Sureme 75 Finalxcbcvbvcb

CA. Aseem Trivedi’s

Supreme

75 THOROUGHLY REVISED Other Topics under Advanced Auditing Enough for Exams………

1 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTE R

1

AUDIT OF ENTITIES CARRYING ON GENERAL INSURANCE BUSINESS

PART A SHORT NOTES { 4 Marks} Q.1 What is Premium Deficiency? The Regulations require that premium deficiency should be recognized if the sum of expected claim costs, related expenses and maintenance costs exceeds related unearned premium. After ascertainment of total unearned premium one is required to estimate the expected claim costs, related expenses and maintenance costs. These estimates are based on the information available on the balance sheet date and the company's knowledge about the trend. If the unearned premium exceeds the expected claim costs, related expenses and maintenance costs, the excess of unearned premium is ignored. IF the total of expected claim, costs related expenses and maintenance costs exceeds the related unearned premiums, a provision for premium deficiency is created in the financial statements. In the case of insurance contracts exceeding four years, estimation of claims is required to be done on actuarial basis subject to regulations that may be prescribed by the Authority. A certificate from a recognized actuary is required

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to be obtained. It may be noted that the Regulations require that for contracts exceeding four years, once a premium deficiency has occurred, future changes in liabilities, that might arise, should be based on actuarial or technical evaluation. The actuarial assumptions used for estimation of liabilities or claims are required to be disclosed in the financial statements. Q.2 Solvency margin in case of an insurer carrying on general insurance business ( Nov. 06, May 12} Answer Solvency margin in case of an insurer carrying on general insurance business: In case of an insurer carrying on general insurance business, the solvency margin should be the highest of the following amounts : (i)

fifty crore rupees (one hundred crores of rupees in case of reinsurer), or

(ii) a sum equivalent to twenty percent of the net premium income; or (iii) a sum equivalent to thirty percent of net incurred claims. Subject to credit for reinsurance in computing net premiums and net incurred claims being actual but a percentage, determined by the regulation but not exceeding fifty percent. It may be noted that conditions regarding maintenance of the above mentioned solvency margin may be relaxed by the authorities in certain special circumstances. If, at any time, an insurer does not maintain the required solvency margin, the insurer is required to submit a financial plan to the authority indicating the plan of action to correct the deficiency in the solvency margin. If, on consideration of the plan, the authority finds it inadequate the insurer has to modify the financial plan. Sub-section (2c) of Sec 64 A states that if an insurer fails to comply with the requirements of the insurance Act, 1938, it shall deemed to be insolvent and may be wound up by the court. Q.3 What is Unexpired Risk Reserve? All policies are renewed annually except in specific cases where short period policies are issued. Since the insurer closes his accounts on a particular date not all risks under policies expire on that date. Some policies extend beyond this date into the following year and the risks continue based on two different ways as discussed above. Therefore, at the closing date, there is un-expired liability under the various policies, which may occur during the remaining terms of the policy beyond the year-end, for which we have to defer revenue. Calculating the revue to be deferred is very time consuming thing and hence a simple method is adopted to provide for un-expired risks. According to the requirements of the Insurance Act, 1938 it is sufficient if the provision is made for un-expired risks i. @ 50% for Fire and Marine Cargo and Miscellaneous Business.

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ii. @ 100% for Marine Hull. It may be mentioned that the provisions of section 44 of the Income Tax Act, 1961, govern Insurance companies. The Income Tax Rules also provide for creation of a reserve for un-expired risks. The deduction of these reserves is also allowed under the Income Tax Act.

Q.4 What is reinsurance ? ( Nov. 00, Nov.03, Nov.05, Nov. 08, Nov.09 }, Virtually all insurers require the help of reinsurance because in insurance business, there are certain risks, which, because of their magnitude or nature, one insurance company cannot afford to cover. The arrangement where by one insurer obtains insurance from another insurer on risks assumed by the former is called reinsurance. The former is called the ceding company, where the latter is called the reinsurer. Types of Reinsurance Contracts A. Facultative Reinsurance: Reinsurance whereby separate contracts are entered into for each particular risk that is mentioned in the policy. Each transaction under facultative reinsurance has to be negotiated individually. B. Treaty Reinsurance: Under this reinsurance a treaty is entered into between the ceding company and the reinsurer for reinsurance of the limits covered under the treaty. The limits may be monetary, geographical, section of business, etc. under this reinsurance it is obligatory on the part of both to accept and cede the risk with the limit specified. Q.5 What is Co-insurance? { May 2000} When the insured prefer to have more than one insurer for the same risk, it would amount to coinsurance. Large business risks are shared between more than one insurers under co-insurance arrangements at agreed percentages. All the formalities like issues the documents, collection of premiums and settlement of claims are handled by the leading insurer. The leading insurer renders statements of Accountants to the co-insurers. The auditor should see that the premium account is credited on the basis of statements received from the leading insurer. Incase the statement is not received, the premium is accounted for on the basis of advices to ensure that all premium in respect of risks assumed in any year is booked in the same year. As a normal audit procedure the audit should also review the communication in the post audit period. The auditor should insist in obtaining a written confirmation to the effect that all incoming advice has been accounted for. The claims provisions and claims paid should also be verified with reference to advice received from the leading insurer. In case of outgoing co-insurance the auditor should scrutinize the transactions relating to outgoing business; i.e. where the company is the leader. These should be checked with reference to the relevant risks assumed under policies and correspondingly for debits arising to the co-insurer on account of their share of claim. It is recommended that all the co-insurer specify all the terms and conditions in their agreement.

4 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

PART B DESCRIBE The Concept { 6 marks} Q.6 State the procedure for verification of Agents’ Balances in the course of audit of a General Insurance Company. ( Nov.04, May 09,Nov.10,Nov.11,) Answer General Insurance Company – Verification of Agents’ Balances: The following are the audit procedures for verification of outstanding agents’ balances: (i)

Scrutiny and review of control accounts debit balances and their nature should be enquired into. (ii) Examination of inoperative balances and treatment given for old balances be looked into. (iii) Enquiring into the reasons for retaining the old balance. (iv) Verification of old debit balances which may require provision or adjustment. Explanation be obtained from the management in this regard. Q.7 In the context of audit of general insurance business, state the provisions regarding management expenses.{Nov.01} Answer Provisions

regarding

Management

Expenses:

Section

40C

of

the

Insurance Act, 1938 read with Rule 17E lays down the provisions regarding limit on expenses of management in general insurance business.

It

requires that no insurer shall, in respect of any class of general insurance business transacted by him in India, spend in any calendar year as expenses

of

management

including

commission

or

remuneration

for

procuring business an amount in excess of the prescribed limits and in prescribing any such limits regard shall be had to the size and age of the insurer. However, any excessive amount over the permissible limits may be approved

by

the

Insurance

Regulatory

Development

Authority

after

consultation with the Executive Committee of the General Insurance Companies.

Further every insurer as aforesaid shall incorporate in the

revenue account a certificate signed by the Chairman and two directors and by the principal offi cer of the insurer, and by an auditor certifying that all expenses of management wherever incurred, whether directly or indirectly, in respect of the business referred to in this section, have been fully debited in the revenue account as expenses.

Such expenses mean all charges,

wherever incurred whether directly or indirectly, including commission payments of all kinds and, in the case of an insurer having his principal

5 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

place of business outside India, a proper share of head offi ce expenses, which shall not be less than such percentage as may be prescribed, of his gross premium income (that is to say, the premium income without taking into account premiums or re-insurance ceded or accepted) written direct in India during the year, but in computing the expenses of management in India the following, and only the following, expenses may be excluded, namely: (i) In the case of an insurer who has his principal place of business in India, a share of head offi ce expenses in respect of general insurance business transacted by him outside India not exceeding a prescribed percentage of his gross direct premium written outside India. (ii) Any expenses debited to the profit and loss account relating exclusively to the management of capital and dealings with shareholders and a proper share of managerial expenses calculated in the prescribed manner. Rules 17E of the Insurance Rules, 1939 deals with the computation and limitation of expenses of management in general insurance business. Q.8 What are Investment norms for General Insurance Companies? In exercise of the power conferred by the Insurance Act, 1938, the Authority, in consultation with the Insurance Advisory Committee, has made the Insurance Regulatory and Development Authority (Investment) Regulations are subject to revision by the Authority from time to time. Regulation 4 of the amended Regulations on investments prescribes that every insurer carrying on the business of general insurance should invest and at all times keep invested its total assets in the following manner: Investment in other than approved investment if (1) Such investment is less than 25 % of total investment and (2) Consent of all the directors have been obtained for such Insurer shall not invest in any one insurance or investment company exceeding (1) 10% of the total asset of insurer (2) 2% of share capital/debenture of the company (insurance or investment company such 2% may be 10% for investment in other than insurance or investment company. It should be noted that funds of the policy holders shall not be invested outside India. Every Insurer shall keep invested all the times 1. At least 20% of investment In government Securities 2. At least 30%(including (1)) State Government and other guaranteed securities 3. At least 5% Housing and Loan to state government

6 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

4. At leat 10%

Approved securities under Infrastructure/Social sector. Other Securities

5. Up to 55%

Part C Describe in Details { 8 Marks} Q.9 Describe the audit procedures to be followed for verification of premiums by a statutory auditor of a general insurance company.{ May 01,Nov.2002} Answer Verification of Premiums: In the audit of a general insurance company, verification of premium is one of the most important aspects for the statutory auditor. The following procedure should normally be applied for verification of premium: (i)

(ii)

(iii)

(iv)

(v)

(vi)

Ascertain that all the cover notes relating to the risks assumed have been serially numbered for each class of business. Ensure that the premium in respect of risks starting during the relevant accounting year has been accounted as premium income of that year but pertaining to risk commencing in the following year has been accounted as “Premium Received in Advance”. Verify the collections lodged by the agents after the balance sheet date to see whether any collection pertains to risk commencing for the year under audit. The auditor should also check that the premium has been recorded originally at the gross figure without providing for unexpired risks and re insurances. In case of co-insurance business, the auditor should see that the company’s share of premium has been accounted for on the basis of the available information on nature of risk and the provisional premium charged by the leading insurer. Check whether premium register have been maintained chronologically, for each underwriting department, giving full particulars including service tax charged as per acceptance advise on the day to day basis. Verify the year-end transactions to check that the amounts received during the year in respect of risks commencing or installments falling due on or after the first day of the next financial year are not credited to premium account but to Premium Received in Advance Account.

