit: (i) The objective of internal audit is to state the accuracy of information and compliance with plans and policies of the management. But the objective of statutory audit is to express an opinion on true and fair view of financial results and financial position of the company. (ii) The scope of work of internal audit is determined by the management, whereas the scope of work and responsibilities of statutory auditor are determined by the relevant law. (iii) An Internal auditor is appointed by the management, but the statutory auditor is appointed by the shareholders. However in certain cases he may be appointed by Directors or the Central Government. (iv) Report prepared by the internal auditor is submitted to the management. But the report of statutory auditor is submitted to the shareholders.UNIT I—AUDITING iW Q. 8 What do you mean by Audit Planning? Discuss important considerations for commencing an audit planning. Ans. Audit Planning includes establishing the overall audit strategy for the engagement and developing of an audit plan, which includes planned risk assessment procedures and planned responses to the risks of material misstatements. Planning is not a discrete phase of an audit but, rather, a continual and iterative process that might begin shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit. Considerations for commencing an audit: @ a) (ii Initial enquiries. The auditor should make a general survey of the industry and obtain a preliminary knowledge of the ownership, management and operations of the organisation. Communication with previous auditor. The auditor, on being appointed, should communicate with the previous auditor which is a professional etiquette and also to gain knowledge about the working and internal control system of the entity. Sending the engagement letter to clarify work engagement. An engagement letter is a written contract between the auditor and the client that serves to minimise misunderstandings. As per SA-210 “Terms of Audit Engagement”, the main contents of the letter in case of initial audit are as follows: * Objective and scope of the audit * Responsibility of the management for the financial statements and maintenance of adequate accounting records. The management is responsible for adequate system of internal control. * Frauds and Errors. The audit should be planned to give reasonable assurance for detecting material misstatements occurring from frauds or errors. * Unrestricted access to records and other information * Possibility of a proper review under the Chartered Accountants Act, 1949. * Indicate representations by management to be obtained. + Mention basis on which fees is computed and paid. * Extent of involvement of the auditors, internal auditor, predecessor auditor, client staff and experts. In certain special circumstances he may send a new engagement letter, For example, in cases of misunderstanding on objective and scope of audit, statutory or professional requirements, change in client’s business, ete. (iv) Acquiring knowledge of client’s business or business review. The auditor should carry out a business review in order to plan and perform the audit effectively and efficiently. It forms a basis for risk assessment and evaluation of audit evidence. The sources of information vary according to the nature, size and complexity of each business. Q. 9. Discuss the functions and limitations of auditing.2 SHIVA DELHI UNIVERSITY SERIES Ans. The main functions of auditing are: * to ascertain the systems of accounting, internal control, management pattern of the business concern. * to test-check the system of internal control to assess its soundness. * to verify the assets and liabilities and ensure that the assets are valued properly. * to assess the arithmetical accuracy of records. * to satisfy that Books of Accounts are maintained according to the requirements of statute governing the business. * to ensure that the opinion covers all aspects which are required to be stated by the law or accepted by the professional standards. Limitations of auditing: Audit may enjoy several benefits, but it is not free from limitations. Limitations are given as under: () An audit may not reveal the complete truth. This may happen when accounts are prepared with malafide intentions. (ii) The auditor's report depends upon the explanations and information given by the management. Incorrect information and explanations affect the auditor's report. (if) An auditor may not always work independently. Reason being that theoretically he is appointed by the shareholders but actually it is the Directors who appoint him. (io) Auditing is a post-mortem examination, There is no use of such an examination when the events have already happened. (2) Audit work generally depends on the prevalent system of internal control, but it may not be effective. Q. 10. Discuss the advantages of auditing. Ans. Main advantages of auditing: (i) It ensures the correctness of the accounts of the concern. (ii) Errors and frauds are located very easily at an early date and chances of their further occurrence are reduced. (iti) Audited accounts are considered more reliable as evidence in the court of law. (iv) Loans and credit can easily be obtained from banks on the basis of audited accounts. (2) Audited accounts are considered more reliable for the purposes of various types of taxation. (vi) The auditing of accounts makes the clerks who maintain them atleast careful and vigilant. (vii) The audited accounts are helpful in the settlement of claims by the insurance company in case of fire (vifi) Audited accounts are taken as more reliable and useful during the course of amalgamation, absorption and reconstruction of companies. (ix) In the case of employer-employee dispute, audited accounts are helpful in the determination of profits and trends of profitability. The Trade Union disputes can easily be settled on the basis of audited accounts of a concern.UNIT I-AUDITING 1B Q. 11. “An auditor is a watchdog and not a bloodhound.” Discuss general qualities