VERIFICATION OF ASSETS – ILLUSTRATION :
(i) Cash in hand and at bank :
Cash in hand includes all the following :
(a) Cash in hand :
1. Special care is necessary with regard to verification of cash balances. There can be no certainty that the cash produced for inspection was in fact held by the custodian.
2. For this reason, the cash should be checked not only on the last day of the year, but also checked again sometime after the close of the year without giving notice of the auditor’s visit either to the client or to his staff.
3. If there is more than one figure for cash balance e.g. when there is a cashier, a petty cashier, a branch cashier and in addition, there are imprest balance with employees, all of them should be checked simultaneously, as far as practicable, so that the shortage in one balance is not made good by transfer of amount from the other.
4. It is desirable for the cashier to be present while cash is being counted and he should be made to sign the statement prepared, containing details and the cash balance counted. If he is absent at the time the cash is being verified, he may subsequently refute the amount of actual cash on hand which may put the auditor in an embarrassing position.
5. If the auditor is unable to check balance on the date of the Balance Sheet, he should arrange with his client for all the balance to be banked and where this cannot conveniently be done on the eve of the close of the financial year, it should be deposited the following morning. The practice should also be adopted in the case of balance at the factory, depot or branch where cash cannot be checked at close of the year.
6. Should this not be possible, the auditor should verify the receipts and payments of cash upto the date he counts the cash. This should be done soon after the cash balances have been counted. The cash book of the day on which the balance is verified should be signed by the auditor to indicate the stage at which the cash balance was checked.
7. If any cheques, or drafts are included in cash balance the total there of should be disclosed.
8. If there is any rough Cash Book or detail of daily balance are separately kept, the auditor should test entries from the rough Cash Book with those in the Cash Book, to prove that, entries in the Cash Book are correct.
9. If the auditor finds any slip, chit or I.O.U’s in respect of temporary advances paid to the employees, included as part of the cash balance, he should have them initialed by a responsible official and debited to appropriate accounts.
(b) Cash in Transit (Remittance in Transit)
1. This refers to amount sent by Branch/Depots/Agents etc. to Head Office but physical cash/cheques not yet received by H.O. or vice versa.
2. Such remittance in transit should be verified from subsequent period cash book/pass book as to whether actually it is received or not.
3. Reconciliation of H.O./Branch Accounts should also be checked.
4. If amount is deposited into bank, pay-in-slip can also be verified.
5. See that entry for remittance in transit is passed by only one party and is reversed in the next year.
(c) Petty Cash
1. Petty Cash in hand should be verified with Petty Cash Book
2. Also check up the balance of Petty Cash Account in General Ledger.
3. Vouch the transaction of last month property to ascertain that fictitious payments are not entered into
4. Some of the points given for verification of cash in hand will be applicable for Petty Cash also.
(d) Bank Balance :
1. To verify cash at bank, the auditor should examine the bank pass book and compare it with the balance as shown by the bank column of the cash book.
2. Check bank reconciliation statement with bank statement / pass book of subsequent period.
3. The auditor should get a certificate regarding the balance at the bank directly from the bank.
4. Ensure that the balance as shown by the cash book is brought into the balance sheet as `Cash and Bank’ and not `Balance as shown by the pass book’.
5. The auditor should also see that the `cheque outstanding’ and`cheques not yet collected’ are genuine and not made up in order to conceal the deficiency. If some of these cheques are more than six months old, he should make inquires, and have them reversed in the books of accounts.
6. Cash in Fixed deposits with the bank can be verified by examining the deposit receipt, or getting a certificate from the banker.
7. If there are more than one bank account such as `Dividend Account’. “Interest Account’ etc. all such accounts should be checked and the balances should be verified upon the same date. Information regarding their balance should also be obtained from the bank directly.
8. If the bank account shows an adverse balance and the client has deposited any security for the overdraft, the auditor should inquire from the bank the particulars of the security and the amount of the interest charged.
(ii) Bills Receivable
1. The auditor should examine the Bills Receivable Book with the Bills Receivable not matured but in hand on the date of the Balance Sheet.
2. When any bills are in the process of collection the details of the same have to be verified with bank certificates.
3. If the Bills Receivables in hand are many, auditor should make a list of bills for his convenience.
4. If there are any bills that have been discounted, and still not matured, he has to examine the details of the same very carefully and should confirm with the bank because they are to be shown as contingent liabilities by way of a note in the Balance Sheet.
5. While examining the Bills, the auditor has to pay special attention to see that they are properly drawn, stamped and duly accepted.
6. He has to check whether any bills is overdue. If so, auditor should ask for the details of the action initiated, etc. If there are any bills which are doubtful of recovery, he should see whether any adequate provision has been made for the anticipated loss on account of bad debts.
7. He has to see that in case of dishonoured bills, the same is not shown as Bills Receivable. the auditor has also to check up whether noting formalities have been properly complied with or not.
8. In case the auditor has visited his client after the Balance Sheet date, many of the bills due on the Balance sheet date might have matured or honoured. Hence the auditor has to vouch such bills with Cash Book or Pass Book and reconcile the balance.
9. If the bill has been renewed after the Balance Sheet date, then also the value of the original bill due on Balance sheet date should be shown as Bills Receivable and interest on renewed bills properly accounted.
10. If the bills endorsed have been dishonoured, the original drawee is to be debited and endorsee is to be credited.
(iii) Loans advanced
Loans may of different types like :
(a) Loans against the security of land and buildings.
(b) Loans against the security of goods
(c) Loans against the security of stocks and shares.
(d) Loans against the security of insurance policies, and
(e) Loans against the personal security of the borrower.
