The Hindu Business Line : Stressing on Standards

In company audit, one question (Q 2b) is a minor deviation from questions asked earlier. The same question has been asked many times in the recent past and any average student would have jumped with joy on seeing it.

Question 4 seems to be dedicated to vouching and verification for the last so many years. This time is no exception. All the four bits are quite simple and can be comfortably dealt with.

A significant point is that questions (on grants, AAS 28, basic principles) for 22 marks strikingly resemble the model paper that appeared in these columns on October 16, 2006.

Overall, the paper has a good spread over the syllabus. No question is asked on audit under computerised environment. The paper is student friendly.

Solutions:

Q1.a. SMT Enterprises entered in to a contract for sale of its goods worth Rs 24 lakh with ST Ltd. The goods were inspected, approved and finalized by the inspection team of ST Ltd. ST Ltd. made the whole payment of Rs 24 lakh. However it requested SMT enterprises to dispatch the goods in six equal monthly instalments from October 2005 to March 2006. In January 2006, due to natural calamity, ST Ltd. informed SMT enterprises to stop dispatching of the remaining three instalments until further notice. At the time of finalising the accounts for the financial year 2005-06, SMT enterprises booked sales amounting to Rs 12 lakh and showed the remaining Rs 12 lakh as advance against sales.

Ans: As per Accounting Standard 9, revenue is measured by the charges made to the customers or clients for goods supplied and services rendered to them. The Sale of Goods Act defines sale as transfer of title in goods. It may coincide with delivery or may be independent of it. Revenue by way of sale is to be recognised at the time of passing of title of the goods from the seller to the buyer.

In the given case, the sale is complete since the gods were inspected, approved and finalised by the inspection team of ST Ltd and the payment also is received. The title in goods has passed on to ST Ltd and SMT enterprises has to include the whole of Rs 24 lakh as sales.

The treatment of SMT Enterprises is not acceptable. The auditor should apprise the management of this provision and insist upon including the whole Rs 24 lakh as sales. In the case of a company, the auditor has to state in the report whether the company has complied with all the applicable accounting standards. Since the seller (SMT Enterprises) is not a limited company, this requirement is not applicable.

Q.1.b. X Ltd. had a major breakdown in its plant in February 2006. In March, it entered into an agreement with an engineering firm for the purposes of repairing its plant for a consideration of Rs 180 lakh. The engineering firm started the repair work on April 1, and completed it the same month. X Ltd. made provision for the said expenditure on repairs in its books of account for the financial year 2005-06 on the plea that the event of breakdown leading to repairs had taken place during the year 2005-06, binding contract for repairs was entered into during the financial year 2005-06 and repair work also was completed before he financial statements were approved by the board of directors of the company.

Ans. AS 4 classifies events occurring after the date of balance-sheet as adjusting events and non-adjusting events. An adjustment has to be made for such events occurring after the balance-sheet date that provide information materially affecting the determination of the amounts relating to conditions existing as at the balance-sheet date.

In the given case, the breakdown was during February and the binding contract was also entered into during 2005-06, though the work was actually carried out during April. Since this event is confirming a position materially affecting the determination of the amounts relating to conditions existing as at the balance-sheet date, it is an adjusting event. Therefore, the contention of the management is justified and the auditor has to merely document the same (AAS 3) and can issue an unqualified report.

Q1.c. The management tells you that work-in-progress is not valued since it is difficult to know the same in view of multiple processes involved and in any case opening and closing WIP would be more or less the same.

Ans. AS 2, dealing with valuation of inventories includes work-in-progress as a part of inventories. Unless the work-in-progress is valued in accordance with the requirements of AS 2, it tantamounts to non-compliance with an accounting standard applicable o the company, warranting a comment under Section 211(3) a, b and c.

Unless the financial statements are drawn up in accordance with GAAPs, of which Accounting Standards are a part, they cannot be said to be showing a true and fair view. Unless the valuation of work in progress is proper, the financial statements would not be showing a true and fair view.

In the given question, the management says that opening and closing WIP would be more or less the same. The variation can be known only if the valuation is carried out. Since the management has not valued work in progress, the auditor should qualify the report as required under Section 211(3) a, b and c. If the quantum of impact on the profit and loss position is determinable, it should be indicated in the audit report. Else, he should state that it is not determinable. The auditor should also comply with the CARO requirements applicable to manufacturing Companies and include necessary statements under CARO.

Q1.d. JKT Ltd., having Rs 40 lakh of paid-up capital, Rs 9.50 lakh of reserves and turnover of the last three consecutive financial years preceding the financial year under audit being Rs 4.90 crore, Rs 4.50 crore and Rs 6 crore but does not have any internal audit system. In view of the management, the internal audit system is not mandatory.

Ans. CARO would be applicable to this company though the paid-up capital and reserves are less than Rs 50 lakh since it is not a private limited company. Under CARO, an auditor is required to state whether the companies having a paid up capital and reserves exceeding Rs 50 lakh as at the commencement of the financial year concerned or having an average annual turnover exceeding Rs 5 crore forconsecutive three financial years preceding the financial year concerned, whether the company has an internal audit system commensurate with size and nature of the business.