of an auditor in the context of this statement. (2008) Ans. “An auditor is a watch-dog and not a bloodhound.” In Kingston Cotton Mill Co. case in 1896, it was observed by Lopes, L.G. that “An auditor is not bound to be a detective, or to approach his work with suspicion or with the foregone conclusion that there is something wrong. He is a watch-dog but not a bloodhound. He is justified in believing the tried servants of the company and is entitled to rely upon their representations provided he takes reasonable care.” Similarly Lord Justice Lindley once observed that “an auditor is not an insurer, he does not guarantee that the books do correctly show the true position of the Company's affairs.” An auditor is not a stock taker and therefore he is not guilty of negligence if he accepts the certificate of a responsible officer in the absence of suspicious circumstances but he must exercise reasonable skill and care. Change in the wordings of the report of the auditor from ‘true and correct’ to “true and fair’ has now increased the responsibilities of an auditor in this regard. An auditor of today is, therefore, expected to be more than a watchdog of a century back. He must always be very alert and agile. If there are materials before him to excite suspicion, he should atleast apprise the shareholders of the matter through his Report (Registrar of Companies vs. Arunajatai, 1963). This statement is connected with the valuation of assets particularly ‘Stock-in- trade’. An auditor, therefore, should be familiar with the following: * Accounting of business under audit. * Auditing techniques, principles and practices. * Effectiveness of the system of internal check. + Method of valuation of stock-in-trade. * Valuation of items of Closing Stock. * Different various laws, ie., Companies Act, Contract Act, Taxation laws, Industrial Acts, etc. Q. 12. “Audit is persuasive in nature and not conclusive.” Critically examine this statement. (2010) Ans. Let us take some instances to prove that auditing is persuasive and not conclusive: (i) The auditor has to depend upon books of accounts and other records presented before him. If books are prepared with malafide intention and there are manipulations in the accounts, the auditor will not be in a position to bring them to light. (ii) The auditor has to take the advice of the experts in the area not falling, within his expertise and he has to rely upon the certificate issued by them which may not be always correct. (iii) It is difficult to find the accounts as complete and genuine everywhere. For example, the details about stock-in-trade cannot be perfectly complete as it is not possible to fix exactly the cost or market price of each item. (io) Another reason that audit is persuasive and not conclusive, is appointment of an auditor. He is appointed by the shareholders as per Companies Act, but actually he is appointed by the Director, so he may4 SHIVA DELHI UNIVERSITY SERIES not be able to work independently. A glaring example is that of Satyam Computers, whose audit report was inconclusive. Q. 13. “Auditing is a process of collection and evaluation of evidence for the purpose of reporting on economic information.” Illustrate the nature of auditing in the context of this statement. (2013) Ans. A good description of Auditing is given in the question, i.e., “Auditing is a process of collection and evaluation of evidence for the purpose of reporting on economic information”. The above lines emphasize the following points: () The information under audit need not necessarily be accounting information. However information must be in a verifiable form. (ii) There should be standards or criteria for evaluation of the information. It is thus clear that Auditing involves evaluating the relevance, reliability and adequacy of evidence in support of verifiable information. It is not a process of mechanical comparison of items in the financial statements with entries in the books of accounts, nor does it involve a mere mechanical ticking of entries in the books of accounts with the vouchers or other records. It is a process of collection and critical evaluation of evidence. It is critical, analytical and investigative. The main roots of Auditing, are not in the accounting which it reviews, but in the logic on which it inclines for ideas and methods. Internal Check, Internal Control and Internal Audit Q. 14. What is internal check? What points should be considered while framing a system of internal check? Ans. Internal check refers to a system of allocating duties among the staff in such a way that every person records a different aspect of a transaction. Internal check is a valuable part of internal control. It is the built-in check in accounting process itself, In this process, the work of one person is automatically checked by another during the course of carrying out, recording and processing transaction. The management of an entity is primarily concerned with designing and implementing of an efficient system of internal control. Such controls should be based on the following principles: (i) Segregation of functions of internal check. It involves assignment of responsibility for a transaction in a manner such that the work of one employee is automatically checked by another. These should be designed at all the points of a transaction cycle. (ii) Physical control. This relates to security devices and measures for the safekeeping of assets, accounting records and unused pre-printed forms. It also involves use of mechanical and electronic equipment in execution and recording of transactions. (iif) Authorisation procedure. Internal check is designed to ensure that transactions are authorized by the management personnel acting within the scope of their authority. (iv) Internal verification/internal audit. Internal check should involve a review of accuracy and propriety of transactions recorded, by a person who is independent and unrelated to the personnel and the department involved in this process.UNIT I—AUDITING 15 The following example explains