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(vii)

Verify the collections remitted by the agents after the cut-off date to verify the risks assumed during the year for those collections. If the premium originally received has been refunded, the auditor should verify whether the agency commission paid on such premium has been recovered from the agent.

Q.10 What are the specific areas to which you will give your attention while examining “Claims Paid” by a General Insurance Company. ( May 04,May 2010} Answer a.

Examination of claims paid: The following specific areas need to be given attention while examining ‘claims paid’ by the general insurance company: (i) (ii)

(iii)

(iv)

(v)

(vi)

(vii) (viii) (ix)

Obtaining information from branches/divisions regarding each class of business categorising the claims value-wise. Ascertaining the status of claims outstanding at the year-end on the basis of information available, with the company, claims for which company is liable, etc. To verify in the case of claims paid on the basis of advices from other insurance companies whether share of premium was also received by the company. Claims communicated to other insurance companies after the year end for losses which occurred prior to the year must be accounted for in the years of audit. Claim payments have been duly sanctioned by authority concerned and acknowledgements obtained from the recipients. Salvage recovered has been duly accounted and letter of subrogation has been obtained in accordance with the laid down procedure. Amounts deposited with the Courts where the litigation is not completed are treated as advance/deposit and held as assets till disposal of such claims. Past payment made against claims are duly vouched. Ensure that the claimant has given unqualified discharge note in the case of final payment of claims. In the case of co-insurance arrangements claims to be booked in respect of company’s share and the balance has to be debited to others insurance companies

PART- D

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PRACTICAL CASE STUDIES { 4 Marks Each} Q. 11 ABC Limited, an Indian insurance company carrying on general insurance business, is facing liquidity problems and, therefore, it has decided to maintain deposits under section 7 of the Insurance Act, 1938 at one percent of total gross premium written in India. The company thinks that it is sufficient, as the company has a Paid-up Capital of ` 150 Crores. As an Auditor of ABC Limited what would be your suggestion to the company for compliance of Insurance Act and rules and regulations made there under? Section 7 of the Insurance Act, 1938 requires every insurer, carrying a general insurance business, o to deposit and o keep deposited with RBI o in it’s one of the offices in India a sum equivalent to three percent of total gross premium written in India in any financial year. o The maximum limit of deposit under this section is Rupees ten crores. o The deposit is to be for and on behalf of the Government of India. o The deposit can be made either by way of cash or investment in approved securities. o The amount of deposit required in the case of reinsurance business is rupees twenty crores. In the given case, Since ABC Limited has decided to maintain deposits at one percent of the total gross premium written in India, which is violation of the Section 7 of the Insurance Act, 1938. The contention of the company that it has a paid up capital of ` 150 Crores would not make the difference. o

Q.12 As at 31st March 2013 while auditing Safe Insurance Ltd you observed that a policy has been issued on 25th March 2013 for fire risk favouring one of the leading corporate houses in the country without the actual receipt of premium and it was reflected as premium receivable. The company maintained that it is a usual practice in respect of big customers and the money was collected on 5th April, 2013. You further noticed that there was a fire accident in the premises of the insured on 31st March 2013 and a claim was lodged for the same. The insurance company also made a provision for claim. Please respond. According to section 64VB of the Insurance Act no risk can be assumed by the insurer unless the premium is received. No insurer should assume any risk in India in respect of any insurance business on which premium is ordinarily outstanding in India unless and until the premium payable is paid or is guaranteed to be paid by such person in such manner and within such time, as may be prescribed, or unless and until deposit of such amount, as may be prescribed, is

9 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

made in advance in the prescribed manner. In view of the above, the insurance company is not liable to pay the claim and hence no provision for claim is required.

CHAPTE R

AUDIT OF BANKS

2

PART-A SHORT NOTES {4 Marks} – Generally not asked PART B Describe a Concept { 4 to 6 Marks } Q.13. What is cash reserve? Every banking company, except a scheduled bank, shall maintain in India by way of cash reserve with itself, or by way of balance in a current account with the Reserve Bank, or by way of net balance in current accounts, or in one or more of the aforesaid ways, a sum equivalent to at least three per cent of the total of its

10 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

demand and time liabilities in India as on the last Friday of the second preceding fortnight. Every scheduled bank is required to maintain with the Reserve Bank an average daily balance the amount of which shall not be less than three per cent of the total of its demand and time liabilities in India. The said rate may, however, be increased by the Reserve Bank by notification up to 15% of the total of demand and time liabilities in India. The average daily balance and the additional balance required by such a notification are generally referred to as Statutory Deposit and Additional Statutory Deposit respectively. Q.14 What is Statutory Liquidity Ratio {May 02,Nov.03} Every banking company shall maintain in India in cash, gold or unencumbered approved securities an amount equivalent to, at the close of business on any day, twenty-five per cent, or such other percentage not exceeding forty, as the Reserve Bank of India may from time to time specify, of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight. This is known as `statutory liquidity ratio' (SLR). All banks are required to advise their statutory central auditors to verify the compliance of statutory liquidity ratio on twelve odd dates in different months not being Fridays. Topic - AUDIT OF INVESTMENTS IN BANK

Q. 15 Define HTM,AFS and HTM category of investments? Is shuffling from one category to another is permissible? { Nov.2008}

Held to maturity :- This category would comprise securities acquired by the bank with the intention to hold them aupt to maturity Held for Trading :- are short term investments held with an intention of trading Available for sale:- Investment which can not be classified into above two categories.

Held to Maturity { Nov.2005, following are the features of this type of investments:

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i. Classified in this category at the time of purchase. Reclassification is also permitted but as per rules as discussed later. ii. Maximum investment under this category can be 25% of the total investment by the bank. iii. Profit / loss on sale of investments in this category should be first taken to profit and loss account and thereafter profit should be appropriated to `Capital Reserve Account' Held for Trading following are the features of this type of investments: i. Purchased with the intention to trade in short term ii. The object is making profit by short term movement in prices. iii. These investments are to br sold with 90 Days. iv. Profit / loss on sale of investments in this category should be taken to profit and loss account. Available for Sale This is a residual category. The investment which are not classified among above two categories are classified here. Profit / loss on sale of investments in this category should be taken to profit and loss account. Shifting among Categories: Following guidelines should be followed while shifting the investment from one category to other: a. Shifting to / from Held to Maturity category can be shifted only once in a year only after approval of of Board of Directors, preferably at the beginning of the year. b. Shifting from Available for Sale category to Held for Trading category is permitted with the approval of Board of Directors / Investment Committee except in case of emergencies where Chief Executive of the bank can authorise such shifting provided later approval is taken from Board of Directors. c. Shifting from Held for Trading to Available for Sale is generally not permitted unless the bank is not able to sell those with in 90 days due to extreme market conditions. However approval of Board of Directors / Investment Committee is required.

12 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

d. Transfer from one to other category has to done at cost / book value /market value whichevr is least on the date of transfer. Q.16 How investments are valued in case of Bank? Following are the valuations rules in a Bank? 1. Held to Maturity: Investment should be carried at acquistion cost except where the acquistion cost is more than face value. In that case the amount above the face value should be amortised over the period of maturity. Any permanent decline in the value of investment in subsidiaries and joint ventures under this category should provided. 2.Available for Sale: All the scrip in this category should be marked to market at the interval of a quarter or less. Net depreciation in any category should be provided for in the profit and loss account and net appreciation should be ignored. The amount of provision made in the profit and loss account, net of taxes and net of consequent reduction in the transfer to Statutory Reserve, should be credited back to profit and loss account from Investment Fluctuation Reserve. In case of subsequent reversal of this amount credit for the same to be given to Investment Fluctuation Reserve. 3.Held for Trading: Should be marked to market in a interval of a month or less. Q.17 What do you mean by Investment Fluctuation Reserve? The banks are required to create Investment Fluctuation Reserve (IFR) with a minimum of 5% of the Investment portfolio . In calculating the portfolio the investment in "Held for Maturity" should not be included. The requirement of 5% is the minimum requirement and banks can create the reserve to the extent of 10%. The bank should try to credit this account with the maximun amount of gains on sale of investment and the portion of realised gains on two categories except "Held for Maturity" .This transfer will be an appropriation to profit and loss account. Topic AUDIT OF ADVANCES Q.18 What is a Non performing Assets { May 2000,Nov. 2000, May 05, May 06, May 11,} Non performing assets are such advances which are not performing to realise the income from interest. Following are the norms how the advance facilities are treated by banks as NPA (a)Term Loans: A term loan is treated as a non-performing asset (NPA) if interest and/or instalment of principal remain overdue for a period of more than 90 days. (b) Cash Credits and Overdrafts: A cash credit or overdraft account is treated as NPA if it remains out of order as indicated above. An account should be treated as

13 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power.In cases where the outstanding balance in the principal operating account is less than the aanctioned limit/drawing power, but there are no credits continuously for 90 days as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should also be treated as 'out of order'. Further, any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on the due date fixed by the bank. (c) Bills Purchased and Discounted: Bills purchased and discounted are treated as NPA if they remain overdue and unpaid for a period of more than 90 days. (d) Securitisation: The asset is to be treated as NPA if the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006. (e) Agricultural Advances: A loan granted for short duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for two crop seasons and, a loan granted for long duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for one crop season. As per the guidelines, “long duration” crops would be crops with crop season longer than one year and crops, which are not “long duration” crops would be treated as “short duration” crops. The crop season for each crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers’ Committee in each State. (f) Credit Card Accounts: RBI vide its Circular No. DBOD.No.BP.BC.78/21.04.048/2013-14 on “Prudential Norms on Income Recognition, Asset Classification and Provisioning ertaining to Advances – Credit Card Accounts” dated December 20, 2013 advised that a credit card account will be treated as non-performing asset if the minimum amount due, as mentioned in the statement, is not paid fully within 90 days from the next statement date. The gap between two statements should not be more than a month. It is further suggested by RBI that banks should follow this uniform method of determining over-due status for credit card accounts while reporting to credit information companies and for the purpose of levying of penal charges, viz., late payment charges, etc., if any . Classification Norms relating to NPAs Accounts with Temporary Deficiencies The classification of an asset as NPA should be based on the record of recovery. Bank should not classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as non-availability of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the limit temporarily, nonsubmission of stock statements and non-renewal of the limits on the due date, etc. In the matter of classification of accounts with temporary deficiencies, banks have to follow the following guidelines: (a) Banks should ensure that drawings in the working capital account are covered by the adequacy of the current assets, since current assets are first appropriated in times of distress. Drawing power is required to be arrived at based on current stock

