C.A.FINAL EXAMINATION ADVANCED AUDITING REVISION MATERIAL PREPARED BY S.GANAPATHY F.C.A email@example.com TOPIC 1. 2. PROFESSIONAL ETHICS IMPORTANT NOTIFICATIONS IN CODE OF ETHICS 3. 4. COMPANY AUDIT AND REPORTING GUIDE TO ANSWERS FOR PRACTICAL QUESTIONS PROFESSIONAL ETHICS (AS AMENDED BY CA AMENDMENT ACT, 2006) Objectives The Code recognizes that the objectives of the accountancy profession are to work to the highest standards of professionalism, to attain the highest levels of performance and generally to meet the public interest requirement. IFAC in its Code of Ethics for Professional Accountants has also stated as under: The Public Interest - A distinguishing mark of a profession is acceptance of its responsibility to the public. The accountancy profession‘s public consists of clients, credit grantors, governments, employers, employees, investors, the business and financial community, and others who rely on the objectivity and integrity of professional accountants to maintain the orderly functioning of commerce. This reliance imposes a public interest responsibility on the accountancy profession. The public interest is defined as the collective well-being of the community of people and institutions the professional accountant serves. These objectives require four basic needs to be met: Credibility - In the whole of society there is a need for credibility in information and information systems. Professionalism - There is a need for individuals who can be clearly identified by clients, employers and other interested parties as professional persons in the accountancy field Quality of Services - There is a need for assurance that all services obtained from a professional accountant are carried out to the highest standards of performance Confidence - Users of the services of professional accountants should be able to feel confident that there exists a framework of professional ethics, which governs the provision of those services Fundamental Principles In order to achieve the objectives of the Accountancy profession, professional accountants have to observe a number of prerequisites or fundamental principles. The fundamental principles are: Integrity - A professional accountant should be straightforward and honest in performing professional services. Objectivity - A professional accountant should be fair and should not allow prejudice or bias, conflict of interest or influence of others to override objectivity. Professional competence - A professional accountant should perform professional services with due care, competence and diligence and has a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives the advantage of competent professional service based on up-to-date developments in practice, legislation and techniques Due Professional Care - It dose not require ultimate expert but does extend to every aspect of the audit including the evaluation of audit risk, the formulation of audit objective, the establishment of audit scope, the selection of audit tests and the evaluation of test result. It requires an individual to exercise the Skill of a level commonly possessed by practioners of that specialty Confidentiality - A professional accountant should respect the confidentiality of information acquired during the course of performing professional services and should not use or disclose any such information without proper and specific authority or unless there is a legal or professional right or duty to disclose Professional Behaviour - A professional accountant should act in a manner consistent with the good reputation of the profession and refrain from any conduct, which might bring discredit to the profession. The obligation to refrain from any conduct, which might bring discredit to the profession requires IFAC member bodies to consider, when developing ethical requirements, the responsibilities of a professional accountant to clients, third parties, other members of the accountancy profession, staff, employers and the general public Technical Standards - A professional accountant should carry out professional services in accordance with the relevant technical and professional standards. Professional accountants have a duty to carry out with care and skill, the instructions of the client or employer in-so-far as they are compatible with the requirements of integrity, objectivity and in the case of professional accountants in public practice, independence. In addition they should conform with the technical and professional standards promulgated by: IFAC (e.g. International Standards on Auditing); International Accounting Standards Board; The Member‘s professional body or other regulatory body; and Relevant legislation. Schedules There are two schedules: The First Schedule - The First Schedule has four parts [Including part IV inserted by Chartered Accountants (Amendment) Act, 2006]. Part I of first Schedule deals with the professional misconduct in relation to Chartered Accountant in practice. Part II deals with the professional misconduct in relation to members of the Institute in service. Part III deals with the professional misconduct in relation to members of the Institute generally. Part IV deals with other misconduct in relation to members of the institute generally. The Second Schedule - The Second Schedule has three parts [Including Part III insulted by Chartered Accountants (Amendment) Act, 2006], Part I of Second Schedule deals with the professional misconduct in relation to Chartered Accountants in practice. Part II deals with the professional misconduct in relation to member of the Institute generally. Part III deals with the other misconduct in relation to members of the Institute generally. Members who are deemed to be in practice Every member of the Institute is entitled to designate himself as a Chartered Accountant. There are two classes of members, those who are in practice and those who are otherwise occupied. In Section 2(2) of the Act, the term ―to be in practice‖ has been defined as follows: ―A member of the Institute shall be deemed ―to be in practice‖ when individually or in partnership with Chartered Accountants in practice, he, in consideration of remuneration received or to be received(i) engages himself in the practice of accountancy; or (ii) offers to