the ways of designing an effective internal check system with regard to credit sales in a big manufacturing concern. (i) Accepting customer order. It includes initial important steps such as registering customer's purchase order, fixation of selling price and delivery dates, granting of any discounts and preparation of sales order. (ii) Credit approval. Before a sales order is processed, the credit department should determine the creditworthiness of the customer. If the order is from an existing customer, new order will not put the account beyond predetermined credit limit. In case of new customer, on being satisfied, along with reference reports of credit agencies, the credit manager may initial or stamp the execution of the sales order. (iii) Issuance of merchandise. The storekeeper issues the goods covered by the sales order to despatch department after the sales order has been approved by the credit department. (iv) Dispatch of goods. This step involves steps such as packaging of goods and arranges transportation for dispatch. Different documents are required in this step such as—Goods outward notes, Acknowledgment issued by transporter, Despatch register, etc. (2) Billing customer. The Sales Department then matches the despatch documents with the sales order and customers’ purchase order, prepares and sends sales invoices to the customer and prepares daily summary of sales billed. (vi) Recording the sales invoices. The clerk who maintains accounts receivable/customers’ accounts ledger should be responsible for recording serially controlled sales invoices against appropriate debtors. (vii) Sending monthly statements to customers. Most receivables are collected through mailed receipts and the names of the debtors who have paid are deleted subsequently. For outstanding debtors, monthly statements should be sent by a senior officer to the customers to verify the statements of debts. (viii) Granting of write off and credits. The authority should write off receivables and approval of credit notes. It involves goods return notes, write off authorisation. Q. 15. Discuss the concept of internal control. What are its objectives? State the features of a good system of internal control. ‘Ans. According to WW. Big, ‘Internal control is regarded as a whole system of controls, financial and otherwise established by the management in the conduct of a business including internal check, internal audit and other forms of control.’ The Council of the Institute of Chartered Accountants’ in England and Wales has defined the term internal control as follows, “By internal control is meant not only internal check and internal audit but the whole system of control, financial and otherwise, established by the management in order to carry on the business of the company in an orderly manner to safeguard its assets and secure as far as possible the accuracy and reliability of its records” . It includes internal check, internal audit and various other forms of control. It is a broad term with a wide canvas. The fundamental objective of internal control is to safeguard the assets of the company against losses, prevent wastes,16 SHIVA DELHI UNIVERSITY SERIES inefficiency, errors and frauds. It helps the management in measuring the implementation of business policies as well as ensuring maximum accuracy of all data and statements. Objectives of internal control AAS-6 (SA 400): The objectives of internal control can be summarised as under: (i) Transactions are executed in accordance with management policy and authorisation. (i) All transactions are recorded with appropriate account. (iii) To prevent the assets from unauthorized access, use of disposition. (iv) To prevent and detect fraud and error. (0) Timely preparation of reliable financial information. Characteristics of a good Internal Control: (i) There should be a well-developed plan of organisation with delegation of proper responsibilities at various levels of operational hierarchy. (ii) There should be a scientifically developed system of procedures with a view to maintain proper controls over capital and revenue of an organisation. (ili) A system of healthy practices and traditions is also necessary for the performance of duties and activities of various departments of the organisation, (io) The personnel engaged in the business should be of high quality and character with a thorough understanding of their responsibilities and a proper background of training and ability. After all, controls are exercised by the personnel engaged in the business and qualified people can better make use of such controls. Q. 16. What is internal check? How does it differ from internal control? Or Distinguish between internal check and internal controls. (2009, 2012) Ans. Internal check. Internal check is a part of the whole system of internal control and is best regarded as a continuous check on the day-to-day transactions. The term “Internal check” implies to such an accounting system of a concer in that no one person singly handles a transaction from the beginning to the end, and the work of one person is automatically checked by another with a view to prevent errors, frauds and irregularities, and to detect errors and frauds. According to Dicksee, “Internal check is such an arrangement of book-keeping routine that errors and frauds are likely to be prevented or discovered by the very operation of the book-keeping itself.” According to De Paula, “Internal check means practically a continuous internal audit carried on by the staff itself, by means of which the work of each individual is independently checked by other mentbers of the staff.” Difference between Internal check and Internal control Internal control Internal check 1. It is an integrated concept incorpo- rating the elements of internal check. It is one components system. of the elements or of internal controlUNIT I-AUDITING Ww 2.It is wider in scope and| It has a narrower meaning than application. internal control. 