In the given situation, paid-up capital and reserves is less than Rs 50 lakh.

The average annual turnover of the company is (Rs 4.90+4.50+6) crore divided by 3, which works out to Rs 15.40 crore/3, that is, Rs 5.13 crore, which is more than Rs 5 crore. Therefore, the auditor has to comment under CARO that the Company does not have an internal audit system. Law does not specify that there should be an internal audit system. The internal audit system is a management tool and is not mandatory.

Q2.a. Managing director of PQR Ltd. himself wants to appoint Ganpati, a practising Chartered Accountant, as first auditor of the company. Comment on the proposed action of the Managing Director.

Ans. An individual who is a Chartered Accountant within the meaning of the Chartered Accountants Act and is practising in India can be appointed as an auditor of the Company. The first auditor of a company can be appointed by the board of directors within one month from the date of incorporation of the company.

In the given question, the managing director himself wants to appoint Ganpati as the first auditor of the company. Since he is a practising chartered accountant, Ganpati is eligible to be appointed the auditor of the company. Ganpati can be appointed only by the board of directors and not by the managing director himself. This can be done if the other directors also agree to it and is done within one month from the date of its incorporation.

Q2.b. PBS & Associates, a firm of chartered accountants has three partners — P,B and S. The firm audits 60 companies, including two branch audits of a company. The firm is offered three Company audits, of which one is a private limited company, other is a foreign company and the third a public company. Decide and advise whether PBS & Associates will exceed the ceiling prescribed under Section 224(1B) by accepting the above assignments.

Ans. Under Section 224 (1B), the ceiling of audits is 20 per partner of a partnership firm. This 20 audits does not include

audit of private limited companies,

audit of foreign companies,

audit of branches of companies.

Audit of a company with all its branches is considered to be one audit. There is also a sub-limit that of the 20, not more than 10 shall be of those companies having a paid-up capital of more than Rs 25 lakh.

In the given question, the firm has three partners. The firm has a ceiling of 60 audits, including two branch audits of a company. These two audits are to be excluded, which brings down the effective audits to 58. The firm is offered three audits, of which one is a private limited company, and the other is a foreign company, both of which are to be excluded from the number for ceiling.

The third audit, of the public limited company, is to be considered, which brings the effective audits to 59, being within the ceiling limit of 60 audits. However, the number of audits for sub-limit of 10 audits per partner should also be considered. Out of the existing audits, if the firm already has 30 audits of companies with a paid-up capital of over Rs 25 lakhs, the proposed audit would exceed the ceiling.

Q2.c. RT Ltd. received Rs 50 lakh as a grant from the State government towards the part cost of a specific machinery. The company credited thst sum as income in its profit and loss account for the year. What are your views on the accounting treatment of the above receipt of Rs 50 lakh?

Ans. The grant received is for purchase of specific machinery, which makes it a capital grant. AS 12 on accounting for grants requires these grants to be credited to the specific asset or to disclose it in the balance-sheet and write it back to the profit and loss account over the useful life of the asset.

In the given situation, the grant is treated as a revenue item by taking it to the profit and loss account. It is a case of treating a capital item as revenue, thereby distorting the profit and loss account. Such an accounting treatment is not justified. The company should comply with the requirements of AS 12 and transfer the credit to the asset account. Alternately, the grant received is to be disclosed as a separate item in the balance-sheet and periodically credited to profit and loss account over the useful life of the asset.

Q2.d. Audit of expenditure is one of the major components of Government Audit. Write in brief what do you understand by

(i) Audit against rules and orders,

(ii) Audit of sanctions,

(iii) Propriety audit.

Ans. C&AG has to satisfy that the expenditure is properly authorised, sanctioned, and spent in accordance with the rules, orders, provisions, and sanctions. The terms are explained in brief as under:

Audit against rules and orders: The C&AG should ensure that the expenditure is incurred in accordance with the rules and regulations framed by the competent authority. Competent authority should have the authority to incur and sanction the expenditure from the Consolidated Fund of India or of the States. The C&AG should ensure that all the persons concerned are fulfilling the rules framed. Such rules and regulations should not be inconsistent with the provisions of the Constitution or any other laws. They should not of a conflicting nature of any other authority. They should confirm to the requirements as laid down by the government.

Audit of sanctions: There should be either a general or a specific sanction for any item of expenditure. The C&AG should ensure that there is a sanction and that the person sanctioning the expenditure has an authority to sanction the expenditure.

iii) Propriety audit: Any government officer aims this audit at ensuring that personal element does not creep in to the discharge of duties. Even if the expenditure has been in conformity with the rules and orders, properly sanctioned and provided for, the auditor should ensure that it is not infructuous, improper or avoidable considering the timing of the expenditure. The expenditure should be well within the limits as the circumstances warrant. The officer concerned should use his discretion while spending public money as if it were his own money. Sanctioning any expenditure should not directly or indirectly benefit the officer concerned. The officer should take a macro view of the situation. Expenditure should not be sanctioned to a specific person or a group of persons unless it has been ordered by a court of law or following an established practice. Propriety audit is aimed at reporting any avoidable expenditure being incurred or any personal benefits arising to an official from a particular transaction.

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