perform or performs service involving the auditing or verification of financial transactions, books, accounts or records, or the preparation, verification or certification of financial accounting and related statements or holds himself out to the public as an accountant; or (iii) renders professional services or assistance in or about matters of principle or detail relating to accounting procedure or the recording, presentation or certification of financial facts or data; or (iv) renders such other services as, in the opinion of the Council, are or may be rendered by a Chartered Accountant in practice: and the words ―to be in practice‖ with their grammatical variations and cognate expressions shall be construed accordingly. Explanation - An associate or a fellow of the Institute who is a salaried employee of a Chartered Accountant in practice or a firm of such Chartered Accountants shall, notwithstanding such employment, be deemed to be in practice for the limited purpose of the training of Articled Clerks‖. Pursuant to Section 2(2) (iv) above, the Council has passed a resolution permitting a Chartered Accountant in practice to render entire range of “Management Consultancy and other Services”. Significance of the certificate of Practice A member who is not in practice is precluded from accepting engagement to render services of any of the types normally prescribed for a Chartered Accountant, even though for doing so, he does not require special qualifications. The Council of the institute is of view that: (i) Once the person concerned becomes a member of The Institute, he is bound by the provisions of the Chartered Accountants Act and its Regulations. If and when he appears before the Income-tax Tribunal as an Income-tax representative after having become a member of the Institute, he could so appear only in his capacity as a Chartered Accountant and a member of the Institute. Having, as it were, brought himself within the jurisdiction of the Chartered Accountants Act and its Regulations, he could not set them at naught by contending that even though he continues to be a member of the Institute and has been punished by suspension from practice as a member, he would be entitled, in substance, to practice in some other capacity. (ii) A member of the Institute can have no other capacity in which he can take up such practice, separable from his capacity to practice as a member of the Institute. Therefore a Chartered Accountant, whose name has been removed from the membership for professional and/or other misconduct, during such period of removal, will not appear before the various tax authorities or other bodies before whom he could have appeared in his capacity as a member of this Institute A Member in practice is prohibited from using a Designation other than Chartered Accountant Under Section 7 of the Chartered Accountants Act, 1949 a member in practice cannot use any designation other than that of a Chartered Accountant, nor can he use any other description, whether in addition thereto or in substitution therefore, but a member who is not in practice and does not use the designation of a Chartered Accountant may use any other description. Nevertheless a member in practice may use any other letters or description indicating membership of Accountancy Bodies, which have been approved by the Council or of bodies other than Accountancy Institutes so long as such use does not imply adoption of a designation and/or does not amount to advertisement or publicity Disabilities for Purpose of Membership Section 8 of the Act enumerates the circumstances under which a person is debarred from having his name entered in or borne on the Register of Members, as follows: (i) If he has not attained the age of twenty one years at the time of his application for the entry of his name in the Register; or (ii) If he is of unsound mind and stands so adjudged by a competent court; or (iii) If he is an undischarged insolvent; or (iv) If he, being a discharged insolvent, has not obtained from the court a certificate stating that his insolvency was caused by misfortune without any misconduct on his part; or (v) If he has been convicted by a competent Court whether within or without India, of an offence involving moral turpitude and punishable with transportation or imprisonment or of an offence, not of a technical nature, committed by him in his professional capacity unless in respect of the offence committed he has either been granted a pardon or, on an application made by him in this behalf, the Central Government has, by an order in writing, removed the disability; or (vi) If he has been removed from membership of the Institute on being found on inquiry to have been guilty of professional or other misconduct; Provided that a person who has been removed from membership for a specified period, shall not be entitled to have his name entered in the Register until the expiry of such period. Failure on the part of a person to disclose the fact that he suffers from any one of the disabilities aforementioned would constitute professional misconduct. The name of the person, who is found to have been subject at any time to any of the disabilities aforementioned, can be removed from the Register of Members by the Council (Section 20). Professional Misconduct For the purposes of this Act, the expression ―professional or other misconduct‖ shall be deemed to include any act or omission provided in any of the Schedules, but nothing in this section shall be construed to limit or abridge in any way the power conferred or duty cast on the Director (Discipline) under sub-section (1) of section 21 to inquire into the conduct of any member of the Institute under any other circumstances‘. Other Misconduct - A member is liable to disciplinary action under Section 21 of the Chartered Accountants Act, if he is found guilty of any professional or ―Other Misconduct‖. Other misconduct has been defined in part IV of the First Schedule and part III of the Second Schedule [Newly inserted parts by Chartered Accountants (Amendment) Act. 2006]. As per Part IV of the First Schedule to the Chartered Accountants Act, A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he(1) is held guilty by any civil or criminal court for an offence, which is