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statement. Proper computation of drawing power is imperative as the advances are to be checked with reference thereto. The creditors should be reduced from the stock and debtors within the stipulated period while calculating the drawing power. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. (b) The outstanding in the account based on drawing power calculated from stock statements older than three months is deemed as irregular. (c) A working capital borrowing account will become NPA if such irregular drawings are permitted in the account for a continuous period of 90 day even though the unit may be working or the borrower's financial positionis satisfactory. (d) Regular and ad hoc credit limits need to be reviewed/ regularised not later than three months from the due date/date of ad hoc sanction. In case of constraints such as non availability of financial statements and other data from the borrowers, the branch should furnish evidence to show that renewal/ review of credit limits is already on and would be completed soon. In any case, delay beyond six months is not considered desirable as a general discipline. Hence, an account where the regular/ adhoc credit limits have not been reviewed/ renewed within 180 days from the due date/ date of adhoc sanction will be treated as NPA. Government Guaranteed Advances The credit facilities backed by guarantees of Central Government though overdue may be treated as NPA only when the government repudiates its guarantee when invoked. This exemption from classification of Central Government guaranteed advances as NPA is not for the purpose of recognition of income. In case of State Government guaranteed loans, this exemption willnot be available and such account will be NPA if interest / principal / other dues remain overdue for more than 90 days. Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc. Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life policies need not be treated as NPAs, provided adequate margin is available in the accounts. Advance against gold ornaments, government securities and all other securities are not covered by this exemption. Q.19 What is Reversal of income { Nov.2010} If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, the entire interest accrued and credited to income account in the past periods, should be reversed or provided for if the same is not realised. This will apply to Government guaranteed accounts also. In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected. respectively.

Q.20 How advances should be classified ? Categories of NPAs

15 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Banks are required to classify nonperforming assets further into the following three ategories based on the period for which the asset has remained nonperforming and the realisability of the dues: i. Substandard Assets ii. Doubtful Assets iii. Loss Assets Substandard Assets With effect from 31 March 2005, a substandard asset would be one, which has remained NPA for a period less than or equal to 12 months. In such cases, the current net worth of the borrower/ guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full. In other words, such an asset will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. Doubtful Assets With effect from March 31, 2005, an asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, – on the basis of currently known facts, conditions and values – highly questionable and improbable. Loss Assets A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.

Q.21 What are PROVISIONING Norms? For Loss assets Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for. For Doubtful assets i. 100 percent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse and the realisable value is estimated on a realistic basis. ii. In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 percent to 100 percent of the secured portion depending upon the period for which the asset has remained doubtful: Period for which the advance has remained in ‘doubtful’ category Provision requirement (%) Up to one year 25

16 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

One to three years 40 More than three years 100 In case of NPAs with balance of 5 crores or more annual stock audit by external agencies is required. Substandard assets A general provision of 15 percent on total outstanding should be made without making any allowance for ECGC guarantee cover and securities available. The ‘unsecured exposures’ which are identified as ‘substandard’ would attract additional provision of 10 per cent, i.e., a total of 25 per cent on the outstanding balance. The provisioning requirement for unsecured ‘doubtful’ assets is 100 per cent. Unsecured exposure is defined as an exposure where the realisable value of the ecurity, as assessed by the bank/approved valuers/Reserve Bank’s inspecting officers, is not more than 10 percent, ab-initio, of the outstanding exposure. Standard assets (i) Banks should make general provision for standard assets at the following rates for the funded outstanding on global loan portfolio basis: (a) direct advances to agricultural and SME sectors at 0.25 per cent; (b) advances to Commercial Real Estate (CRE) Sector at 1.00 per cent; (c) all other loans and advances not included in (a) and (b) above at 0.40 per cent

How and Auditor consider when audit following in case of bank? Q.22 Bills for Collection Q.23 Bill purchased Q.24 Credit card Operations Q.25 Loans Q.26 Inter Branch Office Adjustments Bills for Collection 1. All documents accompanying the bill should be received and entered in the register by a proper officer. 2. The accounts of the principals should be credited only after realisation of the bill. 3. It should be ensured that bills sent by one branch to another branch for collection are not included twice in the amalgamated balance sheet. Bills Purchased 1. At the time of purchase of the bills, an officer should verify that all documents of title are properly assigned to the bank. 2. Sufficient margin should be kept while purchasing or discounting of a bill. 3. All irregular outstanding accounts should be periodically reported to the head office.

17 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

4. Incase of purchase or discounting of a bill, proportionate income should be recognized between the periods. Credit Card Operations ( Nov.09, 1. There should be effective screening of applications with reasonably good credit assessment. 2. There should be strict control over storage and issue of credit cards. 3. The system whereby the merchant confirms the unutilized balance of the customer With the bank before accepting payment should be properly installed. 4. There should be a system of prompt reporting by the merchants of all settlements accepted by them through credit cards. 5. All the reimbursements should be immediately charged to the customer's account. 6. Items overdue beyond a reasonable period should be identified and attended to carefully. 1. There should be a system of periodic review of credit card holder's accounts.

LOANS and advances internal control procedures {Nov.2009} : 1. Auditor should verify Loan documents . 2. Auditor should verify the securities hypothecated against loan. 3. Auditor shall evaluate the internal control, procedures for loans applied by the bank. 4. Auditor shall verify whether loan agreements (sanction limits) are within authority of bank. 5. Auditors shall verify whether bank is properly following up the loan. 6. Auditor shall verify NPA and their provisions. 7. Auditor shall verify Interest calculations. 8. Auditor shall assess whether the person loaned has healthy turnover in account. 9. Whether repayment schedule is made considering repayment capacity of borrower. 10.If borrower is a company, whether there is proper resolution to borrow amount from bank. What are Inter Branch Adjustment? { May 09, The following points require special attention in the examination of Inter Branch transactions.

18 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

(i) While verifying the closing balance, special attention should be paid to the origin and validity of old outstanding unmatched entries, particularly debit entries. The auditor may also seek confirmation of transactions relating to outstanding in appropriate cases. (ii) Whether there are any reversal entries indicating the possibility of irregular payments or frauds. (iii) Whether the balances include any items in the nature of cash in transit included in this head which remain pending for more than a reasonable period. This is because such items are not expected to remain outstanding beyond a very small period during which they are in transit. (v) Whether transactions other than those relating to inter branch transactions have been included in inter branch accounts. Any unusual items put through inter branch accounts as well as old or large entries outstanding in Inter branch accounts should be carefully looked into. The auditor should also seek explanations from the Management in this regard in appropriate cases.

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CHAPTE R

AUDIT OF CO-OPERATIVE SOCIETIES

20 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

3 Q.27What are the significant features of audit of co operative society? 1. Qualification of the auditor: Apart from a chartered Accountant following can be appointed as an auditor provided the State Co-operative Acts specify so. (a) Person holding a Government diploma in co-operative accounts (b) Person holding a Government diploma in co-operation and accountancy (c) Person who has served as an auditor in co-operative department of a government. 2. Appointment of auditors: Registrar of co-operative societies appoints the auditor of a co-operative society and the auditor reports to the Registrar as well as the society. But the audit fees are paid by the societies as may be prescribed by the Registrar on the basis of scale of the co-operative society as may be prescribed. For example fees of co-operative credit societies are determined on the basis of Working Capital. 3. Books, accounts and other records maintained by the co-operative societies: Central co-operative society Act nowhere provides for maintenance of books of accounts but the respective state Acts do provide provisions for maintenance of books of accounts. At least followings books of accounts should be maintained: (a) Detailed Cash Book along with proper narration (b) Sales ledger (c) Purchase ledger (d) Stock register (e) Accounts relating to all the assets of the society (f) Accounts relating to all the liability of the society However it should be noted that it is not necessary that all the above listed books have to be maintained even if there is no such transactions in the society. It should be appreciated that the statutory rules only provides a direction to maintain books

21 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

of account and the society is free to maintain any additional books of accounts for better disclosure and transparency. Following details books can also be maintained: 1) Daily cash sales summary register 2) A register of collection from debtors if any 3) Register of recoveries of loans from salaries 4) Loan disbursement register in case of credit society 5) Any others detailed register depending on nature and volume of transactions. 4. Restrictions on Share holdings: A person cannot become a member and hold shares of limited liabilities societies to the following extent unless it is a registered society. i. 20% of the total number of shares; ii. Shares of the value of Rs. 1000, whichever is higher. 5. Restrictions on loans: A registered society shall not make loans to persons other than its members. However, with a special sanction of Registrar loans can be given to another registered society. 6. Restriction on borrowings: The auditor should verify that borrowings of a registered society are with in the limits and as per the policy in laid down in byelaws of the society. 7. Investment of funds: A co-operative society can invest in one or more of the following: (1) Central or state co-operative bank (2) Securities specified in the Indian Trust Act, 1882 (3) In the shares, securities, bonds or debentures of any other society with limited liability. (4) In co-operative banks other than those mentioned in (i) above, as approved by the registrar. (5) In any other moneys as permitted by Central or State Government. 8. Appropriation of profits: A co-operative society has to transfer at least 25% of its profit to reserve funds, before distribution of dividends or bonus to members. In

22 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

case the financial position of the society does not permit such transfer, the Registrar can reduce the transfer to the extent of 10%. 9. Investment of Reserve fund outside the business or utilization as working capital: The co-operative society may use its reserve fund as follows: (1) In the regular business of the society itself (2) Investing in the securities as per norms discussed in Point 7 above. (3) May be used for some public purpose likely to promote the object of the society. 10. Contribution to Education Fund: Some state Acts require that every society should contribute annually towards the Education Fund of the State Federal Society. The amount of contribution will as may be prescribed depending on the class of society. Further the amount of contribution will be a charge against profit and not an appropriation. The auditor should ensure compliance of these requirements.