Therefore, in each case, the duty of auditor in general is as under :
1. Verify whether object clause of the Memorandum provides for granting of such loans.
2. Examining whether a proper loan ledger has been maintained and it is up-to-date or not.
3. Examination of the security lodged against each loan. The loan agreement is to be scrutinized regarding the rate of interest. Due dates of installment, penalty, interest, etc.
4. He should ascertain whether any loan is doubtful of recovery in which case a provision for the expected loss is to be made.
5. Except in case of a banking or finance company, auditor has to ascertain whether the purpose of advancing is connected with business or not. Section 227(4A) of the Companies Act, 1956 requires an auditor to report whether the parties to whom the loans are given are regular in payment of interest and principal and the terms of the loan are not prima facie prejudicial to the interest of the company.
(a) Loans against the security of Land and building
1. The auditor has to examine the mortgage deed, see if the copy has been properly executed and registered in favor of the client.
2. The auditor has to examine the title deeds deposited with the mortgage deed.
3. The auditor, if required, has to examine the valuer’s certificate in order to ascertain the value and sufficiency of the security.
4. The auditor has to confirm that the property is properly insured and insurance premiums have been paid in time.
5. The auditor has to examine the title of the Borrower to the property, etc.
6. If the mortgage is a second mortgage, the auditor has to confirm that the same is brought to the knowledge of the first mortgagee. In this case he has to take the acknowledgement of title deeds from the first mortgagee.
(b) Loans against the security of goods.
1. The auditor has to examine the nature of the goods and confirm that the goods are really belonging to the borrower. He should see whether the loan is granted against railway receipt, lorry receipt, dock warrant, godown keeper’s receipt etc.
2. In case goods are stored in the godown, he has to see that the rent of the godown is paid in full and the goods are fully insured.
3. The auditor should examine the value of the goods by comparing them with the present market value. Regarding quality and quantity, he may rely on the inspector’s reports.
4. If the goods are of perishable nature, the auditor has to examine the turnover of the stock of the client.
(c) Loans against the security of stocks and shares
1. He should call for a statement of stocks and shares given as security and confirm that all of them are fully paid up.
2. He should see whether an instrument of transfer is properly stamped and is properly executed.
3. He should see that their value is properly disclosed as per the prevailing market rates.
4. He has to ensure that there is a sufficient margin on the loans advanced.
5. He has to see whether the charge is properly registered or not.
(d) Loans against the security of insurance polices :
1. The auditor should see that the policy has completed at least two years.
2. The auditor should confirm that all the premiums have been properly paid and the policy is in force by examining the latest premium receipt.
3. The auditor should ascertain that due notice of assignment has been given to the insurance company.
4. The auditor should see that the loan has been advanced on the basis of surrender value of the policy as certified by the insurance company.
5. The auditor has to ensure that the premium, if any, paid up by the lender to keep the policy in force is properly debited to the Loan Account of the borrower together with the usual interest.
(e) Loans against the personal security of the borrower
The auditor has to examine the documents like Promissory Note, Guarantor’s details and Salary Certificate of the borrower, etc.
(iv) Sundry Debtors
Sundry Debtors represents the amount recoverable from the customers for sale of goods or rendering of services.
1. The undermentioned procedure should be applied for verification of `Book Debts’ or `Sundry Debtors’ after receiving a schedule or list of debtors from the client.
(a) Direct confirmation of balances from debtors by sending confirmatory letters.
(b) Year-end Scrutiny of ledgers.
(c) Verification of the position of debts considered bad or doubtful.
(d) Compliance with legal requirement or presentation.
2. The auditor should arrange to send the letter of confirmation of balances by the client as per client’s records and see that the reply of confirmation is forwarded to his office directly. Usually this should be sent within 15 or 20 days of close of the year under the supervision of the audit staff. After the reply is received, the same should be tallied with the balances shown in the Debtors Ledger and difference properly reconciled.
3. After the said procedure is carried out, he should carry out a thorough scrutiny of the debtor’s individual accounts. Wherever the number of debtors is very large, Test Checks can be applied.
4. While scrutinizing the ledger, the auditor should focus the light on discounts, returns, cash received, rebates allowed, goods returned etc.
5. On ascertaining the balances of the debtors as genuine and correct, the auditor has to verify the debtors to find out bad or doubtful debts to make a provision for the same. If the debts are bad and irrecoverable or doubtful and they are not provided for properly, the financial statements will not portray a `True and Fair’ view. Hence, appropriate provision is to be made by considering the age of the debtor, scrutiny of payments received, management opinion and any other information like financial position of debtors, etc. If the auditor fails in verifying the appropriateness of the provision made, he shall be held liable for negligence.
6. After ascertaining the position of bad or doubtful debts, he should see that the legal requirements of Schedule VI to the Companies Act, 1956 are complied with. For this purpose, the debtors are to be classified as :
(a) Outstanding for a period of more than six months ; and
(b) Other debts.
7. Over and above this, other requirements like debts considered as good and which are fully secured, debts due from the officers, directors, managers of the company, etc., are to be ascertained for disclosure.
8. If the customers have purchased the goods on hire purchase system and some of the installments are not due, the same is not to be shown as `stock out on hire purchase’.
9. Likewise, if the goods are sold on `return or approval’ basis, such customer cannot be shown as a debtor at the close of the year.
10. Further, whenever there are credit balances in some debtors account, the same are not to be deducted from other debtors debit balances and net balance is not to be shown in the assets side, but former is to be shown as Sundry Creditors.
(v) Patent and Trademarks :
1. The ownership of patent rights is verified by inspection of certificate issued for grant of patent, by the prescribed authority.
2. If it has been purchased, the agreement surrendering it in favour of the client should be examined.
3. If there are a number of patents held by the client, obtain a schedule giving the full details thereof or verify with reference to the register maintained by the client.
4. It must be verified that patent rights are alive and legally enforceable and renewal fees have been paid on due dates and charged to Revenue Account. The last renewal receipt should be examined to ascertain that the patent has not lapsed.