punishable with imprisonment for a term not exceeding six months; (2) in the opinion of the Council, brings disrepute to the profession or the Institute as a result of his action whether or not related to his professional work. As per Part III of the Second Schedule to the Chartered Accountants Act, A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he is held guilty by any civil or criminal court for an offence which is punishable with imprisonment for a term exceeding six months This provision empowers the Council to inquiry into any misconduct of a member even it does not arise out of his professional work. This is considered necessary because a chartered accountant is expected to maintain the highest standards of integrity even in his personal affairs and any deviation from these standards, even in his non-professional work, would expose him to disciplinary action. For example, a member who is found to have forged the will of a relative, would be liable to disciplinary action even though the forgery may not have been done in the course of his professional duty. Other misconduct would also relate to conviction by a competent court for an offence involving moral turpitude punishable with cause transportation or imprisonment to an offence not of a technical nature committed by the member in his professional capacity [See section 8(v) of the Act]. Penalty for Falsely claiming to be a Member Etc. Section 24 of the Act provides - any person who (i) not being a member of the Institute; (a) represents that he is a member of the Institute; or (b) uses the designation Chartered Accountant; (ii) being a member of the Institute, but not having a certificate of practice, represents that he is in practice or practices as a Chartered Accountant, shall be punishable on first conviction with fine which may extend to one thousand rupees, and on any subsequent conviction with imprisonment which may extend to six months or with fine which may extend to five thousand rupees, or with both. Maintenance of Branch offices In terms of Section 27 of the Act if a Chartered Accountant in practice or a Firm of Chartered Accountants has more than one office in India, each one of such offices should be in the separate charge of a member of the Institute. (RULE) Failure on the part of a member or a firm to have a member in charge of its branch and a separate member in case of each of the branches, where there are more than one, would constitute professional misconduct. However, exemption has been given to members practicing in hill areas subject to certain conditions. The conditions are: 1. Such members/firm be allowed to open temporary offices in a city in the plains for a limited period not exceeding three months in a year. 2. The regular office need not be closed during this period and all correspondence can continue to be made at the regular office. 3. The name board of the firm in the temporary office should not be displayed at times other than the period such office is permitted to function as above. 4. The temporary office should not be mentioned in the letterheads, visiting cards or any other documents as a place of business of the member/firm. 5. Before commencement of every winter it shall be obligatory on the member/firm to inform the Institute that he/it is opening the temporary office from a particular date and after the office is closed at the expiry of the period of permission, an intimation to that effect should also be sent to the office of the Institute by registered post. It is necessary to mention that the Chartered Accountant in charge of the branch of another firm should be associated with him or with the firm either as a partner or as a paid assistant. If he is a paid assistant, he must be in whole time employment with him. The above rule applies having additional office is situated at a place beyond 50 Kms. from the municipal limits in which the office is situated. However, a member can be in-charge of two offices if they are located in one and the same Accommodation. In this context the Council‘s decisions are as follows: (1) Definition of Office: ―A place where a name-board is fixed or where such place is mentioned in the letter-head or any other documents as a place of business.‖ (2) With regard to the use of the name-board, there will be no bar to the putting up of a name-board in the place of residence of a member with the designation of Chartered Accountant, provided it is a name-plate or a name-board of an individual member and not of the firm. (3) The requirement of Section 27 in regard as to a member being in-charge of an office of a Chartered Accountant or a firm of such Chartered Accountants shall be satisfied only if the member is actively associated with such office. Such association shall be deemed to exist if the member resides in the place where the office is situated for a period of not less than 182 days in a year or if he attends the said office for a period of not less than 182 days in a year or in such other circumstances as, in the opinion of the Executive Committee, establishes such active association. The expression ‗member‘ in the context of above, shall mean, where more than one member is designated as in-charge of an office, then, any one of them and when there is only one member and he leaves the firm during his successor(s) in office. (4) In view of the Council‘s decision, however, the exemption may be granted under proviso to Section 27 (1) of the Chartered Accountants Act, 1949 to a member or a firm of Chartered Accountants in practice to have a second office without such second office being under the separate charge of a member of the Institute, provided (a) the second office is located in the same premises, in which the first office is located or (b) the second office is located in the same city, in which the first office is located or (c) the second office is located within a distance of 50 km. from the municipal limits of a city, in which the first office is located. A member having two offices of the type referred to above shall have to declare, which of the two offices is his main office, which would constitute his professional address. (5) The expression ‗member‘ in the above context shall mean, where more than one member is designated as in-charge