Q.28 What are Special Features of such Audit of co-operative society? Audit of co-operative society is also similar like other form of organization. The auditor has to apply all of his normal audit procedure like checking of posting, vouching, verification etc. However there are some special audit procedures the auditor should keep in mind while conducting an audit of the co-operative society. 1. Examination of overdue debts: The auditor has to classify the overdue debts as overdue from six months to five years and more than five years. Further classification as per the chance of recovery has to be made. The auditor should check the adequacy of provision made on such debts based on the chance of recoverability. Percentage of overdue debts to working capital and its comparison with past years can help in identifying the trend into increasing or decreasing overdue. The auditor should see whether proper action for recovery has been initiated and its current status. 2. Overdue interest: The treatment of overdue interest is same as of income from NPA assets. Interest accrued or accruing in respect of which the principle sum is overdue is the overdue interest. Such interest should be excluded while calculating profits and credit to a separate account called overdue interest reserve account. 3. Certification of bad debts: The laws of different state provide different regulation for writing of the bad debt. For example, Maharastra State co-operative Rule provides that any write off must be certified by the auditor as bad and then only it can be written off. In absence of such a provision the management committee has to approve the write offs.

23 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

4. Adherence to co-operative principles: The auditor has to make an assessment as to fulfillment of the objective of establishing of the co-operative society. 5. Compliance with the provisions of the Act and byeLaws: The auditor has to point out infringement of laws and byelaws by the society. The auditor should also quantify the effects of that infringement. 6. Verification of member's Register and examination of their passbooks: The auditor should verify the entries in members pass book regarding loan given and its repayments the auditor should also confirm the balance with the members in person. This will provide corroborative evidence that the entries in the books of accounts have not been manipulated.

CHAPTE R

4

AUDIT OF VARIOUS ENTITIES

Q.29 What considerations are required in an Audit of depositories? As per SEBI Rules all the depositories and its participants are required to establish adequate control systems depend on the level of activities. SEBI is empowered to conduct the inspection or audit of Depositories. Depositories are required to maintain the following records and documents: 1. Records of securities dematerialized and rematerialized 2. The names of the transferor, transferee and the dates of transfer of securities 3. A register and an index of beneficial owners 4. Records of instruction received from and sent to participants, issuer, issuer's agent and beneficial owners 5. Details of participants 6. Details of securities declared to be eligible for dematerialization 7. Any other records as may be prescribed

24 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Place of keeping the books are to be intimated to the Board and the records should be preserved for a period of 5 years. The SEBI can investigate the affairs of following persons: 1. A depository 2. A participant 3. A beneficial owner 4. An issuer 5. An agent of the issuer The SEBI can investigate the accounts and records of the above persons for the following reasons: 1. To ensure that books of accounts are being maintained as per the regulation 2. To investigate the complaints received from depository, participant, beneficial owner, issuer, agent of the issuer or any other person 3. To ascertain the compliance by all the acts and regulation by depository, participant, beneficial owner, issuer, agent of the issuer 4. To ascertain the adequacy of the systems, procedure and safeguards being followed by a depository, participants, beneficial owners, issuer or its agent 5. Suo motu to ensure that the affairs of depository, participant, beneficial owner, issuer, agent of the issuer are being conducted in the best interest of the investor. The SEBI has power to appoint the auditor to inspect or investigate, into the books of account, records, documents, infrastructure, systems and procedure or affairs of a depository, participant, beneficial owner, issuer, agent of the issuer.

Q. 31 Discuss the Audit Check List of Equipment Leasing Finance Company

a. Ascertain whether proposals for Leasing are accepted only after adequate appraisal. b. The auditor should verify whether there is an adequate system in place for ensuring installation of assets and their periodical physical verification.

25 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

c. The system for ensuring that the asset is adequately insured and properly maintained should be in place. d. The auditor should ensure that leasing transactions are classified and accounted as per AS- 19 “Leases”. e. Ensure that the provisions relating to asset classification, provisioning and income recognition laid down for lease financing by NBFCs are observed.

Q. 32 Discuss the Audit Check List of Hire Purchase Finance Company a. The auditor should verify whether there is a proper system in place for adequate appraisal of proposals. b. The auditor should verify that payments for assets are made directly to the vendor and the assets are in the name of the company. c. The auditor should verify whether an adequate system is in place to ensure installation of the asset and their periodic physical verification. d. If the hire purchase agreement is against vehicles, the registration certificate should contain an endorsement in favour of the financing company. e. The auditor should verify whether there is adequate system to ensure that no charges are created on the assets by the borrower with proper approval of the financing company. f. The auditor should check whether interest income is properly recognized. g. The auditor should verify that hire purchase assets are adequately insured. h. The auditor should examine the valuation of goods sold on hire purchase and goods repossessed. i. The auditor should ensure that provisions relating to asset classification, income recognition and provisioning laid down for hire purchase financing by NBFCs have been observed. Q. 33 Describe the checklist of audit of Investment Company a. The investment certificates should be physically verified. In case if they are pledged with another person; certificate to that effect should be obtained from such institution.

26 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

b. Verify whether investments made by the NBFC are within limits laid down under the NBFC prudential norms. c. Check that no loans have been advanced on the security of its own share. d. Verify that income in the form of interest, dividend and capital gains is properly recognized. e. Test Check the contract notes received from brokers with the prices in the stock market on the respective dates. f. Ensure that there is a proper system of authorization for purchase and sale of investments. g. Check whether investments have been valued as per NBFC Prudential Norms and AS 13 “Accounting for Investments”. h. Check the investments made in subsidiary / group companies for basis for price paid, quantum of investment made etc. i. Check whether investments in unquoted debentures and bonds have not been classified as investments but as term loans for the purpose of asset classification, provisioning and income recognition. j. In case of securities lent / borrowed under securities lending scheme of SEBI, verify the terms and conditions of the agreement. k. In respect of shares/securities held through a depository, obtain a confirmation from the depository regarding the shares/securities held by it on behalf of the NBFC. l. Verify charges received or paid in respect of securities, lend/borrowed;

Q. 34 Describe the Checklist of audit of Loan Company a. The auditor should verify whether there is system in place for proper appraisal, and sanction of loans. b. The auditor should verify the terms of sanction and security obtained. c. Verify that adequate records are maintained as regards the bill discounting facilities. d. Check that the loans are within the limits specified for single and group borrowers.

27 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

e. No loans should be given on the security of NBFCs own shares. f. Check whether norms for asset classification, provisioning and income recognition as specified for credit facilities have been adhered to. g. The auditor may also obtain balance confirmation from the borrowers. h. In case of companies which are engaged in the business of providing short term funds in the ICDs market, the auditor should ascertain whether the NBFC has a regular system for ascertaining the credit worthiness of the clients prior to placed by the company are being rolled over and whether there is any risk of non-recovery. i. An auditor should also verify whether provision for bad and doubtful debts has been disclosed separately in the B/S and the same have not been netted off against the income or against the value of assets as required by the NBFC Prudential Norms Directions.

CHAPTE R

5

AUDIT OF MEMBER OF STOCK EXCHANGE

Q.35 Who can conduct business at stock exchanges and how SEBI controls the same? 



Business at Stock Exchange can be transacted only by its members. They enter into transaction either on their own behalf or their clients or sub-brokers Every active member shall get his accounts audited by a chartered accountant. Company can also become a member of stock exchange.. SEBI may levy monetary fine & penalties on any person in following cases: (i)

Failure to furnish document information etc. required by Board

(ii)

Failure to maintain books of accounts/returns.

28 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

(iii)

Failure by sponsor of any collective investment scheme including M.F. to obtain registration certificate. To comply with terms of such certificate, to dispatch unite certificate, to refund application money, to invest money in desired manner & in specified securities.

(iv)

Failure to Issue contract notes in form required, to deliver security, make payment to client, charging excess brokerage.

(v) Failure to enter into agreement with client. (vi) Person dealing/communicating on basis of price sensitive information. (vii)

Failure to disclose aggregate of shareholding in body corporate before acquiring furthers share & to make public announcement to acquire share at minimum price in case of takeovers.

Q.36 HOW MANY TYPES OF MEMBERS GENERALLY THERE IN STOCK EXCHANGE? Only the members can transact business at the stock exchanges. Their membership is restricted and is based on rules and regulations regarding the admission of members as developed by them. There are two different categories of members: 1. Jobbers: They do trading for their personal gain or loss. They normally purchase or sell Shares to other members. 2. Brokers: They act as agents on behalf of their principals for buying and selling shares on prescribed rates of brokerage. Further the members can be named according to the acts of the members as: 1. Floor Brokers: They execute orders on the floor of the stock exchange on behalf of other members on a small commission. 2. Dealers in non-cleared securities: They mainly deal in the not-too-active scrip’s. They do buying and selling shares on their own account. They generally buy what is offered and sell as per demand. 3. Odd-lot dealers: They deal in shares, which are in a smaller lot than the market lot. They buy shares in odd lot at a low price and make them into marketable lots for sale and thus make profit. 4. Dealers in Government Securities: This is a specialized form of jobbing and broking business, involving dealings in gilt-edged securities issued by Central and State Governments, Electricity Boards, Municipal Corporations and Financial Institutions. 5. Underwriters and brokers to the new issues: This is a specialized field where the underwriters undertake to underwrite the shares/ debentures offered to the public in consideration of a specified commission.

29 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Q.37 What do you mean by MARGIN and how many type of Margin stock exchanges accept from members? Due to wide fluctuations in prices of securities over a period of time, the exchange levies margin on its members. This certain deposit is to be kept with exchange by its members. This mechanism is adopted, in order to restrict excessive speculations and safeguard the interest of the investors. The members are required to collect margins from their clients and deposit it with the clearing house of exchange. The three types of margins are – 1. Volatility Margin : The volatility margin is imposed to curb excessive volatility in the securities.It is also used to prevent building up of excessive outstanding positions. This margin is calculated at the discretion of stock exchange to charge margin on any particular security because of its volatile nature, on specific percentage. 2. Gross Exposure Margin : It is the percentage of net cumulative outstanding position in each security that the member should keep with the exchange at all times. This margin is calculated on continuous basis. This margin is to be kept with stock exchange in advance. Gross exposure is calculated on all securities unlike volatility margin which is on any specific security. 3. Mark to Market Margin : This margin is imposed to cover a loss that a member may incur in case the transaction is closed out at the closing price of the trading day, which is different from the price at which the transaction has been entered into. It is the notional loss if net cumulative outstanding position in all the securities were closed out at closing price of relevant transaction date, for a specific member.

Q.38 How one can classify the markets in stock exchange on the basis of orders? There are four types of market. I.