3. It aims at regulating the whole | It is a systematic arrangement of system of controls, financial or | accounting routine among the staff in otherwise, established by the | such a way that the work of one clerk management in order to carry on | interlocks with and cross-checks the the business of the company in an | work done by another. orderly manner. 4.It is designed to assist | It is designed to prevent and/or management in its functions to | detect errors and frauds and attain operational efficiency in | irregularities and assist in achieving adherence to managerial policies | the reliability of accounting records outside the strict scope of | only. accounting. Q. 17. Explain the meaning and objectives of Internal Audit. To what extent an External Auditor can rely upon the Internal Auditor in carrying out his work as per AAS-7 (SA 610)? (2009, 2013) Or To what extent an auditor should rely on internal check system. (2015) Ans. “Internal Audit is the audit of the company affairs and activities from within”. —Howard F. Stettler Internal Audit is an independent appraisal activity within an organisation performed by an employee of the organisation or an outside agency, especially appointed for the purpose. Objectives: Broadly, the objects of internal audit are as follows: * Study and evaluation of the adequacy and effectiveness of accounting, financial and operating controls. * Ascertaining the degree of compliance with predetermined policies, plans and procedures. * Accounting for business assets and measures for their safety. * Examining the reliability of accounting and other data compiled within the organisation. Relying upon the work of an internal auditor by external auditor as per AAS-7 (SA 610): * Internal audit function constitutes a separate component of internal control and its objective is to determine whether other internal controls are well designed and properly operated. * AAS-7 (SA 610) seeks to provide guidance as to the procedures to be applied by the external auditor in assessing the work of the internal auditor for the purpose of placing reliance upon that work. * Much of the work of the internal auditor can be useful to the statutory auditor in his examination of the financial information, including financial statements, though the statutory auditor alone will be responsible for his report and for determination of the nature, timing and extent of the auditing procedures.18 SHIVA DELHI UNIVERSITY SERIES Q. 18. Explain the objectives of internal check system. As an auditor, how will you evaluate the efficiency of internal check system? (2010) Ans. Objectives of internal check: An effective system of internal check aims to achieve the following objectives: (i) Proper division of work. (ii) It helps in fixing up responsibility for particular acts or omissions. (if) Minimisation of errors and frauds. (iv) Reliability of books of accounts. () Early preparation of final accounts. Evaluation of efficiency of internal check system: The auditor can evaluate the efficiency of internal check as under: (i) He is satisfied that proper care has been taken in division of work. In other words, no one person alone handles a transaction completely from beginning to the end and the work (involving transactions) of each person is checked by another person. (ii) He can also evaluate the reliability of internal check system in the following ways: — He can call for a brief statement from the client with regard to the system of internal check in operation. — He examines the system in the light of the size and nature of business to determine its adequacy. — He assesses the capability of system in minimising and preventing errors. An efficient internal check system helps an auditor to a great extent in the conduct of his work, but it does not reduce his legal responsibility. Q. 19. What points should be considered while framing a system of internal check? (2013 Nov.) Ans. Fundamental principles of an effective internal check system: The following points are to be taken into consideration in framing a good system of internal check: (i) No single person should have an independent control over any important aspect of business. All dealings and acts of every employee should, in the ordinary course, come under the review of another. In this way, the frauds may be discovered by the automatic operation of the system of checks. (ii) The duties of each member of the staff should be changed over from time to time without notice so that the same officer or subordinate may not continue performing the same functions for a considerable length of time without a break. (iif) Every member of the staff should be encouraged to go on leave at least once a year. This will help in detecting the concealed frauds. (iv) Persons having physical custody of assets must not be permitted to have access to Books of Accounts. (v) To prevent loss or misappropriation of cash, mechanical devices e.g., automatic cash registers, calculating machines etc. should be employed.UNIT I—AUDITING 19 The self balancing ledger should be used and the total accounts should be under the control of a responsible official. (vi) Procedures should be laid down for the verification and testing of different Sections of Accounting records periodically to ensure their accuracy. (vii) The financial and administrative power should be subdivided very judicially and the effect of such division may be reviewed periodically. (viii) For stock taking at the close of the year, the trading activities should be suspended for some time. The task of pricing and evaluation of stock should be done by the staff other than that of Stock Section. (ix) Members of the staff should not be allowed to take away goods without proper permission (x) There should be efficient accounting control in respect of each important class of assets. (xi) Ledger keepers should not be allowed to have a direct access to either the debtors or the creditors of the business. (xii) A detailed record should be maintained of all goods received and sent out of the business premises. Audit Procedure—Vouching and Verification of Assets