of an office, then any such member and in other cases more than one member where a change in the designated member in-charge of an office takes place during the year. THE FIRST SCHEDULE (See Sections 21(4) and 22) PART I Professional misconduct in relation to chartered accountants in practice A chartered accountant in practice shall be deemed to be guilty of professional misconduct, if he— (1) allows any person to practice in his name as a chartered accountant unless such person is also a chartered accountant in practice and is in partnership with or employed by himself; (2) pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or brokerage in the fees or profits of his professional business, to any person other than a member of the Institute or a partner or a retired partner or the legal representative of a deceased partner, or a member of any other professional body or with such other persons having such qualifications as may be prescribed, for the purpose of rendering such professional services from time to time in or outside India. Explanation. - In this item, ―partner‖ includes a person residing outside India with whom a chartered accountant in practice has entered into partnership, which is not in contravention of item (4) of this Part; (3) accepts or agrees to accept any part of the profits of the professional work of a person who is not a member of the Institute: (4) enters into partnership, in or outside India, with any person other than a chartered accountant in practice or such other person who is a member of any other professional body having such qualifications as may be prescribed, including a resident who but for his residence abroad would be entitled to be registered as a member under clause (v) of sub-section (1) of section 4 or whose qualifications are recognised by the Central Government or the Council for the purpose of permitting such partnerships; (5) secures, either through the services of a person who is not an employee of such chartered accountant or who is not his partner or by means, which are not open to a chartered accountant, any professional business: Provided that nothing herein contained shall be construed as prohibiting any arrangement permitted in terms of items (2), (3) and (4) of this Part; (6) solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means: Provided that nothing herein contained shall be construed as preventing or prohibiting -(i) any chartered accountant from applying or requesting for or inviting or securing professional work from another chartered accountant in practice ; or (ii) a member from responding to tenders or enquiries issued by various users of professional services or organisations from time to time and securing professional work as a consequence; (7) advertises his professional attainments or services, or uses any designation or expressions other than chartered accountant on professional documents, visiting cards, letter heads or sign boards, unless it be a degree of a University established by law in India or recognised by the Central Government or a title indicating membership of the Institute of Chartered Accountants of India or of any other institution that has been recognised by the Central Government or may be recognised by the Council: Provided that a member in practice may advertise through a write up setting out the services provided by him or his firm and particulars of his firm subject to such guidelines as may be issued by the Council; (8) accepts a position as auditor previously held by another chartered accountant or a certified auditor who has been issued certificate under the Restricted Certificate Rules, 1932 without first communicating with him in writing; (9) accepts an appointment as auditor of a company without first ascertaining from it whether the requirements of section 225 of the Companies Act, 1956 [1 of 1956] in respect of such appointment have been duly complied with; (10) charges or offers to charge, accepts or offers to accept in respect of any professional employment, fees which are based on a percentage of profits or which are contingent upon the findings, or results of such employment, except as permitted under any regulation made under this Act; (11) engages in any business or occupation other than the profession of chartered accountant unless permitted by the Council so to engage: Provided that nothing contained herein shall disentitle a chartered accountant from being a director of a company (not being a managing director or a whole time director) unless he or any of his partners is interested in such company as an auditor; PART II Professional misconduct in relation to members of the Institute in service A member of the Institute (other than a member in practice) shall be deemed to be guilty of professional misconduct, if he being an employee of any company, firm or person— (1) pays or allows or agrees to pay directly or indirectly to any person any share in the emoluments of the employment undertaken by him; (2) accepts or agrees to accept any part of fees, profits or gains from a lawyer, a chartered accountant or broker engaged by such company, firm or person or agent or customer of such company, firm or person by way of commission or gratification. PART III Professional misconduct in relation to members of the Institute generally A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct, if he – (1) not being a fellow of the Institute, acts as a fellow of the Institute; (2) does not supply the information called for, or does not comply with the requirements asked for, by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the Appellate Authority; (3) while inviting professional work from another chartered accountant or while responding to tenders or enquiries or while advertising through a write up, or anything as provided for in items (6) and (7) of Part I of this Schedule, gives information knowing it to be false. PART IV Other misconduct in relation to members of the Institute generally A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he— (1) is held guilty by any civil or criminal court for an offence, which is punishable with imprisonment for a term not exceeding six months; (2) in the opinion of the Council, brings disrepute to the profession or the Institute as a result