Normal Market – All orders which are of the regular lot size or multiples thereof are traded in the Normal Market. For D-mat shares, lot size is 1 share.

II.

Odd lot Market – An order is called an odd lot order if the order size is less than the regular lot size, such orders are traded in the odd lot market. But for order matching both price & quantity should tally with each other.

III.

Spot Market – in all respects spot orders are similar to the normal market orders except that spot orders have different settlement periods vis-à-vis normal orders. Pay in pay out takes place on the same day.

IV.

Auction Market – Stock exchange on behalf of their members initiate auctions to purchase from the market, the number of shares short deposited by the members. In this way, they complete the settlement process. Loss is recovered from members but profit it any deposited to investors education & protection fund.

30 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Q. 39What is Circuit Filter

Circuit filters are price bands imposed by the Securities Exchange Board of India (SEBI) to restrict the movement of stock prices (up or down), of listed securities. This is to curb manipulation done in share prices by operators. Stock exchanges introduced circuit filters, as per SEBI guidelines to prevent a steep fall/rise in stock prices and to safe guard interest of investors from volatility in price. How do they work? When the stock price breaches a stipulated price band as decided by stock exchanges, trading in that particular stock is suspended. For example, if you have a share price of Rs 100, and there is a circuit breaker of 5%, it will stop trading if the share price goes above Rs 105. Similarly. if the stock drops below Rs 95, the lower end circuit filter is applied and trading is suspended. Circuits limit for stock exchanges There are three circuit filters for indices - 10%, 15%, and 20%. These filters are applied to Sensex or Nifty whichever crosses the limit first. The trigger also depends on the time at which it occurs. Q.40 what is rolling settlement? Rolling settlement is a system to settle share transactions in predefined number or days. It is a mechanism of settling trades done on a stock exchange on the Day Day of Trade (T) plus "X" trading days. "X" trading days could be any number of days like 1,2,3,4 or 5 days. So, if we say the rolling settlement for a transaction is T+3 then it means that the transaction will be settled in TODAY + Next 3 Days. In other words, in T+3 environment, a trade done on T day is settled on the 3rd working day excluding the T day. In Rolling Settlements, share trading done on each single day are settled separately from the trades done on earlier or subsequent trading days. In India, after April 1, 2002, all trades done on stock exchange are settled on T+3 basis. There could be some deviations because of Bank Closing or National Holidays. At NSE and BSE, trades in rolling settlement are settled on a T+2 basis i.e. on the 2nd working day. Saturdays and Sundays are excluded because the stock exchanges remain closed on weekends.

31 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTER

6

AUDIT OF PUBLIC SECTOR UNDERTAKINGS

Q.41 WHAT IS OBJECTIVE AND SCOPE OF AUDIT OF PUBLIC SECTOR ENTERPRISES? The scope and extent of Audit of Public Enterprises has not been defined in any act but is determined by the Comptroller and Auditor General. Audit of public enterprises in India is not restricted to financial and compliance audit; it extends also to efficiency, economy and effectiveness with which these operate and fulfill their objectives and goals. Another aspect of PSU audit relates to questions of propriety and the propriety element is the examination of management decisions on sales, purchases, contracts, etc. to see whether these have taken in the best interest of the undertaking and confirm to accepted principles of financial propriety. A multiple set of audit exists in case of public enterprises audit under the Companies Act, 1956. Apart from audit by a statutory auditor, the C & AG issues a set of directions to them and can also issue a separate report by way of comment on the report submitted by the statutory auditor. The C&AG also has the right to conduct supplementary or test audit. The objective of Government audit is to ensure: 1. That all the expenditure is duly authorized; 2. That the expenditure is sanctioned properly and incurred by a competent person; 3. That the payment has in fact been made and to competent person; 4. That in case of audit of receipts, sums are duly recovered and also credited into correct account; 5. That all the expenditure conforms to the general principle of propriety as discussed below.

Q.42 WHAT DO YOU MEAN BY PROPRIETY AUDIT? The dictionary meaning of the word propriety is “accuracy or justness”. But in auditing term it stands for verification of transactions on the ground of best public interest, commonly accepted customs and standards of conduct. Instead of too much dependence on documents vouchers, supporting of expenses etc. it shifts the emphasis to the

32 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

substance of transactions and looks into appropriateness thereof on ground of financial prudence, public interest and waste less expenditure. Thus propriety audit is concerned with scrutiny of exclusive decisions bearing on the financial and the Profit and Loss situation of the company with special regard to public interest and commonly accepted customs and standards of conduct. While performing a propriety audit, the auditor would judge whether in making payment, incurring expenditure the officer has exercised same level of vigilance, as an ordinary person will do in his own expenditure. The standards of propriety in vogue with regards to Government spending in India can be taken as general principle of propriety. They are as follows: i.

The expenditure should not be prima facie more than the occasion demands and that every official exercises the same degree of vigilance as in respect of his own money. ii. No authority in the exercise of its powers of sanctioning expenditure should pass an order, which will be directly or indirectly to its own advantage. iii. The funds should not be utilized for the benefit of a particular person or group of persons. iv. Apart from the agreed remuneration or reward there should not be left open any other avenue to indirectly benefit the management, personnel, employees and others. v. Allowances and other payments, other than those covered in the agreed remuneration should not be allowed to be a source of profit for the recipient (e.g., daily allowance for outstation work)

Q. 43 write short note on Supplementary Audit? The Audited accounts along with report of the Statutory Auditors are reviewed by C&AG. On the basis of the review and predetermined parameters, a decision is taken whether to conduct supplementary audit under section 619 (3) (b) of the Companies Act, 1956 of the financial statements of a PSE. This supplementary audit carried out independently is limited primarily to the inquiries of the statutory auditors and Company personnel and a selective examination of some of the accounting records. Based on such a supplementary audit, significant audit observations, if any, are reported under section 619 (4) of the Companies Act, 1956 to be placed before the Annual General Meeting. The supplementary audit by C&AG also oversees any undue observations of auditors, if any, and provides a safeguard to the management of PSEs. The Annual reports of the Central Public Sector Enterprises including financial statements are laid before both the houses of the Parliament. A gist of significant audit observations made on the accounts of CPSEs are compiled in C&AGs' Audit Report and are laid before both the houses of the Parliament

33 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

34 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTE R

7

AUDIT OF COST RECORDS

Q.44 What is Cost Audit? Cost audit is the audit of costing records of a company. Cost audit represents the verification of cost accounts and a check on the adherence to cost accounting plan. In brief cost audit comprises: (a) Verification of cost accounting records such as accuracy of the cost accounts, cost reports, cost statements, cost data and costing technique, and (b) Examination of these records to ensure that they adhere to cost accounting principle, plans, procedure and objectives. Q.45 What are the various types of Cost Audits? (1) On behalf of management : (i) Establishing accuracy of cost data (ii) Whether objectives of Cost Account being achieved. (iii) Abnormal losses and gains with causes.

35 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

(iv) Determine unit cost of production (v) Proper overhead rates. (vi) Fixation of contract price. (vii) Improving quality of Cost Accounting System. (2) On Behalf of a Customer :

For Cost plus contracts

(3) On Behalf of Government

:For subsidies etc., may be to determine fair price.

(4) By Trade Association

:

Maintenance of a price.

(5) Statutory Cost Audit

:

U/s. 233 B of the Companies Act

Other circumstances where cost audit may be called for : (i) Price fixation, (ii) Cost variation within the industry, (iii) Inefficient management (iv) Tax assessment (v) Trade dispute. Q.46 What are the requirements of Cost Audit in a Company? The Central government may on its discretion order for the audit of cost accounts of any company by the auditor in such a manner as decided by the Central Government. The auditor will be a Cost Accountant with in the meaning of the Cost and Works Accountant Act, 1959. However, if the Central Government is in the opinion that sufficient number of cost accountants are not available for conducting the cost audit of the companies generally, then the Government may, by notification in the Official Gazette, direct that, for such period as may be specified in such notification, Chartered Accountant with in the meaning of Chartered Accountant Act 1949 as possess the prescribed qualification, may also conduct the audit of the cost accounts of the companies, and thereafter the Chartered. Accountant may be appointed to audit the cost accounts of the company. Further a firm of Cost Accountant or Chartered Accountant may be appointed as auditor u/s 233B. The Board of Directors of the company with the previous approval of the Central Government will appoint such an auditor.All the disqualification applicable to a company auditor u/s 226(3)&(4) will be applicable to a cost auditor also. Further the statutory auditor of a company cannot be appointed as cost auditor for that company. Before the appointment of the cost auditor by the Board, a written representation should be taken from the auditor that the proposed appointment will be in accordance with the limit prescribed under section 224(1B). Such an auditor shall make his report to the Central Government in such form and manner and with such time as may be prescribed and shall also at the same time forward a copy of the report to the company concerned. The company shall, within 30 days from the date of receipt of a copy of the report, furnish to the central government with full information and explanation on every reservation or qualification contained in such report. After the report has been furnished and the Central government is of opinion that any further information or explanation is necessary, then Government may call for such further information and explanation and

36 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

thereupon the company shall furnish the same within the time as may be specified by the Government. The Central Government may take any steps as deemed necessary based on the report. It may be directed that the report should be circulated among the members of the company, along with the notice of General meeting held first time after submission of report. The Government may specify to circulate the whole of the report or any part of that.

CHAPTE R

8

AUDIT UNDER

FISCAL LAWS

37 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Q.47 Write short note on EXCISE AUDIT? The concept of Excise Duty came into force with effect from 1 st December 1999. But that time it was applicable only for limited manufacturers. At present it is applicable to entities based on following slabs

Quantum of annual total duty payment

Frequency of audit

More than 3 crores

Every year

From 1 Cr. Up to 3 Crore.

Once in every two years

Fron 50 Lakhs to up to 1 crore

Once in every five year

Below 50 Lakhs

10% of the units every year

Process of auditing 1. Preliminary review about assessee 2. Gathering information through records and documents 3. Physical verification of plant 4. Evaluation of Internal control and risk assessment 5. Verification 6. Conclusion and reporting

Q.48 Write short note on Service tax Audit Director General of Audit, New Delhi has prepared Service Tax Audit Manual, 2010. As per the guidelines, tax payers whose annual service tax payment (including cash and CENVAT) was Rs.3 crore or more in the preceding financial year may be subjected to mandatory audit each year. It is preferable that Audit of all such Units is done by using Computer Assisted Audit Program (CAAP) techniques. The frequency of audit for other taxpayers would be as per following norms:-

38 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Quantum of annual total ST ( Cash +CENVAT) payment

Frequency of audit

More than 3 crores

Every year

From 1 Cr. Up to 3 Crore.