5. See that the patents are properly registered in the name of the client only.
6. See that the cost of patent is being written off over its useful period of life.
7. In case the patent is acquired, cost paid for the same and all relevant expenses are to be capitalized.
8. If the patent is created by the client by the research experiments and laboratory work, only the actual expenses incurred for it in the process are to be capitalized.
1. The auditor has to examine the written agreement of assignment along with the royalty paid to the authors etc., for such copyrights.
2. He has to see that such assignments are properly registered.
3. If the client is the owner of many copyrights, the auditor should ask the client to prepare a schedule of copyrights and get the detailed information to confirm that the same is shown in the Balance Sheet.
4. Regarding the value of copyrights, it should be remembered that this asset has no value in the long run. Hence, value is determined on revaluation basis and period of copyrights.
5. If any copyrights does not command the sale of any books, then the same should be written off in such year. The auditor has to verify the same in detail.
(viii) Know-how :–
1. Know how is recorded in the books only if it has been paid for. If it is developed in house, it cannot be capitalized. The auditor should keep this in mind while verifying know-how.
2. Know-how can be of two types :
(a) Relating to manufacturing process – The auditor should ensure that the expenditure is written off in the year of
(b) Relating to design, plans of plants, building etc. – The auditor should ensure that the expenditure is capitalized and depreciation is charged on the capitalized figure.
In case lumpsum payment is made for both types of know-how, both the types should be segregated on a reasonable
basis. Under the Income-Tax Act, cost of Know-how can be deducted subject to the rules laid down. The auditor should keep this fact in mind while computing the tax liability for the year under audit.
(viii) Investments :
Investment may be a share certificate, government bond certificate, government loan certificate, debenture certificate, etc. For verification of such securities, the following procedure is adopted.
1. Obtain a schedule of investments in hand at the beginning of the audit period. Obtain the details of description of
investments together with distinctive number of face value, date of purchase, book value, market value, rate of interest, date of payment of interest or, date around which dividend is declared, etc., with also the details of interest or dividend received along with tax deducted at source.
2. Add to the above list, purchase made during the year and delete the investments sold during the year with all the above details.
3. Balance this schedule and compare the balance with general ledger and Balance sheet.
4. Check the market value of investments with reference to stock exchange quotations or other suitable method, on Balance Sheet date and see that the values are disclosed in the Balance sheet.
5. Inspect the certificates or securities physically on the Balance Sheet date.
6. Compare the income received with amount due and adjust the accrued income.
7. Confirm the uncalled liability on partly paid shares held as investment shown as contingent liability by way of a note to the Balance Sheet.
8. See that adequate provision is made for any shortfall in the book value of investment shown in the Balance Sheet.
9. See that, regarding the investment in subsidiaries, disclosure requirement of section 212 of Schedule VI of the Companies Act, 1956 are complied with.
10. For investment in the capital of partnership, the partnership deed and copy of accounts of partnership firms, is to be verified. Also adjust the share of profit and loss for the partnership period.
11. Investments which stand in the name of persons other than that of the company are to be confirmed with appropriate sanction.
12. For investment lodged with others as security or lying with banks or share brokers, obtain a certificate from the parties concerned.
13. In case of application money paid for shares which are still to be allotted, that fact is to be specially disclosed in the Balance Sheet.
(ix) Leasehold Property :
Normally the lease or right to use the property is granted for certain number of years. At the expiry of the period of lease, the rights go back to the original lessor. Various steps involved in the verification of leasehold rights are stated below.
1. Inspect the lease agreement to ascertain the amount of premium paid, period of lease, other terms and conditions, like maintenance, insurance, etc.
2. See that the lease is properly registered with the Registrar because a lease for a period exceeding one year is not valid unless it has been granted by a registered document.
3. Ascertain those conditions, the failure of which might result in the forfeiture or cancellation of lease, and see whether they have been properly complied with.
4. See whether sub-lease is valid as per lease agreement, in case if it is granted, by referring to sub-lease agreement.
5. See that the premium paid and acquisition expenses of lease are being amortised (written off) over the period of lease adopting a suitable basis.
6. In case, any provision is to be made under the dilapidation clause for payment on the expiry of the term of lease, see that the same is properly and continuously provided.
7. In case of leasehold land, if any building is constructed by the lessee, see the position and ascertain the correct method of presentation of such expenditure for disclosure in the Balance Sheet.
1. Whenever the company has purchased or acquired a running business and has paid for it an amount, in excess of the book value of its net assets, the excess is called `Goodwill’. It can be verified from the vendor’s agreement and the auditor has to see whether there is a specific sum which is paid or whether it is the excess of price paid over the tangible assets and see that it is properly recorded.
2. When the company has written up the values of all its assets on a revaluation and has raised a Goodwill Account in the books, the Goodwill appears in the Balance Sheet. In this case, the auditor has to see the basis of valuation and get satisfied about the same. If he is not satisfied, the fact should be reported to the shareholders.
3. He has to see that such excess is credited to a Capital Reserve or Revaluation Reserve and no dividend is being declared from it.
4. He has also to see the disclosure requirement of Schedule VI and ensure that the fact are disclosed for 5 years subsequent to the date of revaluation.
5. Sometimes, Goodwill which is written off earlier may be brought back in the books of account to adjust the debit balance of Profit and Loss account. In this case, the auditor should investigate the fact and satisfy in full before approving such method of creating Goodwill. He should also refer to the board resolution. In case he is not satisfied, the fact should be reported to the shareholders.
6. If Goodwill has been created by any other means, the auditor should see that all relevant facts are properly disclosed and are supported by documentary evidence.