of his action whether or not related to his professional work. THE SECOND SCHEDULE [See sections 21(3), 21B(3) and 22 ] PART I Professional misconduct in relation to chartered accountants in practice A chartered accountant in practice shall be deemed to be guilty of professional misconduct, if he – (1) discloses information acquired in the course of his professional engagement to any person other than his client so engaging him, without the consent of his client or otherwise than as required by any law for the time being in force; (2) certifies or submits in his name, or in the name of his firm, a report of an examination of financial statements unless the examination of such statements and the related records has been made by him or by a partner or an employee in his firm or by another chartered accountant in practice; (3) permits his name or the name of his firm to be used in connection with an estimate of earnings contingent upon future transactions in a manner, which may lead to the belief that he vouches for the accuracy of the forecast; (4) expresses his opinion on financial statements of any business or enterprise in which he, his firm, or a partner in his firm has a substantial interest; (5) fails to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement where he is concerned with that financial statement in a professional capacity; (6) fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity; (7) does not exercise due diligence, or is grossly negligent in the conduct of his professional duties; (8) fails to obtain sufficient information, which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion; (9) fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances; (10) fails to keep moneys of his client other than fees or remuneration or money meant to be expended in a separate banking account or to use such moneys for purposes for which they are intended within a reasonable time. PART II Professional misconduct in relation to members of the Institute generally A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct, if he— (1) contravenes any of the provisions of this Act or the regulations made thereunder or any guidelines issued by the Council; (2) being an employee of any company, firm or person, discloses confidential information acquired in the course of his employment except as and when required by any law for the time being in force or except as permitted by the employer; (3) includes in any information, statement, return or form to be submitted to the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the Appellate Authority any particulars knowing them to be false; (4) defalcates or embezzles moneys received in his professional capacity. PART III Other misconduct in relation to members of the Institute generally A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he is held guilty by any civil or criminal court for an offence which is punishable with imprisonment for a term exceeding six months. RECENT NOTIFICATIONS ISSUED UNDER THE CODE OF ETHICS No.1-CA(7)/60/2002 : In exercise of the powers conferred by clause (ii) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of the Institute of Chartered Accountants of India hereby specifies that a member of the Institute in practice shall be deemed to be guilty of professional misconduct, if he accepts the appointment as statutory auditor of Public Sector Undertaking(s)/ Government Company(ies)/Listed Company(ies) and other Public Company(ies) having turnover of Rs. 50 crores or more in a year and accepts any other work(s) or assignment(s) or service(s) in regard to the same Undertaking(s)/Company(ies) on a remuneration which in total exceeds the fee payable for carrying out the statutory audit of the same Undertaking/company. Provided that in case appointing authority(ies)/regulatory body(ies) specify(ies) more stringent condition(s)/restriction(s), the same shall apply instead of the conditions/restrictions specified in this Notification. Explanation: 1. The above restrictions shall apply in respect of fees for other work(s) or service(s) or assignment(s) payable to the statutory auditors and their associate concern(s) put together; 2. For the above purpose, (i) the term ―other work(s)‖ or ―service(s)‖ or ―assignment(s)‖ shall include Management Consultancy and all other professional services permitted by the Council pursuant to Section 2(2)(iv) of the Chartered Accountants Act, 1949 but shall not include: - i. ii. iii. audit under any other statute; certification work required to be done by the statutory auditors; and any representation before an authority; (ii) the term ―associate concern‖ means any corporate body or partnership firm which renders the Management Consultancy and all other professional services permitted by the Council wherein the proprietor and/or partner(s) of the statutory auditor firm and/or their ―relative(s)‖ is/are Director/s or partner/s and/or jointly or severally hold ―substantial interest‖ in the said corporate body or partnership. (iii) the terms ―relative‖ and ―substantial interest‖ shall have the same meaning as are assigned under Appendix (10) to the Chartered Accountants Regulations, 1988. 3. In regard to taking up other work(s) or service(s) or assignment(s) of the undertaking/company referred to above, it shall be open to such associate concern or c corporate body to render such work(s) or service(s) or assignment(s) so long as aggregate remuneration for such other work(s) or service(s) or assignment(s) payable to the statutory auditor/s together with fees payable to its associate concern(s) or corporate body(ies) do/does not exceed the aggregate of fee payable for carrying out the statutory audit. 