Once in every two years

From 25 Lakhs to up to 1 crore

Once in every five year

Up to 25 Lakhs

2% of the units every year

Q.49 Describe VAT audit ? VAT is a tax on the value added to the commodity at each stage in production and distribution chain. VAT is an indirect tax on consumption. The total amount of tax, which is to be collected at the final or retail point of sale, is collected in installments. Major states who have introduced VAT have generally incorporated audit provisions in their VAT legislation. a. The turnover of sales/purchases of goods has been properly determined. The sales turnover arrived at by applying the generally accepted accounting policies may not be the same as required under the VAT law. b. The turnover of purchases should be verified to enable the auditor to get the purchases eligible for grant of input tax credit segregated from other purchases. c. The auditor is expected to list out the due dates of filing of returns and find out the reasons for delay in filing the returns, if any. d. The auditor should apply tests as will enable him to ascertain whether the auditee is eligible for composition. e. The auditor may also be expected to check the consolidation of the returns filed for all the periods covered in the year under audit. f. The auditor should check whether all the transactions relating to sale and purchase are entered in the books of account and have been taken into consideration while filing the returns. Audit Report under the Vat Law - At the end of the audit the auditor has to arrive at his conclusion on the matters to be reported in the audit report. The format of the audit report is generally prescribed under the relevant VAT law and the auditor has to fill in all the columns of the audit report that are applicable. His

39 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

opinion is on the adequacy of accounting records, correctness and completeness and arithmetical consistency of returns filed.

TOPIC – TAX AUDIT NOTE :- questions of this topic are highly practical oriented hence you have to answer all the questions relating to this topic according to your practical knowledge earned in office.

Q.50. As a tax auditor, how would you report on the following: a. Labour charges paid on which tax deducted at source at an inappropriate rate. b. Capital expenditure incurred for Scientific Research Assets. Ans: a. If tax is deducted at an inappropriate rate, the amount is disallowable under section 40(a)(ia) of the Income-tax Act. This fact needs to be reported in Form 3CD where all amounts inadmissible under section 40(a) are to be reported. b. Clauses 15 of Form 3CD requires to report the expenditure on Scientific Research (capital as well as revenue) covered under section 35 of the IT Act, 1961. Accordingly, the auditor should report the amount of capital expenditure not debited to the P/L a/c which is eligible for deduction u/s 25 as Scientific Research Expenditure. Q.51 : Discuss the reporting requirements in Form 3CD of the Tax Audit Report U/S 44AB of the Income-tax Act, 1961 for the following: a. Tax on distributed profits. b. Brought forward loss or depreciation allowance. (NOV 2009 OLD)

Ans: a. The tax auditor has to report on profit distributed during the FY and therefore the amount of tax paid on such distributed profit at the prescribed rate plus

40 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

surcharge at the applicable rate on tax and education cess thereon, the dates of payment with amount, has to be reported. b. The manner of reporting: S.No. Assessment Year Nature of loss/allowance (in rupees) Amount as returned (in rupees) Amount as assessed (in rupees) Remark For giving the above information, the auditors should verify the assessment records i.e., • Income tax return filed. • Assessment orders • Appellate orders • Rectification/revision orders of the earlier years and ascertain if the figures given in the above clause are correct.

Q.52 Mr. X, who conducts the tax audit u/s 44AB of the IT Act, 1961 of M/s ABC, a partnership firm has received the entire audit fees of Rs. 25,000 in April, 2010 in respect of the tax audit for the year ended 31.3.2010. The audit report was however signed in September, 2010. Comment. Ans: A person is disqualified from being an auditor if he is indebted to the company for more than Rs. 1,000. This provision for disqualification would apply only in case of an auditor appointed under the Companies Act, 1956. When a CA is appointed to conduct a tax audit u/s 44AB of the Income -tax Act, 1961, his appointment is not under the Companies Act, 1956 but under the Income-tax Act, 1961. In the Income-tax Act, 1961 there is no such provision. Mr. X would still be able to carry out audit and he would not be disqualified.

Q.53 A leading jewellery merchant used to value his inventory at cost on LIFO basis. However, for the current year, in view of requirements of AS 2, he changed over to FIFO method of valuation. The difference in value of stock amounted to Rs. 55 lakhs which is higher than that under the previous method. In such a situation, what are the reportingresponsibilities of a Tax Audit under Section 44AB of Income-tax Act, 1961.

41 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Ans: The change in the method of valuation of stock is not a change in method of accounting, as it is only a change in accounting policy. However in the Income-tax Act, 1961this is considered under method of accounting. Under the Income-tax Act, 1961, if the change in method of valuation is bonafide, and is regularly and consistently adopted in the subsequent years as well, such change would be permitted to be made for tax purposes. In the instant case, the change in the valuation of stock from LIFO basis to FIFO basis is pursuant to mandatory requirements of the AS 2 ‘Valuation of Inventories’ and therefore should be viewed as bonafide change. This apart, the tax auditor in his report has to specifically refer to the method of valuation of stock under Clause 12 in Form 3CD.

(a) Method of valuation of closing stock employed in the previous year. (b) Details of deviation, if any, from the method of valuation prescribed under section 145A and the effect thereof on profit or loss. The auditor has to see that the method of stock valuation is followed consistency from year to year. It is also necessary to ensure that method followed for valuation of stock results is correct profits or gain. The change from LIFO to FIFO is bonafide, the disclosure of which would have to be made in the FS. As far as section 145A is concerned, tax auditor need not change the method of valuation of purchases, sales & inventories which is regularly employed by assessee. All that he has to do is to adjust the valuation for any tax, duty, cess or fee actually paid or incurred by the assessee, if the same had not already been adjusted.

Q.54 Mr. Ram, the Tax Auditor finds that some payments inadmissible u/s 40A(3) were made, and advised the client to report the same in form 3CD. The client contends that cash payments were made since the other parties insisted upon the same and did not have Bank Accounts. Comment. Ans: The audit under section 44 AB of the Income Tax Act 1961 requires that the tax auditor should report whether in his opinion the particulars in respect of Form 3CD are true and correct. It is the primary responsibility of the assessee to prepare the information in form 3CD. The auditor has to examine whether the information given is true and correct. The form 3CD is not a report of Tax Auditor. The report is in the form of 3CA or 3CB depending on the nature of the organization of the entity. If the tax auditor is satisfied that the information contained in form 3CD is true

42 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

and correct then he can give unqualified report in form 3CA or 3CB. But in the given case the tax auditor has found that the form 3CD contains the incomplete, misleading and false information. Disallowance under section 40A(3) is attracted if the assessee incurs any expenses in respect of which payment of aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draft exceeds Rs. 20,000/-. However, exemption is provided in respect of certain expenditure in Rule 6DD. In such cases, disallowance under section 40A(3) would not be attracted. Under clause 17(h) of Form 3CD, amounts inadmissible under section 40A(3), read with Rule 6DD, have to be reported. Cash payment made on insistence of other parties on the contention that they do not have bank accounts is not covered under the list of exceptions provided under Rule 6DD. Mr. Ram has to report the payments inadmissible under section 40A(3) under clause 17(h) of Form 3CD.

.Q.55. Mr. V carries on the business of dealing and export of diamonds. For the year ended 31st March 2012, you as the tax auditor, find that the entire exports are to another firm in U.S.A. which is owned by Mr. V’s brother. Hint Ans: Clause 18 of form 3CD, annexed to tax audit report in Form 3CA/3CB, requires the tax auditor to specify particulars of payments made to person specified u/s 40(A)(2)(b) of the IT Act 1961. Persons specified in the said section are relatives of an assessee and sister concerns, etc. Mr. V has not made any payments to his brother. On the contrary, he must have received payments from him against exports made and, thus, this clause would be required to verify whether the exports are genuine, i.e. , whether the diamonds have been delivered by verifying the necessary delivery documents, relevant invoices, etc., the reasonableness of the price and whether the export realization have been received Q.56 TUI Ltd. an Indian company, subject to IT Act, 1961, discloses advance Income-tax paid (Current tax asset) and provision for Income-tax (Current tax liability), separately in B/S for the year ended 31.3.2011, i.e., it does not offset the amount. Comment. : As per AS 22 – Accounting for Taxes on Income, an enterprise should offset assets and liabilities representing current tax if the enterprise: (i) Has a legally enforceable right to set off the recognized amounts and (ii) Intends to settle asset & liability on a net basis. An enterprise will normally have a legally enforceable right to set off an

43 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

asset and liability representing current tax when they relate to income taxes levied under the same governing taxation laws and the taxation laws permit the enterprise to make or receive a single net payment. Since TUI Ltd is an Indian Company, and as per IT Act, 1961, such set off is allowed which is legally enforceable. In view of Provisions of AS 22 and IT Laws, TUI Ltd. should offset advance tax paid against provision for IT & show only the net amount in B/S.

Q57. ABC Printing Press, a proprietary concern, made a turnover of above Rs. 63 lacs for the year ended 31.03.2011. The Management explained its auditor Mr. Z that it undertakes different job work orders from customers. The raw materials required for every job are dissimilar. It purchases the raw materials as per specification/requirements of each customer, and there is hardly any balance of raw materials remaining in the stock, except pending work-inprogress at the year end. Because of variety and complexity of materials, it is rather impossible to maintain a stock-register. Give your comments. Hint Ans: The explanation of the entity for the use of varieties of raw materials for different jobs undertaken may be valid. But the auditor needs to verify the specified job-orders received and the different raw materials purchased for each job separately. The use of different papers (quality, quantity and size) ink, color etc. may be examined. If possible, the auditor may also enquire with the other similar printers in the locality to ensure the prevailing custom. At the same time, he has to report and certify under the Para 28(b) and Para 9(b) of Form 3CD read with the Rule 6G (2) of the Income-tax Act, 1961, about the details of stock and account books (including stock register) maintained. He (or his deputy) must verify the closing stock of raw materials, work-in-progress and finished goods of the concern, at least on the date of its balance sheet. In case the said details are not properly maintained, he has to specifically mention the same with reasons for nonmaintenance of stock register by the entity.