and Liabilities Q. 20. What is vouching? What are its objects? Or “Vouching is the essence of auditing”. Explain this statement. (2008, 2013N) Or “Vouching is the backbone of auditing’. Discuss. (2013) Ans. “ Vouching consists of comparing entries in Books of Accounts with documentary evidence in support thereof’. —Dicksee “The examination by the auditor of all documentary evidences, which are available to support the authenticity of the transaction entered in the client's records”. —Spicer and Pegler According to the Institute of Chartered Accountants of India, an auditor should obtain sufficient appropriate evidentiary matter to afford a reasonable basis for an opinion regarding financial statements examined by him. On the basis of vouchers, an auditor should satisfy himself that documentary and other evidence of sufficient validity is available and is in order. It is widely felt that vouching is the essence of auditing. It is the foundation and the first step of auditing. It is essential therefore, that due care and attention is given to vouching function during the auditing process. While vouching, an auditor should compare entries with related vouchers and ascertain the genuineness and validity of vouchers. “Truly it is said to be the essence of auditing since it is, through vouching that an auditor can satisfy himself the authenticity and completeness of the transactions recorded in the books.” —Base Objects of vouching: The main objects of vouching may be stated as follows: (i) All transactions connected with the business have been properly recorded in the Books of Accounts.20 SHIVA DELHI UNIVERSITY SERIES (ii) To ascertain that recorded transactions are genuinely connected with the business. (it) The vouchers in support of the entries are legally valid i., they are authentic, properly dated, addressed to the business of the client and are not fraudulent in any respect. (iv) The vouchers have been carefully processed through each stage of an effective system of internal check. (2) The vouchers have been properly authorised. Q. 21. What is the meaning of verification of assets? What are its objects? Ans. Verification of Assets means ‘truth proving’ or ‘confirming the truth’, Verification is the process by which the auditor satisfies himself, by actual inspection or otherwise, as to the existence, ownership, valuation and accuracy of the various items appearing in the Balance Sheet. According to J.R. Batliboi, “The auditor must satisfy himself that they (the assets) really existed at the date of Balance Sheet and were free from any charge and that they have been properly valued. In verifying the liabilities, he has to see that all liabilities have been inserted at their proper figures and that no liability has been omitted”. The Institute of Chartered Accountants of India, in its ‘Statement of Auditing, Practices’ has laid down that verification of assets should be aimed at establishing their: (a) existence, (b) ownership (c) possession; (d) freedom from encumbrances or lien (e) proper recording and (f) proper valuation. Verification includes the following points: (a) Existence. Assets are in existence really at the date of Balance Sheet. (b) Ownership. Ownership in the assets rests with the concern. (c) Possession. Possession of the assets lies with the concern. (@) Charge. The assets are free from any charge or mortgage or lien. (e) Use. Assets are purchased for the business and Balance Sheet shows it. (f) Valuation. Values of the assets as to the Balance Sheet are correct. Objects of verification: The auditor has— * to certify whether the Balance Sheet shows a true and fair financial position and for this he has to verify the assets and liabilities. * to certify the ownership and title of assets appearing in the Balance Sheet. * to ascertain the existence of the assets appearing in the Balance Sheet. * to verify the fact whether the assets are free from charge or not * to detect the frauds and irregularities, if any, in the Books of Accounts of the concern. * to ensure the arithmetical accuracy of the Books of Accounts Q. 22. Write a note on verification of liabilities. Ans. In order to verify the liabilities, the auditor has to ensure that: (i) liabilities shown in the Balance Sheet are actually payable. (ii) liabilities represent obligations of business to third parties created for its legitimate operations. (iti) all known liabilities have been properly accounted for and contingent liabilities have been shown as a footnote. (iv) liabilities are stated in the Balance Sheet at fair and reasonable amount.UNIT I-AUDITING a Q. 23. Distinguish between vouching and verification. Discuss the duties of auditor in respect of valuation of asset. (2016) Or What is verification? Distinguish between vouching and verification. (2013) ‘Ans. Duties of the auditor in respect of valuation of assets. Valuation is the act of determining the value of assets and critical examination of these values on the basis of normally accepted accounting standards. Valuation of assets is to be made by the authorized officer and the duly of the auditor is to see whether they have been properly valued or not. For ensuring the proper valuation, auditor should obtain the certificates of professionals, approved valuers and other competent persons. The Auditor can rely upon the valuation of concerned officer but it must be clearly stated in the report because an auditor is not a technical person. An auditor should keep in mind the following points regarding the assets while making valuation of assets: * Original cost of the Asset Expected working life of the Asset Annual wear and tear Scrap value at the end. Method of valuation should be the same as last financial year. Difference between Vouching and Verification Basis of Difference Vouching Verification 1. Nature Vouching examines the| Verification refers to the entries relating to the| examination of the assets transactions recorded in the | and liabilities appearing in Books of Accounts. the Balance Sheet of the concern 2. Basis It is based on documentary | Physical inspection as well examination. as documentary examina- tion is conducted. 