4. This notification shall apply for any appointment(s) on or after 1st April, 2002. No.1-CA(7)67/2002: In exercise of the powers conferred by clause (ii) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of the Institute of Chartered Accountants of India hereby notifies that a member of the Institute in practice shall be deemed to be guilty of professional misconduct, if he does not follow the direction given, by the Council or an appropriate Committee or on behalf of any of them, to the incoming auditors not to accept the appointment as auditors, in the case of unjustified removal of the earlier auditors. No. 1-CA(7)63/2002: In exercise of the powers conferred by clause (ii) of Part-II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of the Institute of Chartered Accountants of India hereby specifies that a member of the Institute shall be deemed to be guilty of professional misconduct if he accepts appointment as auditor of a concern while he is indebted to the concern or has given any guarantee or provided any security in connection with the indebtedness of any third person to the concern, for limits fixed in the statute and in other cases for amount exceeding Rs. 10,000/-. Explanation :1. For the above purpose, the term ‗auditor‘ does not include internal auditor, concurrent auditor or an auditor giving report to the Management. 2. For the above purpose, the limit of Rs. 10,000/- shall be the aggregate amount in respect of the proprietor and/or the partner/s of the firm of chartered accountants. ANNOUNCEMENT Recently, the Council at its 245th Meeting held from 31st August, 2004 to 2nd September, 2004 in pursuance to power under Section 2(2)(iv) of the Chartered Accountants Act, 1949 has decided that the "Financial Insurance Advisory Services under the Insurance Regulatory & Development Authority Act, 1999 including insurance brokerage" be included within the said definition. Accordingly, a sub-Clause (xxvi) has been added in the definition. The full text of the definition is as follows: "2.2.4 The definition of the expression the "Management Consultancy and other Services" is given below: The expression "Management Consultancy and other Services" shall not include the function of statutory or periodical audit, tax (both direct taxes and indirect taxes) representation or advice concerning tax matters or acting as liquidator, trustee, executor, administrator, arbitrator or receiver, but shall include the following: i. ii. iii. iv. v. vi. vii. viii. ix. x. xi. xii. xiii. xiv. xv. xvi. xvii. Financial management planning and financial policy determination. Capital structure planning and advice regarding raising finance. Working capital management. Preparing project reports and feasibility studies. Preparing cash budget, cash flow statements, profitability statements, statements of sources and application of funds etc. Budgeting including capital budgets and revenue budgets. Inventory management, material handling and storage. Market research and demand studies. Price-fixation and other management decision making. Management accounting systems, cost control and value analysis. Control methods and management information and reporting. Personnel recruitment and selection. Setting up executive incentive plans, wage incentive plans etc. Management and operational audits. Valuation of shares and business and advice regarding amalgamation, merger and acquisition. Business Policy, corporate planning, organisation development, growth and diversification. Organisation structure and behaviour, development of human resources including design and conduct of training programmes, work study, job-description, job evaluation and evaluation of work loads. Systems analysis and design, and computer related services including selection of hardware and development of software in all areas of services, which can otherwise be rendered by a chartered accountant in practice and also to carry out any other professional services relating to CIS. xviii. xix. Acting as advisor or consultant to an issue, including such matters as:a. drafting of prospectus and memorandum containing salient features of prospectus. Drafting and filing of listing agreement and completing formalities with Stock Exchanges, Registrar of Companies and SEBI. Preparation of publicity budget, advice regarding arrangements for selection of (i) ad-media, (ii) centers for holding conferences of brokers, investors, etc., (iii) bankers to issue, (iv) collection centers, (v) brokers to issue, (vi) underwriters and the underwriting arrangement, distribution of publicity and issue material including application form, prospectus and brochure and deciding on the quantum of issue material (In doing so, the relevant provisions of the Code of Ethics must be kept in mind). Advice regarding selection of various agencies connected with issue, namely Registrars to Issue, printers and advertising agencies. Advice on the post issue activities, e.g., follow up steps, which include listing of instruments and despatch of certificates and refunds, with the various agencies connected with the work. b. c. d. Explanation: For removal of doubts, it is hereby clarified that the activities of broking, underwriting and portfolio management are not permitted. xx. Investment counseling in respect of securities [as defined in the Securities Contracts (Regulation) Act, 1956 and other financial instruments.] (In doing so, the relevant provisions of the Code of Ethics must be kept in mind). Acting as registrar to an issue and for transfer of shares/ other securities. (In doing so, the relevant provisions of the Code of Ethics must be kept in mind). Quality audit. Environment Audit. Energy Audit xxi. xxii. xxiii. xxiv. xxv. xxvi. Acting as Recovery Consultant in the Banking Sector. Financial Insurance Advisory services under the Insurance Regulatory Development Authority Act, 1999 including insurance brokerage." ANOUNCEMENT Sub: Revision/clarification of Directions as contained in the Code of Ethics - Para (b) & (d) under Clause (6) of Part-I of the First Schedule to the Chartered Accountants Act, 1949 in relation to (i) Application for empanelment for allotment of audit and other professional work and (ii) Responding to Tenders, Advertisements and Circulars respectively The Institute came across various queries from members seeking clarifications on certain matters relating to paras (b) & (d) under Clause (6) of Part-I of the First Schedule to the Chartered Accountants Act, 1949. Recently, the Council at its 243rd meeting held from 24th to 26th June, 2004 considered the same and decided that under the direction para (b), so far as the audit work is concerned, the present position that the members should not respond to such empanelment in which the payment of any registration or other fee or deposit is required, should prevail. However, in non-exclusive