(xi) Plant and Machinery :
1. Now-a-days as per provision of Section 227(4A) of the Companies Act, 1956 every company is required to maintain a Fixed Asset Register showing full particulars including cost, location, depreciation, details of purchase, expenses capitalised, etc. Therefore, the auditor should ask for such a register maintained by the client and see that all items of plant and machinery are recorded properly giving full details.
2. As per the provision of the same section, all fixed assets are required to be physically verified by the management. Therefore, the auditor should enquire whether such physical verification was undertaken or not. If yes, he should ask for necessary papers pertaining to the same. If there is any discrepancy, reasons for the same should be asked.
3. Any new purchase made during the year are to be verified with reference to purchase invoice and other papers regarding installation of the same.
4. Total value of plant and machinery as shown by Fixed Asset Register should tally with ledger account maintained in the financial books.
5. Where any item of plant and machinery is sold, scrapped or transferred the auditor should check relevant entries for the same and verify that they are removed from the Fixed Assets Register.
6. The auditor should verify that adequate depreciation is provided on all items of plant and machinery and method of depreciation is consistently followed from year to year.
7. Auditor should see that the entire plant and machinery stands in the name of the client and are free from any charge or encumbrances. If plant and machinery is mortgaged, then he has to verify that the documents are properly executed and mention of mortgage is made in the Balance Sheet.
(xii) Furniture and Fixtures :
1. The auditor has to see that a proper record showing quantitative details of furniture and fixtures owned by the client is maintained.
2. The auditor has to see that all expenses incidental to the purchase of furniture and fixtures is capitalised along with the purchase price paid for it.
3. The auditor has to enquire whether the furniture and fixtures have been properly insured or not.
4. The auditor has to see that adequate provision for depreciation on furniture and fixtures is made.
5. The auditor if possible can go for physical verification of furniture on test check basis or he can rely on the management certificate to that effect.
6. He has to further see that any damaged or unusable furniture, if existing, is fully written off in the books.
(xiii) Freehold Property (Land & Buildings) :
1. The auditor has to examine the title deeds of the property owned by the client and confirm that the same is freehold.
2. If the property has been purchased during the year, the auditor has to examine the correspondence with the broker, or solicitor in details.
3. When a building has been constructed on the freehold property, the same is to be verified from builder’s bill or architect’s certificate.
4. Where the title deeds are deposited with the mortgagee on a mortgage, then a certificate from him to that effect is to be obtained for verification.
5. If the title deeds are deposited with the bankers or solicitors for safe custody, the auditor should get a certificate from them to confirm the fact.
6. If required, the auditor should ask the solicitor of the client to confirm the validity of the title deeds relating to the property.
7. The auditor has to see that the conveyance of the property is in the name of the client and the same is properly registered.
8. The auditor has to ensure that the property is properly insured.
9. The auditor should see that separate account for land and building is maintained. Because on land, usually no depreciation is provided.
10. In case there is appreciation of land and buildings value by revaluation, the auditor has to see the basis of revaluation and confirm that the same is properly disclosed in the Balance Sheet, to comply with the generally accepted accountancy principles and also the provision of Companies Act, 1956.
(xiv) Motor Cars :
1. In respect of motor vehicles mileage or usage method is better because the time of total mileage that the particular vehicle will give, can be ascertained without much difficulty and the mileage in a particular year can also be known, so proportionate cost of the asset can be written off over the mileage traveled. For example, if the total mileage of a vehicle costing Rs. 80,000 is 1,60,000 miles and in a year suppose 15,000 miles are traveled, then the depreciation for that vehicle would be:
8000 x ——————— = Rs. 7,500
2. Where number of motor cars is large, it would be advisable if the client maintains a motor vehicle register. Where no such register is maintained, the balance of Motor Car account in the General Leger should indicate the registration number and cost of each vehicle.
3. The auditor should examine the registration book to see whether the description agrees with the details given by the client. The auditor should see that the person in whose favour registration is made holds it on behalf of the client and gives a confirmation that he holds it and there is no charge on it.
4. Many a times, vehicles are purchased by the client for the purpose of employees who pay a certain sum of money every month from the salaries. When all the money has been paid, the client transfers the car in the employee’s name. The auditor should check the relevant records for recovery made and the transfer price.
5. Sometimes cars are owned by employers and given to employees and cost of maintenance is borne by the client and the auditor in these cases affirms that whenever the client owns a car, he should provide depreciation on it.
6. Similarly, when the car is sold as scrap to the employees the auditor should compare the written down book value with the scrap price realized and see that the balance is charged to revenue account.
(xv) Loose Tools, Patterns, Dies, etc.
Auditor’s duties with regard to the verification and valuation of such assets may be stated as follows:
1. Since the duration of the usefulness of such assets is very low, there is no need of maintaining separate accounts for each of them. The auditor in this case should see whether proper supervision has been exercised over these assets, as there is every possibility of pilferage of such small assets.
2. The auditor should collect a list of small tools, dies, moulds, rigs, etc. from a responsible officer and examine the same very carefully. He should also see that such a list has been certified by a responsible officer.
3. As regards the valuation of small tools, the auditor should see that in the case of the concern which manufactured its own tools, the tools are not to be valued in excess of the cost.
4. Generally, these types of assets appear to be either lost or consumed very rapidly. So the conventional method of
depreciation should not be applied in their cases. The suggestion as given by Montgomery in this connection may be stated. “Charging the cost of replacement of such items to maintenance in lieu of depreciating them is usually a satisfactory alternative”. The auditor should see whether the above mentioned suggestion has been accepted or not.
6. The auditor should also see whether such an asset has been properly shown in the Balance Sheet.
(xvi) Assets Acquired on Hire Purchase Agreement
1. Assets purchased on hire purchase basis:
The auditor should take the following steps:
a) verify the minutes book of board meetings and see that there is proper resolution passed by the board to approve
the purchase of asset on hire purchase books.
b) Examine the hire purchase agreement carefully and note down the terms and conditions of the agreement.
c) Ensure that installments due are paid and the charges are charged against current profits.
d) See that the depreciation is charged on cash price of the asset.
e) See that the amount due to the hire vendor is shown as a current liability on liability side.
f) For new purchase, check bill agreement or other supporting.