3. Time ‘The transactions of the | Verification is done at the whole year are analysed | end of the year when the before the end of the year. | Balance Sheet is prepared. 4, Scope It has no concern with| It includes valuation as valuation. well. 5. Personnel The task of vouching is| The task of verification is done by juniors like audit | done by the auditor himself clerks. or by his assistants. 6. Tests of details | Vouching includes tests of | Verification means tests of details of transactions. details of balances.2 SHIVA DELHI UNIVERSITY SERIES Company Auditor—Qualification, Disqualification, Appointment; Removal, Rights and Duties Q. 24. State the provisions of Indian Companies Act, 2013 regarding qualifications, disqualifications, appointment, reappointment and removal of auditors. Or Can a properly appointed auditor be removed before expiry of his term? If so, explain the procedure for such removal. (2011, 2013 Nov) Or How are the first auditor of a limited company appointed or removed?(2010) Or Discuss the provision of India Companies Act, 2013 regarding appointment and re-appointment of an auditor. (2008) Ans. Qualifications of an auditor: (i) Practising Chartered Accountant [Section 141(2)]. A person shall be qualified for appointment as auditor of a company if he is a Chartered Accountant within the meaning of the Chartered Accountants Act of 1949. (ii) Partnership firm as auditor. In case of a firm, if ll its partners practising, in India are qualified for appointment as auditors, it may be appointment by its firm name to be the auditor of a company. In such a case, any of its practising partners can act in the name of the firm. (iii) Limited Liability Partnership Firm. LLP can be appointed as auditors of a company but only Chartered accountant partners are authorised to act and sign on behalf of the LLP. Disqualifications of an auditor: The Companies Act, Section 141(3) lays down that none of the following persons are qualified for appointment as auditor of a company: (i) a body corporate, other than limited liability partnership. (ii) an officer or employee of the company, (iii) a person who is a partner, or who is in the employment of an officer or employee of the company. (iv) a person who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company (that is co- subsidiary), provided that the relative may hold security or interest in the company of face value not exceeding 21 lakh’. (2) a person who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company, or a subsidiary of such holding company (that is co-subsidiary), in excess of 5 lakh’, (vi) a person who, or his relative or partner has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, or its subsidiary, or its holding or associate company, or a subsidiary of such holding company (that is co- subsidiary), in excess of &1 lakh’. (ii) a person or a firm who, whether directly or indirectly, has businessUNIT I-AUDITING 23 relationship with the company, or its subsidiary, or its holding or associate company, or a subsidiary of such holding company (that is co- subsidiary) or associate company of such nature as may be prescribed. (viii) a person whose relative is a director or is in the employment of the company as a director or key managerial personnel. (ix) a person who is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies. (x) a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction. (xi) any person whose subsidiary or associate company or any other form of entity, is engaged in providing non-audit services as on the date of appointment. (Non-audit services are disqualifications Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned above after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor. Appointment of Auditors: The appointment of auditors is dealt with u/s 139 of the Companies Act as under: “Every company, whether public or private, must appoint an auditor or auditors to audit its accounts.” 1. First Auditor [Section 139(6)] (i) The first auditor of the company may be appointed by the Board of Directors within one month from the date of incorporation of the company. (ii) Such auditor shall hold office till the conclusion of first A.G.M; (iii) In case the first auditor of the company is not appointed by the directors, the member shall, with in 90 days at an extraordinary general meeting, make an appointment. (iv) In this case also tenure of first auditor shall be from the date of appointment till the conclusion of first A.G.M. 2. Subsequent Auditors (i) Every company shall, at its first annual general meeting appoint an individual or a firm as an auditor; (ii) The auditor so appointed by members shall hold office from the conclusion of that meeting till the conclusion of its sixth annual general meeting subject to ratification at every A.G.M.; (iii) The company shall inform the auditor about his appointment; (iv) The company shall obtain a written consent of the auditor to such appointment; (v) The company shall also obtain a certificate as to the fulfillment of conditions laid down under Section 141 from the auditor. (vi) The company shall file a notice of such appointment with the Registrar with in 15 days of the meeting.or SHIVA DELHI UNIVERSITY SERIES 3. Terms of appointment [Section 139(2)]. No listed company or a company belonging to such class or classes of companies as may be prescribed, shall appoint or reappoint— (a) an individual as auditor for more than one term of five consecutive years; and (b) an audit firm as auditor for more than two terms of five consecutive years; Provided that— (i) an individual auditor who has completed his term under clause (2) shall not be eligible for reappointment as auditor in the same company for five years from the completion of his term; and (ii) an audit firm which has completed its term under clause (b), shall not be eligible for reappointment as auditor in the same company for five years from the completion of such time. 4. Reappointment of an auditor [Section 139(9)]. The retiring auditor by whatsoever authority shall be reappointed at the Annual General Body Meeting except in the following cases: (i) If he is not qualified for reappointment. (ii) Ifhe has given a notice in writing of his unwillingness to be reappointed. (iii) A resolution is passed to the effect that he shall not be reappointed or that somebody else be appointed in his place. Note: Where at any AGM. no auditor is appointed or reappointed, the existing auditor shall continue to be the auditor of the company [Section 139(10)]. 