44 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

45 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTER

9

Diverse Audits

Q.58 Write Short note on ENERGY AUDIT The increasing cost and the shortage of energy has laid profit-making industries into a loss making one. Industries are running behind the energy management plans to cope with the situation. This can be achieved by reducing avoidable losses, improving the effectiveness of energy use or increasing energy use efficiency. The steps in energy management involves: a. Conducting energy audits b. Implement the energy conservation measures c. Post installation monitoring d. Setting targets etc. Energy audit is the first steps in energy management plans. Energy audit involves assessing energy use pattern of a factory or energy consuming equipment and identifying energy saving opportunities. The functions of energy auditor is not like an financial auditor who express an opinion, while an energy auditor recommends the steps for improving the efficiency of the energy consumption leading to monetary benefits. To make energy audits truly effective audits must be conducted round the clock and by an internal energy audit department. Internal energy audit department should include the members from each energy consumption areas within the entity.

Q. 59 Write short note on Environmental Audit?

46 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Environment reporting deals with the disclosure by an entity of environmentally related data like environmental risks, impacts, policies, strategies, targets, costs etc to those who have an interest in such information. These reports may be provided along with annual reports, a stand-alone corporate environmental performance report or in any other form. These information could be audited or unaudited. But now, the central government has made energy audit compulsory for some industries and the report has to be submitted to concerned State Control Board on or before 15th day of May every year for 31 st march. Environmental audit deals with verification of the information contained in such reports with a view to expressing an opinion there on. Environmental audit is a critical analysis of (i) Policies (ii) principles (iii) systems (iv) procedures (v) practices and (vi) performance of the aspect, which relates the environment.

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CHAPTER

10

PEER REVIEW

Q. 60 Write short note on Peer Review? Peer review means review by a PEER means person of same standing. What do you mean by Peer Review means an examination and Review of the systems and procedures to determine whether the same have been put in place by the Practice Unit for ensuring the quality of assurance services as envisaged by the Technical, Professional and Ethical Standards and whether the same were consistently applied in the period under review. Q.61What is Practice Unit and who is reviewer? Practice Unit:- means a firm of Chartered Accountants or a member in Practice, practicing whether in an individual name or a trade name or such other entity as recognized by the Institute of Chartered Accountants of India from time to time. Reviewer - means a member duly approved and empanelled by the Board on fulfilling the qualifications prescribed for a Reviewer as per Para 10.0 of this Statement. Q.62What do you mean by Technical, Professionl and Ethical Standards? Technical, Professional and Ethical Standards - means (i) Accounting Standards issued by ICAI and /or prescribed and notified by the Central Government of India; (ii) (a) (b) (c) (d) (e)

(iii)

Standards issued by the Institute of Chartered Accountants of India including Engagement standards Statements Guidance notes Standards on Internal Audit Statements on Quality Control (f) Notifications / Directions / Announcements / Guidelines / Pronouncements / Professional standards issued from time to time by the Council or any of its committees. Framework for the Preparation and presentation of financial statements, framework of statements and Standard on Auditing, Standard on Assurance Engagements, Standards on Quality Control and Guidance Notes on related services issued, from time to time, by

48 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

the Institute of Chartered Accountants of India and framework for assurance engagements; (iv) Provisions of the various relevant statutes and / or regulations which are applicable in the context of the specific engagements being Reviewed including instructions, guidelines, notifications, directions issued by regulatory bodies as covered in the scope of assurance engagements; Q.63 What is Scope of Peer Review? The Peer Review process shall apply to all the assurance services provided by a Practice Unit. Once a Practice Unit is selected for Review, its assurance engagement records pertaining to the Peer Review Period shall be subjected to Review. The Review shall cover: (i) Compliance with Technical, Professional and Ethical Standards: (ii) (iii) (iv)

(v)

(vi)

Quality of reporting. Systems and procedures for carrying out assurance services. Training programmes for staff (including articled and audit assistants) concerned with assurance functions, including availability of appropriate infrastructure. Compliance with directions and / or guidelines issued by the Council to the Members, including Fees to be charged, Number of audits undertaken, register for Assurance Engagements conducted during the year and such other related records. Compliance with directions and / or guidelines issued by the Council in relating to article assistants and / or audit assistants, including attendance register, work diaries, stipend payments, and such other related records.

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50 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTER

11

CORPORATE GOVERNANCE AND AUDIT COMMITEE

Q.64 WHAT DO YOU MEAN BY CORPORATE GOVERNANCE? AND HOW IT IS IMPLEMENTED IN INDIA? Corporate governance is the system by which companies are directed and controlled by the management in the best interest of the stakeholders and other ensuring greater transparency and better and timely financial reporting. The Board of Directors are responsible for the governance of their companies. Clause 49 of the Listing Agreement Where a company desires to list its shares and other securities on a stock exchange, it has to agree and implement the code of corporate governance. The clauses of the agreement are discussed ahead. The responsibility of the auditor is to verify that the requirement of these clauses have been complied with and report non-compliance, if any.

Q.65 What do you mean by Audit Committee According to clause 49 of listing agreement there should be a. Qualified and Independent Audit Committee in a listed company. A qualified and independent audit committee shall be set up, giving the terms of reference subject to the following: 1. The audit committee shall have minimum three directors as members. Two-thirds of the members of audit committee shall be independent directors. 2. All members of audit committee shall be financially literate and at least one member shall have accounting or related financial management expertise. Explanation (i): The term “financially literate” means the ability to read and understand basic financial statements i.e. balance sheet, profit and loss account, and statement of cash flows. Explanation (ii): A member will be considered to have accounting or related financial management expertise if he or she possesses experience in finance or accounting, or requisite professional certification in accounting, or any other comparable experience or

51 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

background which results in the individual’s financial sophistication, including being or having been a chief executive officer, chief financial officer or other senior officer with financial oversight responsibilities. 3. The Chairman of the Audit Committee shall be an independent director; 4. The Chairman of the Audit Committee shall be present at Annual General Meeting to answer shareholder queries; 5. The Audit Committee may invite such of the executives, as it considers appropriate (and particularly the head of the finance function) to be present at the meetings of the committee, but on occasions it may also meet without the presence of any executives of the company. The finance director, head of internal audit and a representative of the statutory auditor may be present as invitees for the meetings of the audit committee; 6. The Company Secretary shall act as the secretary to the committee.

Q.66 What are the Powers of Audit Committee The Audit Committee shall have powers, which should include the following: 1. To investigate any activity within its terms of reference. 2. To seek information from any employee. 3. To obtain outside legal or other professional advice. 4. To secure attendance of outsiders with relevant expertise, if it considers necessary.

CHAPTE R

12

AUDIT UNDER COMPUTER INFORMATIONS SYSTEM ENVIRONMENT

Q.67 What is CAATs and explain their utility? CAAT means Computer Assisted Audit Techniques.To increase the audit efficiency CAATs are the advanced tools with the auditor. Commonly following are known as CAATs 1. Audit software: Audit software consists of computer programs used by the auditor, as a part of his auditing procedure. This software interacts with the data of the entity’s computer to process data of audit significance from the entity's accounting system. Audit software can be classify into,

52 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

i. Package programs: These are generalised computer programs used by the auditor to perform general data programming functions like creating data file, preparing specific reports. ii. Purpose written programs: These programs are specifically designed to perform some specific audit tasks in specific circumstances. Generally the auditor develops these programs by himself or some times modify the programs used by the entity itself. iii. Utility Programs _ These programs are not designed specially for audit purposes. These are the programmes of general utility like sorting, creating and printing files. iv. System Management Programs: These programs are generally a part of operating system itself. The use of these in audit requires extra skills and care unlike utility programs. 2. Test data: Test Data Techniques involves processing of test data and comparing the results with predetermined results. The purpose is to test controls in operation

Q.68 What is utility to apply CAAT? What considerations required to apply it?

Following are the utilities of using CAATs 1. Tests of details of transactions and balances 2. Analytical review procedures. 3. Compliance test of general EDP controls 4. Compliance test of EDP application controls 5. Sampling programs to extract data for audit testing 6. Reperforming calculations performed by the entity's accounting systems

In determining whether to use CAATs, the following factors should be considered: 1. Computer Knowledge, Expertise And Experience of the Auditor: -

53 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

2. Availability of CAATs and Suitable Computer Facilities with the client 3. Impracticability of Manual Tests due to lack of visible audit trail. 4. Comparison of effectiveness and efficiency as against the manual tests 6. Control over the whole process of the CAATs Application . 7. Documentation about CAATs.

Q.69 what is Service Bureau ? Some clients may decide to get their data processed by outside agencies because of many reasons. Service Bureaus are agencies, which process accounting data on behalf of their clients. The auditor should consider the following matters in detail along with the client: 1. Ownership & stability of service Bureau 2. Location of the bureau. 3. Back _ ups maintained by the bureau. 4. Documentation of the system provided to the client. 5. Liability of the bureau in case of loss or unauthorized access / modification of data. 6. The internal controls built in the software used by the bureau to process the client's transactions. 7. Security provisions over the client's data and files, and the effectiveness of supervision. Advantages of service bureaus to the auditor 1. The auditor can rely on grater control since a service bureau will be independent of the client's user department. 2. Input data will be available for longer period and more detailed printouts will be available. Disadvantages of service bureaus to the auditor 1. The auditor will have no legal right to examine the controls in operation at the bureau unless permission is sought at the time the service contact is drawn up.

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2. Security of data and its retention in case of loss or destruction is at risk.

