The Hindu Business Line : Can you give a clean report after auditing photocopied records?

THE auditor of a limited company has given a clean report on the financial statement on the basis of photocopies of the books of accounts, vouchers and other records, which were taken away by the income-tax department during search under Section 132 of the I-T Act, 1961.

Where the auditor is not in a position to form an opinion because the audit is carried on photocopies of the records, the auditor should issue a disclaimer in the audit report. AAS 28, on audit reporting, requires the auditor also to give reasons for not being able to form an opinion.

In the given case, the I-T department carries away the books of account and other records and the audit was carried out based on photocopies of the records. The auditor would be running a high degree of "audit risk" by giving such a clean report.

The auditor should use his judgment on the reliability of these records. If the photocopies are certified by the I-T department, he may subject the records to such further examination as he deems fit. If he is satisfied, he may document the fact and consider issuing a clean report.

But it would be advisable for the auditor to include a disclaimer in the audit report to the effect that the audit was carried out based on photocopies of the records since the original records were not available for audit.

It would not be proper to mention in the audit report that the I-T department carried the books of account away, as this would violate the basic principle of confidentiality (AAS 1). AAS 21, on compliance with legal requirements, also does not require such a disclosure.

This is one of the questions that appeared in the November 2004 CA (PE II) paper on auditing. A look now at the other questions:

Situation analysis

E AND S were appointed as joint auditors of X and Y Ltd. What will be their professional responsibility if the company has cleverly concealed certain transactions that escaped the notice of both the auditors?

AAS 12, on joint auditors, states that the liabilities of joint auditors shall be joint and several, unless the extent of work is divided among them before commencing the audit, which is in writing and a copy of the same kept by each of the joint auditors.

In such a case, the liability would be restricted to the work accepted by each one of them. All the joint auditors continue to be jointly responsible for the collective decisions taken by them, such as the nature, extent and timing of the audit procedures to be carried out. The specific auditor to whom the work is allocated is responsible only to the extent of execution of the job allocated to him.

In the given case, whether the joint auditors are liable depends upon the following factors: a) nature of the transactions; b) materiality of the transactions; and c) whether the concealment could have been noticed in the normal course of audit.

AAS 2 read with AAS 4 states that the auditor would be responsible only for those misstatements which remain undetected even after the audit is completed, if the auditor, in the normal course of business, could have noticed them. If this is established, the area in which the fraud was perpetuated has to be considered.

If it can be identified with the work undertaken by any one of the joint auditor, he singularly would be responsible for negligence. If it is a collective decision or if the joint auditors have not divided the work between them before the commencement of the work, both of them would be jointly and severally responsible for negligence.

Aakansha is a member of the Institute of Chartered Accountants of England and Wales. Is she qualified to be appointed as auditor of Indian companies?

Under Section 226 (1) of the Companies Act, a person shall not be qualified for appointment as auditor of a company unless he is a chartered accountant within the meaning of the Chartered Accountants Act, 1949. Thus, in the given case, Akanksha is not qualified to be appointed as an auditor of Indian companies.

B owes Rs 1,001 to C Ltd of which he is an auditor. Is his appointment valid? Will it make any difference, if the advance is taken for meeting out travelling expenses?

As per Section 226 (3)(d) of the Companies Act, a person is disqualified to be an auditor of a company if he is indebted to the company to a sum exceeding Rs 1,000, whether directly or indirectly or by way of a guarantor.

In the given case, the auditor owes Rs.1,001 to the company, thereby attracting Section 226 (3)(d). He is deemed to have automatically vacated the office and a casual vacancy arises since he is the existing auditor of the company. His appointment will no longer be valid.

It would not make any difference if the amount is an advance for meeting out travelling expenses. The purpose of this clause is to ensure independence of the auditor. Moreover, companies only reimburse the expenses, which indicates that the auditor should first incur the expenditure and then claim the reimbursement.

Statements to comment upon

AS AN auditor, comment on the following situations/statements:

You are the auditor of a manufacturing company whose year ends on March 31. An event occurred after the year ended but before you complete the audit. The audit report issued by you is dated July 20. The sales ledger balance at March 31was Rs 95,000. By July 20, Rs 65,000 only had been received against this amount as full and final payment.

Accounting Standard (AS) 4, dealing with events occurring after the date of the balance-sheet, classifies the events as adjusting and non-adjusting events. Adjusting events are those that provide information materially affecting the determination of the amounts relating to conditions existing as at the balance-sheet date.

In the instant case, the entity realised Rs 65,000 in full and final settlement of sales of Rs 95,000. This event effects the financial position as on the date of the balance-sheet. Therefore, it is an adjusting event. Also, AS 9 recommends recognition of only Rs 65,000 in the relevant year.

Audit and Assurance Standard (AAS 19), dealing with subsequent events, requires the auditor to consider all the events occurring between the balance-sheet and report dates.

Therefore, the auditor should consider this aspect and advise the entity to treat the difference of Rs 30,000 as cash discounts, as the amount is received in full settlement. It cannot be treated as sales returns.

AAS Ltd is procuring the packing materials from XY and Co., a partnership firm consisting of Mr X and Mr Y. Mr Y is the managing director of the AAS Ltd. The total value of purchases made from XY and Co. by AAS Ltd during the year 2003-04 had been Rs 38 lakh.

AS 18, dealing with related parties, requires disclosures to be made by the reporting entity, if applicable to it. AAS 23 requires the auditor to ensure that transactions with related parties are at `arm's length'. CARO requires the auditor to ensure whether all the transactions, which exceed Rs 5 lakh with parties, entered in the register maintained under Section 301 are so entered and whether they are made at reasonable prices having regard to prices prevailing in the market.

In the instant case, since Mr Y, the MD AAS Ltd is also a partner in XY, the partnership firm XY, therefore, becomes a related party. The auditor would be required to ensure that the transactions are carried out on commercial expediency and are at an arm's length as stated in AS 18.

Also, the firm becomes a party to be mentioned in the register maintained under Section 301. Since the value of transactions is in excess of Rs 5 lakh, the auditor should also offer a comment under CARO.

X Ltd's profits are good, but it suffers temporarily in liquidity. It proposes to declare dividend of 10 per cent in its annual general meeting (AGM), but the board proposes to defer payment of dividend by two months from the AGM date by getting a resolution passed in AGM.

Section 205A(1) requires that the company pay the dividends within 30 days from the date of declaring the dividends at the AGM and to transfer a sum equal to the dividend payable to a separate bank account entitled "unpaid dividends Account" within five days after expiry of 30 days from declaring the dividend at the AGM.

Upon failure to transfer such amount, the company shall pay interest on the outstanding from the date of default till the date of actual payment to the shareholders (sub-section 4).

For any default, the company and every officer of the company shall be liable to a penalty of Rs 5,000 per day of default.

In the given case, the board proposes a 10 per cent dividend and to defer payment of dividend by two months from the date of AGM by getting a resolution passed in the AGM. The dividend is payable within 30 days from the date of declaring the dividends.

If the company is willing to face the penal provisions, it may hold back divided payment for two months.

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