area, where Chartered Accountants and other professionals are invited, members may be permitted to respond to such empanelment at their discretion in which the payment of any registration on other fee or deposit is required. Even if only Chartered Accountants are invited in such non-exclusive area, they are permitted to pay reasonable amount towards registration or other fee or deposit. So far as the para (d) is concerned, the Council noted that it had already permitted the members to pay earnest money/security deposit at their discretion in non-exclusive area, which are open to both chartered accountants and other professionals. The Council clarified that in nonexclusive area, where Chartered Accountants and other professionals are invited, members may be permitted to pay earnest money/security deposit at their discretion. Even if only Chartered Accountants are invited in such nonexclusive area, they are permitted to pay reasonable amount towards earnest money/security deposit. The revised directions/guidelines in full under Para (b) & (d) are as under: “(b) Application for empanelment for allotment of audit and other professional work. The government departments, government companies/corporations, courts, co-operative societies and banks and other similar institutions prepare panels of chartered accountants for allotment of audit and other professional work. Where the existence of such a panel is within the knowledge of a member, he is free to write to the concerned organisation with a request to place his name on the panel. However, it would not be proper for the chartered accountant to make roving enquiries by applying to any such organisation for having his name included in any such panel. It is permissible to quote fees on enquiries being received from the above bodies, which maintain such panel. It is, however, not proper for the members to send printed or cyclostyled copies of the scales of fees in reply to such enquiries. Members are also advised that they should not respond to such empanelment in which the payment of any registration or other fee or deposit is required so far as the audit work is concerned. However, in non-exclusive area, where Chartered Accountants and other professionals are invited, members may be permitted to respond to such empanelment at their discretion in which the payment of any registration on other fee or deposit is required. Even if only Chartered Accountants are invited in such non-exclusive area, the members are permitted to pay reasonable amount towards registration or other fee or deposit. The members are also permitted to respond to such empanelment wherein the empanelling/appointing authorities charge a reasonable amount towards processing/administrative cost or towards stationery/application form for the purpose of empanelment. An advertisement for any part-time work undertaken by practising chartered accountants, would not be permissible because it would essentially be an offer of professional services and therefore would offend the rule.‖ “(d) Responding to Tenders, Advertisements and Circulars. The Council is of the opinion that members should not: i. ii. respond to advertisements inviting applications for appointment of auditors; respond to tenders or circulars inviting quotations for professional services restricted to chartered accountants either by statute or in terms of tender or circular; and respond to an enquiry asking for quotation of fees in circumstances indicating that such enquiry has been made to more than one members and as such the same partakes the nature of a circular or tender. iii. The Council is of the opinion that while no relaxation should be given in the matter of responding to tenders in the audit field, which is exclusive to chartered accountants, in other areas where members compete with nonchartered accountants, the restrictions be relaxed. Further, in audit field, which is exclusive for Chartered Accountants, when the services are to be provided to Government Agencies, they seek tenders/quotations to ensure transparency and financial discipline in their organisation. Considering this, the Council is of the opinion that the restrictions in such cases may also be relaxed. In view of the above, the following relaxations are permitted:i. When the matter relates to audit and related services as defined in the ‗Framework of Statement on Standard Auditing Practices and Guidance Notes on Related Services‘ which as per law can be provided only by chartered accountants, the members are permitted to respond to such advertisements/queries/ circulars/tenders if the same has been sought by World Bank/International Monetary Fund/Asian Development Bank or other similar International Body/any Government Company or Agency/Autonomous Body sponsored or regulated by the Government/Nationalized Institution or any other similar body which the Committee on Ethical Standards & Unjustified Removal of Auditors (CESURA) may from time to time prescribe. ii. In case of any other services, including audit services to be provided out of country, the members are permitted to respond. While responding, the members are advised to ensure that, amongst others the provisions of Clause (12) of Part I of the First Schedule to the Chartered Accountants Act, 1949 are not violated. Attention of the members are also drawn to (i) the notification no. 1-CA(7)/75/2004 dated 12th May, 2004 issued by the Institute regarding restrictions on minimum fees and (ii) the scale of fees recommended by the Institute as self regulatory measure as appearing in Code of Ethics. The Institute came across various Tenders/Advertisements/ Circulars wherein Government Agencies while inviting tenders/quotations, ask the members to purchase the priced tender/quotation documents and/or to deposit Earnest Money/Security Deposits. Recently, the Council considered the issue and while noting that the Government Agencies are asking the members to purchase tender/quotation documents and/or to deposit Earnest Money/Security Deposit while responding to tenders/advertisements/ circulars etc., the Council decided that: i. ii. Members are permitted to pay a reasonable amount as price for tender/bid document; No earnest money/security deposit is permissible in areas, which are exclusive to Chartered Accountants as per law, and in other areas, which are open to both Chartered Accountants and other professionals; members are permitted to pay earnest money/security deposit at their discretion. Even if only Chartered Accountants are invited in such non-exclusive area, they are permitted to pay reasonable amount towards earnest money/security deposit.