(xvii) Live Stock
a) Check entries in Live Stock Register and compare them with ledger and financial statement.
b) Book value in respect of animals which are dead or not useful should be written off.
c) See whether management has taken physical count on regular occasions.
(xviii) Stores and Spare Parts
1. The asset known as stores and spare parts consists of materials which are means for consumption in the business and not for resale. Lubricants, dyes, fuel, etc., are examples of stores, while spare parts of machinery are preserved to maintain it in proper order.
2. The asset as such should be clearly shown in the Balance Sheet.
3. The auditor should obtain an inventory of stores and spare parts duly certified by a responsible officer. He should count the stock himself and thus verify the existence by personal inspection, if possible.
4. It is to be remembered that the stores consumed are debited to the Manufacturing Account and spare parts used are debited to the Machinery Account.
5. The asset is to be shown at cost price in the Balance Sheet. It is not a depreciable asset by use and provision for depreciation is not necessary.
6. However, the loss on account of breakage or waste on being worn out should be duly written off.
7. The asset should be revalued annually.
(xix) Contingent Assets
Some of the examples of contingent assets may be the following :
(a) Option to apply for shares in another company on favourable terms;
(b) Refund of octroi paid for goods sent out later on;
(c) Claim for money from a previous endorser of a bills receivable discounted but might be dishonoured;
(d) Uncalled share capital;
(e) Legal action for infringement of a copyright, etc.
Usually, contingent assets are not shown at the foot of the Balance Sheet on the assets side and the Companies Act does not require the contingent assets to be disclosed as such.
(xx) Remittance in Tansit
The question of remittance-in-transit will arise where there is a head office and branch office and head office sends cash for meeting the day-to-day expenses. If at the end of the year probably in the last week, cash might have been sent by the head office but not received by the branch office or alternatively branch might have sent its collection from customers to the head office but the head office might not have received it before the end of the accounting period, then it is a case of “Remittance in Transit.”
(a) To verify this item the auditor should call for the bank statements of head office and branches and reconcile them. Any cash received by the branch or head office in the first week of the new accounting year might have been in transit on the last day of the previous year. For the purpose of recording such cash in the balance sheet an entry is passed in the books as :
Cash in transit A/c Dr.
To Branch A/c. or Head Office A/c.
(b) Verify cash in transit from the Cash Book/Pass Book or subsequent period as to whether actually it is received or not.
(c) Check the statement of Reconciliation of H.O. and Branch Accounts.
(d) Verify pay-in-slip, if the amount is deposited into the bank.
(e) See that the entry passed as per item no. (a) is reversed in the next year.
(xxi) Miscellaneous Expenditure
According to Schedule VI of the Companies Act, 1956, Miscellaneous Expenditure (to the extent not written off) are as follows :
(a) Preliminary Expenses.
(b) Commission or Brokerage on underwriting or subscription of Shares or Debentures.
(c) Discount allowed on issue of Shares or Debentures
(d) Interest paid out of capital.
(e) Development and other expenditure
(a) Preliminary, Expenses
1. These are the expenses incurred for creating or incorporating a company i.e. legal expenses for drafting Memorandum of Association, Articles of Association, Stamp fees, etc.
2. Auditor should check the prospectus or the statement in lieu of prospectus for amount of preliminary expenses.
3. Contract with promoters, vendors, underwriters should be checked.
4. Board of Directors authorization for payment of expenses should be checked. Receipts should be obtained for payments.
5. Actual expenditure for preliminary expenses should not exceed amount mentioned in prospectus or statement in lieu of prospectus. Such excess should be approved by shareholders in general meeting.
6. Preliminary expenses can be written off against Share Premium Account (Section 78), if any.
7. Preliminary expenses should be written off in a reasonable number of years (usually 3 to 5 years).
8. Preliminary expenses to the extent not written off should be shown under Miscellaneous Expenditure, on the Asset side of the Balance Sheet.
9. Preliminary expenses written off during the year should be shown separately in the Profit & Loss Account.
(b) Commission or Brokerage on Issue of Shares or Debentures (Sec. 76) :
1. Such commission should be allowed by Articles of Association.
2. Rate of commission should not exceed 5% of the share issue price or rate prescribed under Articles of Association, whichever is lower.
3. Rate of commission should not exceed 2.5% of the debentures issue price or rate prescribed under Articles of Association whichever is lower.
4. Amount of commission payable should be mentioned in prospectus or statement in lieu of prospectus.
5. Copy of contract should be filed with the Registrar.
6. However in case of brokerage (i.e. percentage of commission payable to brokers who deal in shares and procuring of shares, etc.) above mentioned restriction of 5% or 2.5% is not applicable.
7. Actual payment should be authorized by Board of Directors.
8. Commission on issue of shares or debentures can be written off against Share Premium Account (Section 78) if any.
9. Such commission or brokerage should be written off in a reasonable number of years (usually 3 to 5 years).
10. Commission or brokerage to the extent not written off should be shown under Miscellaneous Expenditure on Asset side of the Balance Sheet.
11. Commission or brokerage written off during the year should be shown separately in Profit & Loss Account.
(c) Discount allowed on Issue of Shares or Debentures (Sec.79) :
Auditor should verify :
1. Such discount should be approved by ordinary resolution in general meeting as well as it should be authorized by the Company Law Board.
2. Rate of discount cannot exceed 10% unless higher percentage is approved by Company Law Board.
3. Such shares cannot be issued within one year from certificate of commencement. Further such shares should be issued within two months from the date on which issue is sanctioned by Company Law Board.