5. Appointment of auditor in case of Government Companies: First auditor. Appointment of the first auditor shall be made by Comptroller and Auditor General of India (CAG) within 60 days from the date of registration: If CAG fails to appoint then the Board of such company shall appoint first auditor within 30 days. If Board also fails to appoint the first auditor within the given time then it shall inform the members and the members shall make the appointment of first auditor within 60 days at an Extra Ordinary General Meeting (EGM). Such first auditor will hold office till the conclusion of the first A.\G.M. Subsequent appointment of auditor. [Section 139(5)] Appointment of auditor shall be made by CAG with in 180 days from the commencement of the financial year. He shall hold the office till the conclusion of the A\G.M. 6. Appointment in case of casual vacancy (i) Non-Government companies. An auditor in a casual vacancy may be appointed by the Board of Directors within 30 days. But where such vacancy is caused by the resignation of an auditor, members shall fill it within 3 months of recommendation of board of directors at a general meeting. The tenure of auditorship would be till the conclusion of the next A.G.M. [Section 139(8)(i)] (ii) Government owned companies. Any casual vacancy in the office of auditor of Government company shall be filled by the CAG of India within 30 days. If CAG fails to do so, the Board of Directors shall fill itUNIT I-AUDITING 25 within next 30 days. The tenure of auditorship would be till the conclusion of the next A.G.M. [Section 139(8)(ii)]. 7. Removal of auditor [Section 140] () An auditor may be removal from his office before the expiry of his term only by a special resolution of the company and prior approval of the Central Government. (ii) The auditor shall be given a reasonable opportunity of being heard before being removed. (iif) Statement of purpose to be filed: (a) The auditor who has resigned from the company shall file within a period of 30 days from the date of resignation, a statement in the prescribed form with the company and the Registrar of Companies indicating the reasons and other relevant facts. (b) In the case of Government companies, the auditor shall also file such statement with the CAG. indicating the reasons and other relevant facts with regard to his resignation. (iv) If the auditor does not file such statement as above, he/it shall be punishable with a fine of not less than %50,000, but which may extend to %5,00,000. (2) Special Notice: (a) Special notice shall be required for a resolution at an annual general meeting appointing as auditor a person other than retiring, or providing expressly that a retiring auditor shall not be reappointed except where the retiring auditor has completed a consecutive tenure of 5 years/10 years. () On receipt of notice of such resolution, the company shall forthwith send a copy thereof to the retiring auditor. (0) Where notice is given of such a resolution and the retiring auditor makes representation in writing to the company (not exceeding a reasonable length) and requests its notification to the members of the company, the company shall, unless the representation is received by it too late for it to do so— * in any notice of the resolution given to the members of the company, state the fact of the representation having been made; and send a copy of the representation to every member of the company to whom notice of the meeting is sent, whether before or after the receipt of the representation by the company. if a copy of the representation is not sent because it was received too late or because of the company’s default, the auditor may (without prejudice to his right to be heard orally) require that the representation shall be read out at the meeting; if a copy of representation is not sent as aforesaid, a copy thereof shall be filed with the Registrar; Power of Tribunal to direct removal of Auditor: () The Tribunal may either suo mofo or on an application made by Central26 SHIVA DELHI UNIVERSITY SERIES Government or by any concerned person, direct the company to change its auditors. (ii) Such an order can be passed if the Tribunal is satisfied that auditor acted fraudulently or colluded with company or its directors or its officer to commit fraud. (iti) If the application is made by Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall pass an order within 15 days of application. (iv) In case the final order is passed, then the auditor shall not be eligible to be appointed as auditor of any company for a period of 5 years and further be liable for action under Section 447. Remuneration of Auditors [Section 142]. The remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as the company in general meeting may determine. The Board of Directors may fix remuneration of the first auditor appointed by it. The remuneration shall, in addition to the fee payable to an auditor, include the expenses, if any, incurred by the auditor in connection with the audit of the company and any facility extended to him but does not include any remuneration paid to him for any other service rendered by him at the request of the company. Q. 25. Discuss the powers/rights and duties of a company auditor. (2016) Or Discuss the rights of the company auditor. (2013Nov.) Or What are the duties of auditor of limited company? (2012, 2014) Ans. The Companies Act, 2013 confers the following powers and rights on the