CHAPTER

13

MANAGEMENT AUDIT AND OPERATIONAL AUDIT

Q.70What is Management Audit and what are its Objectives? It is the audit of the management, by the management and for the management which attempts to evaluate the performance of the various management processes and functions. Management audit is systematic independent appraisal activity within an organization, which aims to evaluate the decision-making efficiency of the management. Unlike the annual review by outside accounts,

55 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

which focuses on financial results of the past year and thus is backward-looking, a management audit represents a more positive, forward-looking approach that evaluates how well management accomplishes its stated organizational objectives, In a management audit, the auditor will look to see whether management is getting information relevant to the decisions and actions. Hence management audit is an intensive analysis of information needs and the efficiency of the existing system in meeting them. Management Audit is a tool to improve management performance by recognizing facts and information about management presented after appropriate examination, verification and evaluation, by professionally qualified and competent people. To assess how effective management is in planning, organizing, directing, and controlling the organizations activities, and how appropriate management's decisions are for reaching stated organization objectives. This evaluation of managerial performance is achieved with the aid of management audit questionnaire. Q.71 What is Operational Audit and What are its objective? Operational audit has been defined as a systematic process of evaluating an organization’s effectiveness, efficiency and economy of the operations under management’s control and reporting to appropriate persons the results of the evaluation along with recommendations for payment. Since operational auditing is a newly emerged term, there is lack of consensus in the definition of this. However there is not many opposition of the view that operational audit is a review and appraisal of the operations of the organization carried out by a competent independent person and also in understanding operational auditing as an extension of internal auditing with a definite work content which stretches beyond the traditional field of internal auditors, i.e. financial accounting The independent status is important to maintain its objectivity and usefulness. The concept of operational audit is a logical extension of internal audit. Operational audit is the audit for management. Traditionally, the emphasis of internal auditing was on accounting and financial operations only. But nowadays the audits of functional areas likes’ production, marketing etc. are in demand. Thus, operational auditing is merely an extension of traditional internal auditing into operational areas. Operational auditing concentrate on effectiveness, efficiency and economy of operations and therefore it is future oriented. The work of operational auditor doesn’t end with the reporting of the deficiencies but also he has to suggest the measure to be taken to meet overcome those. As management Audit is an “audit of the management”, the same way operational audit is the “audit for the management”. Followings are the objective of operational Audit:1. Appraisal of control –Operational auditing deals with the administrative controls and its purpose is to determine whether the controls are adequate. 2. Evaluation of performance – During performance evaluation, an operational auditor is heavily dependent upon availability of acceptable standards. 3. Appraisal of objectives and plans – Though controversial, one school of thought holds that operational auditing can be stretched to evaluate management objectives and plans. If the management policy favours installation of controls, controls would have to stay within the policy frame. Therefore, the basic things that should be evaluated is management policies, plans and objectives. 4. Appraisal of organization structure – Organisational structure provides the line of relationship and delegation of authority and tasks. This is also another important area for appraisal by the operational auditor.

56 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTE R

INVESTIGATIONS

14 Q.72 What is Investigation and How it differs from Audit? The term investigation implies a systematic and in-depth examination or enquiry to establish a fact or to evaluate a specific situation. The specific purpose may be evaluation of state of affairs or establishing of a fact. Auditing, on the other hand, is independent examination of books of accounts and records of a business enterprise with a view to express an opinion on the truth and fairness of such accounts. The objective of auditing is very general in nature and is well documented , while

INVESTIGATION-1 Q.73 Define the steps involved in Investigation on Behalf of Incoming Partner Objective :- to know whether (i) The terms offered to incoming partner are reasonable (ii) His capital contribution would not be unreasonable and safe. The investigator should take care of the following (i) First of all the investigator should ascertain the history from the inception and growth of the firm. (ii) The investigator should Study the provisions of the partnership deed to know the advantages and disadvantages to the incoming partner. (iii) The Investigator should analyse the profitability and the rate of return of the firm’s business over a period of time. (iv) The investigator should also verify the assets and liability of the firm.. (v) He should also observe that what is position of orders on hand the range and quality of customers should be thoroughly examined. (vi) He should evaluate the competency of key personnel’s employed. (vii) He should study the important contractual and legal obligations. (viii) He should evaluate why admission of partner is offered (ix) He should evaluate that what shall be the manner of computation of good will of admission and retirement of a partner should be ascertained.

INVESTIGATION -2 Q.74 Define the steps involved in Investigation on Behalf of Bank Proposing to Advance Loan to a Company.

57 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

Objective (i) (ii) (iii)

: To the the the

know – purpose for which a loan is required, sources from which it would be repaid and security that would be available to it.

Procedure :The investigator should (1) Evaluate the purpose for which the loan is required . (2) Evaluate the repayment schedule offered by the buyer. (3) Evaluate the financial standing and reputation of entity. (4) Study the Memorandum or the Articles of Association to borrow money for the purpose for which the loan will be used. (5) Study the history of growth and development of the entity for at least the past 5 years. To investigate the profitability of the business, the investigating accountant should take the under-mentioned steps – (a) Prepare a condensed income statement from the Profit and Loss Accounts for the previous five years, showing various items of income and expenses, gross and net profits earned and taxes paid annually during each of the five years. (b) Compute the under-mentioned ratios – Compute the under-mentioned ratios – (i) Sales to Average Stocks held (ii) Sales to fixed assets. (iii) Equity to fixed assets. (iv) Current Assets to current liabilities. (v) Quick assets (the current assets that are readily realizable) to quick liabilities. (vi) Equity to long term loans. (vii) Sales to Book debts. (viii) Return on Capital Employed. (c) Break-up of annual sales product-wise.

1.

(i)

2.

Verification of assets and liabilities included in the financial statement submitted by the applicant: The investigator should prepare schedule of assets and liabilities in them the particulars given below: Fixed Assets: (i) Description of the item. (ii) Gross value (iii) Depreciation rate used (iv) Total depreciation written off (v) Nature of charge on assets created (vi) Revaluation of the assets if carried out recently (vii) Basis of revaluation. Inventory: The different types of raw material and finished goods held.

58 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

(ii) (iii) (iv)

Basis of valuation of the inventory. Slow moving and obsolete items. In case the stock has been pledged or hypothecated the fact should be stated.

(v)

Assessment of the redundancy of stock consequent to changes that occurred after balance sheet. 3. Sundry Debtors: (i) Composition of debtors. (ii) Age wise classification debtors. (iii) The adequacy of the provision if any created. (iv) Classification as follows – a. Debts due in respect of which the credit has not expired. b. Debts due in respect of which the credit has expired. c. Debts due from directors and employees. d. Debts due from subsidiary companies or affiliated companies. e. The subsequent recovery of debts after the Balance Sheet date. 4. Investment: The schedule of investment should be prepared showing date of purchase, cost, nominal value, market value and in case it is pledged for a loan, the details of people. 5. Secured Loans: The loans should be classified between debtor and other showing there in the secured and unsecured classification. The particulars of the assets pledged for securing the debt should be clearly stated. 6. Provision for Taxation: The breakup of the year wise provisions and a note on the adequacy of a each provision shall be provided. 7. Other liabilities: A statement to the effect that all the liabilities have been properly disclosed showing the age wise analysis of trade creditors. 8. Insurance: A statement of insurance policies giving details of the risk covered and the particulars of the prepayment 9. Contingent liabilities: A list should be provided giving a break up of the contingent liabilities existing. Finally, the investigator should ascertain whether any other application has been made by the applicant for loans to other institutions or agencies and if so the result of such applications on the date of review.

INVESTIGATION -3 Q. 75 Define the steps involved in investigation of frauds of following Investigation of Fraud under Cash Receipts – The probability of cash being diverted before being entered in the books is very high and hence (iv) Income received from different sources should be scrutinized. (v) Carbon copies of receipts marked ‘duplicate’ should be scrutinized. (vi) The record of small or negligible sources of income such as sales of scrap or sale of waste paper.

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(vii) Recoveries from customers and sundry parties along with deductions on account of cash discounts should be reviewed and checked thoroughly. Payments – 1) Acknowledgement for payments has to be carefully scrutinized 2) Care is required where a figure appears to have been erased on altered on such acknowledgement. 3) Payment by bearer Cheques should be checked. 4) Payment as regards wages should be examined for possible over totaling of wage sheets and entries regarding dummy workmen. 5) Check whether payment has been made in respect of supplies which have not been received. 6) Petty Cash Book itself should be vouched and totaled. Investigation of Frauds Under Ledger Balances in customers’ ledger – The first steps is to find out (1) Whether the customers are properly debited in respect of goods received. (2) Test the entries in the order book with those in the sales daybook. (3) Amounts adjusted on account of goods returned or difference in price as well as amounts written off as bad debts should be checked. (4) Balance confirmations from customers. Balances in Suppliers ledger – (1) The Bought Journal should be vouched by reference of Goods Inward Book. (2) Amounts have been correctly credited in respect of goods duly received or not. (3) Request the supplier to furnish statements of their accounts to find out whether or not any balance is outstanding or due and (4) Confirm that allowances and rebates given by them is correctly adjusted. Investigation of Fraud of stock – (5) The defalcation of trading stock, etc. is usually possible through a collusion among a number of persons. (6) Check whether there is (a) A system of stock control, and existence of detailed record of the movement of stock, or (b) Availability of sufficient data from which such a record can be constructed. (7) Physically check the quantities in stock and those shown by the stock book.

60 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

(8) Shortages observed on physical verification of stock should be reconciled with the discrepancies observed on checking the books. Q.75 What is Due Diligence? 'Due Diligence' is a term that is often heard in the corporate world these days in relation to corporate restructuring. The term 'corporate restructuring' normally includes internal reconstruction, amalgamations, spin-offs, divestiture, mergers, joint ventures, split-off, etc. Certain corporate restructuring exercises are not within the group (also known as external corporate restructuring exercises, for example, a joint venture between two parties where one party hives off an existing unit or division into another company into which the joint venture partner then acquires an interest or has acquired an interest. These are all corporate restructuring exercises that involve more than one party. For such a corporate restructuring exercise to succeed, it must be planned properly. A key element in such an exercise, where it involves the acquisition of another entity, unit or assets of an entity, is the performance of a 'due diligence' review. Due Diligence may also required to be performed in cases of venture capital financing, lending, leveraged buyouts, public offerings, disinvestments, coporatisation, etc. Sometimes, in a restructuring exercise, while the unit may remain within a group, it may pass from under the charge of one management team to that of another team. This situation also gives rise to the need for a due diligence review. Due Diligence can be sub-classified into discipline-wise exercises be as follows: (a) Commercial /operation Due Diligence : i.e. to check whether the target is commercially feasible. (b) Financial Due Diligence : To check the financial feasibility of the target by examining the financial statement and devising their profit trends. (c) Tax Due Diligence (Direct and Indirect) : Whether the target is paying appropriate taxes on a regular basis. Moreover, ascertain what are the tax benefits available to target. (d) Information system Due Diligence : Whether information system of target is providing right information to the right management at the right time in the right quantity. (e) Legal Due Diligence : Whether the target is complying with all the applicable laws and regulations. (f) Environmental Due Diligence : To check the compliance of target with environmentally related rules and regulations.

(g) Personnel Due Diligence :

To ascertain employees of target company are efficient.

whether

61 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

the