4. Prospectus should contain particulars regarding discount.
5. Discount on issue of shares or debentures can be written off against Share Premium Account (Section 78) if any.
6. Such discount should be written off in a reasonable number of years. (usually 3 to 5 years).
7. Such Discount to the extent not written off should be shown under Miscellaneous Expenditure on Asset side of the Balance Sheet.
8. Discount on issue of share or debenture written off during the year should be shown separately in Profit & Loss Account.
(d) Payment of interest out of Capital (Section 208)
Auditor should verify :
1. Such interest is allowed when construction work started by the company cannot be completed for some years, e.g. construction of plant and machinery, etc.
2. Such interest should be authorized by Articles of Association or by special resolution. Further the Central Government approval is necessary for payment of such interest.
3. Rate of interest cannot exceed 4% p.a. It cannot be paid after the half year immediately succeeding half year in which construction work was completed.
4. Actual payment of interest should be checked with entries in bank statement.
5. Payment of interest out of capital according to Section 208 does not amount to reduction of capital.
6. Such interest can be debited to cost of construction or it can be treated as deferred revenue expenditure which would be shown under `Miscellaneous Expenditure’.
7. In case such interest is transferred to `Miscellaneous Expenditure’, it should be written off in a reasonable number of years (i.e. 3 to 5 years)
8. The amount written off during the year should be shown separately in Profit & Loss Account.
(e) Development and other expenditure
Auditor should verify :
1. Board of Directors approval for such expenditure.
2. Receipts should be obtained from persons to whom payment is made.
3. Deferred Revenue Expenditure should be written off as early as possible (usually 3 to 5 years )
5. The amount written off should be shown separately in Profit & Loss Account.
6. Examples of other expenditure.
(a) Heavy advertisement expenditure for introducing a product.
(b) Research and development expenditure etc.
VERIFICATION OF LIABILITIES :
Meaning : The verification of liabilities implies an enquiry into the nature, extent and existence of liabilities.
It involves ensuring the following:
1. That all the liabilities have been clearly stated on the liability side of the Balance Sheet.
2. That all the liabilities relate to the business itself.
3. That they are correct and authorized.
4. That they are shown in the Balance sheet at their actual figures. It is an important duty of an auditor to verify the liabilities appearing in the Balance Sheet of the company. The object of verification of liabilities is to ascertain whether there is any improper inflation or deflation of values or improper creation of an imaginary liability in the
books. This form of manipulation is done in most cases to inflate or deflate the profits of the concern and thus make the position of the business appear stronger than what actually is, to create a secret reserve.
As a result of such manipulation, the Profit and Loss Account and the Balance Sheet prove to be incorrect and thus the Balance Sheet does not exhibit a true and fair view of the state of affairs of the concern. So, the auditor must take all possible steps to ensure that all liabilities are recorded properly in the books of accounts of the business. It is advisable that the auditor should, besides verifying the liabilities as shown in the Balance Sheet, get a certificate from the management that all liabilities of any nature have been included in the books of accounts and the contingent liabilities have been shown by way of a foot-note to the Balance Sheet or have been provided for.
(i) Share Capital
Though capital is not a liability of the company the auditor is required to verify it so that he can report on the genuineness of the balance sheet.
The duties of the auditor can be enumerated as follows :
1. If it is the first year of existence of the company
(a) He should examine the Memorandum of Association and Articles of Association
(b) He should check the Cash Book, Pass Book, Director’s Minute Book to find out the number of shares, the various classes of shares, the amount received thereon and the amount due from the shareholders.
(c) If some shares have been allotted to the vendors, he should examine the agreement between the vendors and the company.
(d) In case shares are issued at a premium he should ensure that the premium on issue should be credited to a separate account.
(e) Allotment and call money should be verified.
(f) He should check the forfeiture and reissue of shares, if any
(g) He should ensure that all the relevant provisions of the Companies Act are complied with.
(2) If it is not the first year of the company
(a) The share capital would be the same as in the previous year unless there are some alterations or addition by way of fresh issue or otherwise. He should ensure that the relevant legal provision are fulfilled.
(b) Similarly for reduction of share capital, he should see the provisions of the Act as specified in Sec. 100.
(c) In case bonus shares are issued, the auditor should check whether the permission from concerned authorities is taken, whether proper resolution is passed and whether the capitalization entries are correctly passed.
(d) In case rights shares are issued the auditor should check the bank book, bank statements. He should ensure that the required resolutions are passed and that the permission of the concerned authorities is taken, with particular reference to Sec. 81.
(ii) Reserves and Surplus
Reserves may be general or specific in nature. Sinking fund, Capital Redemption Reserve, Reserve for Contingencies are specific reserves.
Auditor’s duty in verification of reserves is as follows :
(1) He should check the Profit and Loss Appropriation account for transfer to reserves, to see the provisions of transfer of profit to reserve are complied with.
(2) He should check the board resolution for transferring the profit to the respective reserves.
(3) He should ensure that the movement in the reserve accounts i.e. additions to/deductions from previous year’s balance are properly disclosed as per the requirements of the law.
(4) Ensure that reserves are properly utilized as required by law.
(5) See that the reserves are properly disclosed in the balance sheet as per the law.
(iii) Loans Borrowed
For verification of loans, the auditor should consider the following points :
1. The auditor should examine the Memorandum and Articles of the Company to find out the powers of the Company to borrow money.
2. The auditor should examine the agreement and correspondence regarding the loan.
3. The auditor should vouch the receipts of cash on account of loan, with the receipts issued in respect of the loan and the corresponding entries in the cash book.
4. The auditor should examine the certificate of registration issued by the Registrar of Companies, if the loan has been secured by mortgaging any property.
5. The auditor should vouch the payment of interest with the counterfoils of the receipts issued to the vendors and the corresponding entries in the Cash Book.