auditors: 1. Right of access at all times to Books, Accounts and Vouchers of the company. Section 143(1) confers upon the auditor right of access at all times to Books, Accounts and Vouchers of the company, whether kept at the Head Office of the company or elsewhere. The term Vouchers includes all documents, correspondence, agreements and evidence which serve to support any entry in the financial statements. The term Books include all the Books, which affect or may affect the financial statements. It includes Financial, Statutory and Statistical Books, Cost records, Stock Books, Minutes Books of General Meetings, Directors’ Minute Book, etc. ‘The auditor can exercise this right at all times which implies normal business hours on any working day. 2. Right to obtain information and explanations. Section 143(1) empowers the auditor to call for any explanation or information from the employees and officers including the Managing Director and other Directors of the company, which he thinks is relevant for the purpose of audit and proper discharge of his duties. In case any information or explanation is not given to him, he should mention this fact in his audit report. 3. Right of access to records of subsidiaries. The auditor of a holding company also has the right of access to the records of all its subsidiaries in so far as it relates to the consolidation of its financial statements with that of subsidiaries.UNIT I— AUDITING 27 4. He also enjoys the following rights under Section 146: (i) to receive all notices of and other communications related to any general meeting of the company; (ii) to attend and to be heard at any general meeting on any part of the business which concerns him as an auditor. 5. Right to receive remuneration. An auditor has a right to receive remuneration as per Section 142. Duty not to render certain services [Section 144]. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the Audit committee, but which shall not include any of the following services whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company, namely; (i) accounting and book keeping services; (ii) internal audit; (iii) design and implementation of any financial information system; (iv) actuarial services; (2) investment advisory services; (vi) investment banking, services; (vif) rendering of outsourced financial services; (vif) management services; and (ix) any other kind of services as may be prescribed. Duties of auditor. The auditors have the following statutory duties in addition to any other duties which may be imposed upon them by the articles of the company: 1. Section 143(1) requires the auditor to enquire the following matters; namely (i) whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members; (ii) whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company; (ii) where the company is not an investment company or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company; (iv) whether loans and advances made by the company have been shown as deposits; (2) whether personal expenses have been charged to revenue account; (vi) where it is stated in the books and documents of the company that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading. 2. Under Section 143(2): (i) The duty of auditor is to report to the members of the company on:28 SHIVA DELHI UNIVERSITY SERIES (a) accounts examined by him; and (b) every financial statement laid before a general meeting during his tenure. (ii) He shall also give his opinion that the financial statements give true and fair view of the state of the company affairs as at the end of financial year and in the case of the profit or loss and cash flow for the year. Under Section 143(3). The auditor in his Audit Report must, state: () whether he has obtained all the information and explanations, which were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements. (ii) whether proper books of accounts as required by law have been maintained by the company. (iii) whether the financial statements comply with the accounting standards. (iv) the observations or comments of the auditors on financial transactions which have any adverse effect on the functioning of the company; and (2) whether any director is disqualified from being appointed as director under Section 164(2). (vi) whether the report on the accounts of any branch office audited by a person other than the company’s auditor has been sent to him and the manner in which he has dealt with it in preparing his report. (vii) any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith. (vif) whether the company has adequate internal financial controls system in place and the operating effectiveness of such control. (ix) such other matters as may be prescribed. Note: Where the auditor affirms the above facts without any qualification, reservation, or adverse remarks, his report is termed as ‘clean’ or ‘unqualified’ otherwise it is a ‘qualified report’. The auditor must not hesitate to bring to the notice of the shareholders of the company any irregularity in the books of accounts, Duty to sign Audit Report [Section 145]. The person appointed as an auditor of the company shall sign the auditor's report or sign or certify any other document of company in accordance with the provision of sub-section (2) of Section 141, and the qualification, observations or comments on financial transactions or matters which have any adverse effect on the functioning of the company mentioned in the auditor’s report shall be read before the company in general meeting and shall be open to inspection by any member of the company. Q. 26. What are the duties of a company auditor? (2009, 2012) Or What are the duties of an auditor of a Ltd. Company? (2014) Ans. Duties of a Company Auditor: The following are the duties of a Company Auditor under the Act: (i) Duty to submit report [Sections 143(2)(3)] (ii) Duty to enquire into specified matters [Section 143(1)] (iii) Duty to make statements on additional matters specified by the Central Government (io) Duty to sign audit report, etc. [Section 145]