6. He should also check the repayment of loan with the counterfoils of the cheque books, the bank pass book and the cash book.
In addition to the above, the auditor may ask for a confirmatory letter from the party who has advanced the loan to ensure that the interest on loan is not due and the recoupments of loan are recorded in the books of account correctly.
In the case of bank overdraft, the agreement with the bank and the security offered should be examined by the auditor.
(iv) Trade Creditors :
1. The auditor should ask for a schedule of creditors and check the same with the purchase ledger as that is already examined by him.
2. He should ensure that all purchase made during the year especially at the end of the year are included in the accounts of the creditors.
3. In case of suspicion about any creditors, the auditor with the consent of the client can ask the statement of account to be sent and verify the same by scrutinizing ledger accounts.
4. He should see the various debt is given for discount, goods returned etc, and confirm that the same are genuine.
6. The auditor should ask for the reason for not paying any overdue creditors.
(v) Contingent Liabilities
Contingent liabilities are those liabilities which may or may not arise in the future for payment. The auditor’s duty is to see that all known and unknown liabilities have been brought into the accounts at the date of the Balance Sheet and have been shown in the Balance Sheet separately as such.
1. Liabilities on Bills Receivable discounted and not matured : If the bills receivable are discounted with a bank and the money so received from it is made use of, the entire money will be refunded to the bank if the acceptor does not make payment on the date of its maturity. This is why such a contingent liability is distinctly shown in the Balance Sheet by way of a footnote.
2. Liabilities for calls on partly paid shares : The amount called on shares held and paid should be verified from the cash book and the liability for the amount uncalled should be ascertained.
3. Liability under a guarantee : The auditor should ascertain the liability for a guarantee given by the client for a loan or overdraft to his friend or partner. In case of non payment of such a loan, the possible liability should be ascertained.
4. Liability for cases against the company not acknowledged as debts : It is a liability in a disputed case where damages may have to be paid. A contingent liability should be ascertained and a note should be made at the foot of the Balance Sheet.
5. Liability in respect of arrears of Dividend on Cumulative preference Shares : The auditor should examine the Articles of Association which should lay down rules in this regard and due provision should be made for such a liability.
Auditor’s duty :
The auditor should very carefully check the various contingent liabilities named above. There may be some such liabilities for which no provision has been made in the books but merely a note has been made at the foot of the Balance Sheet, e.g. Bills Receivable which have been discounted and which have not matured at the date of the Balance Sheet, arrears of fixed cumulative dividends, etc. For liabilities in respect of which provision has to be made in the Balance Sheet, viz a suit, etc., the auditor should examine such cases and ascertain the amount to be specifically reserved for the purpose. The auditor should examine the Director’s Minute Book, correspondence made with the legal advisers and the information obtained from the officials of the business. He has to ensure that proper provision has been made for all such liabilities and if he is not satisfied, he should mention the fact in his report. It is to be remembered that the requirements of the Companies Act regarding the contingent liability should be complied with in the Balance Sheet on the liabilities side.
(vi) Provision for Taxation :
1. In case of a limited company it is compulsory that the taxation provision is to be made. But it cannot be ascertained accurately because the final liability on this account can be known only when the assessment is completed. Therefore, a fair estimate for providing this liability is necessary. Hence, the auditor has to verify the calculation done to arrive at the provision expected to be made.
2. However, when finally the assessment is over, the auditor should see that the excess or short provision is properly adjusted in the books.
3. Where any appeal is pending and the liability challenged, the same is a contingent liability. Hence the same is to be properly ascertained and disclosed in the Balance sheet.
(vii) Employees’ deposits :
Normally, in commercial and industrial ventures, the employees who deal with cash or stores are required to deposit cash security as a safeguard against some possible mis-appropriation or pilferage. Sometimes, the employees instead of paying cash, endorse trustee securities in favour of the employers. It should be remembered in this connection that :
1. Such a security in cash or in securities should be deposited separately in the bank.
2. It should be shown distinctly on the liabilities side of the Balance Sheet.
3. He should verify the amount of deposits by reference to the certified schedule received from the client.
(viii) Reserve for Bad and Doubtful Debts
The verification should be done as follows :
1. The auditor should obtain a certificate from some responsible officer of the business and then check the amount provided for bad and doubtful debts.
2. The schedule of debtors should be compared with the balance of ledger accounts to ascertain the possible amount of bad and doubtful debts.
3. The adequacy of such a reserve has specially to be checked. He should examine the nature, the circumstance of a particular business and the necessary rules in practice in this connection.
(ix) Bills Payable :
The auditor should verify the Bills Payable in the following ways:
1. The Bills Payable Book should be checked with the Bills Payable Account.
2. The Bills Payable already paid should be checked from the Cash Book and the returned Bills Payable should be examined.
3. To verify the Bills Payable which have not yet matured at the year end, the auditor should examine the Bills Payable book and should check the Cash Book of the succeeding years to see whether any payment has been made in respect of such bills. In case of any doubt, the auditor may ask the drawers for the confirmation of the bill.
4. The auditor should see if any charge has been created on the assets of the concern by accepting the bill and he should see that the facts are disclosed in the Balance Sheet.
(x) Proposed Dividend :
1. The auditor should ensure that the dividend proposed complies with the provisions of the Companies Act, the decisions of the Court, especially in the matters of provision for depreciation, distribution of capital profits, transfer to reserves etc.
2. The auditor should verify the board resolution and the entry in the Profit and Loss Appropriation account.
3. The auditor should ensure that as per the requirements of the Companies Act, 1956 gross dividend has been provided for.
4. To ensure completeness, the auditor should cross-check the names in the dividend list with those in the register of
(xi) Outstanding Expenses :
The auditor should obtain a certificate from a responsible officer to the effect that all the outstanding expenses have been included in the current year’s accounts. The amount paid on various accounts should be verified from the entries in the Cash Book. It should be ensured that the outstanding expenses included that part which is unpaid at the date of the Balance Sheet. The following points should be noted.
1. He should carefully note that all expenses, e.g. rent, rates, interest, wages, salary, audit fee, legal expenses, etc., have been accounted for in the books.
2. He should check entries in the books passed on the basis of invoices to ensure that they are not related to the year under audit.
3. He should compare all the paid and unpaid expenses of the current year with those of the previous year to see that there is not much difference.
4. It should be ensured that all outstanding wages and salaries have subsequently been paid.
(xii) Bank Overdraft
The verification of bank overdraft will be on the same lines as that of loans and advances. The difference is that it is the financial assistance obtained from the bank. The auditor should examine the Bank Pass book and call for a statement of mortgaged assets. It is to be remembered that the assets so mortgaged should be clearly stated as such in the Balance Sheet.
(xiii) Debentures :
1. The auditor has to examine the provisions regarding the power of the company to issue debentures as contained in Memorandum and Articles of Association.
2. If the debenture is issued as mortgage debenture, he has to verify the registration certificate issued by the Registrar.
3. He should carefully examine the terms of debentures issue as contained in Trust Deed and ensure that the same have been properly complied with.
4. The auditor should vouch the cash received on this account with the cash book.
5. The auditor should verify whether the interest on debentures is paid or provided, properly at regular intervals intervals or not.
6. In case the debentures have been redeemed during the year the same is to be confirmed with the Minutes of Board of directors. Counterfoils of the cheque books. Bank Pass book and Cash book, returned debenture certificate etc.
7. If the debentures have been issued as a collateral security, then he should see that the fact is properly disclosed in the Balance Sheet.
(xiv) Unclaimed Dividend
For verifying unclaimed dividend, the auditor should follow the following procedure.
1. See that the Bank Account from which dividend is paid is properly reconciled. See that dividend account is opened for each year to avoid mistake of one year’s dividend getting mixed up with next year’s dividend. See that no entries remain in these Bank Accounts reconciliation like accounts debited by bank but not accounted in books, etc. because then the Unclaimed Dividend shown in the books will be wrong.
2. See that wherever dividend is declared on shares, where calls are in arrears and directors have decided to adjust the dividend payable against calls in arrears, the appropriate entries have been booked.
3. See that a full list of shareholders who have not claimed dividend is prepared. This is necessary firstly to prove that there are no mistakes committed while reconciling the Bank Account and secondly to prove the accuracy of the Member’s Register. The auditor should compare this list with the Member’s Register to see that unclaimed dividend for every shareholder is matching with the number of shares held by him as per Share Register. This will also
disclose if any dividend is paid to a shareholder who has already transferred his shares provided he has not en-cashed his dividend warrant.
5. See that if the statutory time limit of 3 years is over, the money being in Unclaimed Dividend Account is transferred to the Central Government with details of shareholders who have not claimed the dividend.
(xv) Calls in Arrears :
The auditor should verify Calls in Arrears as under :
1. Find out whether calls in arrears are arising on account of capital issued during the year or is continuing on account of capital issued in earlier years.
2. If it is on account of capital issued during the year, see that correct amount has been arrived at towards call in arrears by referring to the application form money paid towards application, shares allotted, total share money payable, calls made, calls money payable and calls paid. For this he will have to conduct share allotment audit to arrive at all the relevant data.
3. In case calls are in arrears from earlier years, see that reminders have been sent to the shareholders for payment of calls. If the Board has decided to charge interest on such calls in arrears see that reminder contains the request to pay the calls in arrears with interest. If any part of the calls in arrears have been received during the year on which interest was payable see that such call moneys are received with interest.
4. If any transfer application has been received for shares on which some calls are in arrears, see that no transfer has been effected without arrears having been paid first.
5. If the Directors have declared dividend, see that dividend payable on such shares is proportionately reduced and if the directors have decided to appropriate dividend on such shares where calls are in arrears see that dividend is not physically paid out but appropriate accounting entries crediting calls in arrears and debiting dividend payable is passed.
6. See that, if the Board has passed any Resolution forfeiting shares on which calls are in arrears, the same is reflected properly in the accounts by passing of necessary entries and such shares are not continued to be shown as part of capital at full value and calls in arrears continued to be deducted therefrom.
(xvi) Fixed Deposits :
The auditor should keep in mind the following points while conducting a fixed deposit verification –
1. Fixed Deposits should be accepted according to Section 58A of Companies Act, 1956 and Reserve Bank of India’s guidelines.
2. Fixed deposits from director for less than six months (but exceeding 3 months) should not exceed 10% of paid up share capital and free reserves.
3. Total fixed deposits should not exceed 25% of paid-up share capital and free reserves.
4. Fixed deposit should not be accepted if the period exceeds 36 months.
5. Interest on fixed deposits can not exceed 15% p.a.
6. Brokerage can be paid subject to limits mentioned below.
(a) Upto 1 year – not to exceed 1% of amount of deposits.
(b) 1 to 2 years – not to exceed 1.25% of amount of deposits
(c) 2 to 3 years – not to exceed 1.50% of amount of deposits.
7. Liquid assets should be maintained at not less than 10% of deposits maturing 31st March.
8. Receipts should be issued to the deposit holders.
9. Fixed Deposit Register should be maintained.
10. Return of fixed deposits should be sent to the Registrar before 30th June. In case it is not sent, auditor should mention it in the Auditor’s Report as per Section 45 MA of Reserve Bank of India Act, 1934.
11. Interest accrued but not due should be provided and it should be shown under Current Liabilities.
12. Fixed Deposits received along with accrued and due interest would be shown under `Unsecured Loans’.