‖ AS A PART OF AND IN CONTINUATION OF THE EXISTING REGULATION [UNDER REGULATION 190A, WHICH APPEARS AS APPENDIX NO.(9) TO THE CHARTERED ACCOUNTANTS REGULATIONS 1988 (2002 EDITION)] ―IT IS FURTHER RESOLVED that the general and specific permission granted by the Council is subject to the condition that i. any member engaged in any other business or occupation, in terms of general or specific permission granted as per Appendix No.(9) given above shall not be entitled to perform any attest function. However, a member engaging in any of the following area(s), in terms of the specific or general permission so granted, shall be entitled to perform attest function : a. b. c. d. e. f. g. h. i. j. Authorship of books and articles Holding of Life Insurance Agency Licence for the limited purpose of getting renewal commission. Attending classes and appearing for any examination. Holding of public elective offices such as M.P., M.L.A. & M.L.C. Honorary office-bearership of charitable, educational or other non-commercial organisations. Acting as Notary Public, Justice of the Peace, Special Executive Magistrate and the like. Part-time tutorship under the Coaching Organisation of the Institute. Valuation of papers, acting as paper-setter, head-examiner or a moderator for any examination. Editorship of professional journals - (not in employment) Acting as surveyor and Loss Assessor under the Insurance Act, 1938 - (not in employment). k. l. m. Acting as Recovery consultant in the Banking Sector - (not in employment). Any coaching assignment organized by the Institute, its Regional Councils and Branches of Regional Councils. Engagement as Lecturer in an University, affiliated college, educational institution, coaching organisation, private tutorship, provided the direct teaching hours devoted to such activities taken together do not exceed 25 hours a week. Engagement in any other business or occupation permitted by the Executive Committee from time to time. n. ii. A member who is not entitled to perform attest function shall not be entitled to train articled clerks. The decision (of the Council) taken at its 223rd meeting held in February, 2002 prescribing the criteria for individual cases of articleship shall continue to be in operation mutatis mutandis. The Council in this connection also clarified that the Attest function for the purpose of this Resolution would cover services pertaining to audit, review, certification, agreed upon procedures, and compilation, as defined in the Framework of Statements on Standard Auditing Practices and Guidance Notes on Related Services published in the July, 2001 issue of the Institute‘s Journal. NOTE: The Notification No.75/2004 issued by the Council has been revised and substituted by Notification No. CA(7)93/2006 dated 18-092006 The revised notification contains the following changes in the Table: a) In the first column, the number of partners will be ―5 or more partners but less than 10 partners‖. b) In the second column, the number of partners will be ―a Firm having 10 or more partners‖. c) In the first row, the population shall be 3 million and above d) In the second row, the population shall be less than 3 million. e) In the first row, the amounts shall be Rs.6,000 p.a. and Rs.12,000 p.a. f) In the second row, the amounts shall be Rs.3,500 p.a. and Rs.8,000 p.a. PRACTICAL QUESTIONS ON CODE OF ETHICS Decide whether any of the following actions would amount to misconduct under the provisions of the C. A. Act and Regulations. Give reasons for your answer. 1. A multinational company floated a tender for recruiting internal auditors for their Singapore branch and a Chartered Accountant practicing in Mumbai applied for the tender. 2. A Chartered Accountant in practice applied to a Government Corporation for including his name in the panel for allotment of professional work. The empanelment requires payment of registration fees. 3. A Chartered Accountant in practice was elected as Member of Parliament and used the designation ―Chartered Accountant and Member of Parliament‖ in his visiting cards. 4. A public company issued a prospectus containing details of directors of the company with descriptions about their expertise, specialisation and knowledge. A chartered accountant in practice was one of the directors of the company. 5. The auditor of a company was removed due to a dispute regarding the exorbitant fees and expenses charged by him and the company appointed another auditor. The incoming auditor after communicating with the previous auditor accepted his appointment ignoring the objection made by the previous auditor. Would your answer be different if the disputed audit fees and expenses was provided in the accounts signed by the directors of the company and the previous auditor. 6. A chartered accountant in practice while replying to a communication made by the incoming auditor indicated that the reason for the change was due to his detection of frauds made by the client. 7. A chartered accountant in practice accepted audit of company after obtaining a certificate from the management regarding compliance with the provisions of the Companies Act, 1956, regarding his appointment. 8. The annual general meeting of a company was adjourned without appointing an auditor. After adjournment of the meeting, a member of the company issued a special notice to the company proposing the name of another auditor in place of the retiring auditor. The proposed auditor was appointed in the adjourned meeting and he accepted the appointment. 9. A firm of chartered accountants was appointed as statutory branch auditor of two branches of a bank. The firm sent its acceptance to the Head office of the bank and completed audit of the first branch. On contacting the second branch, the firm was not permitted to commence the audit and a letter was sent to the firm that their appointment was cancelled due to non-receipt of acceptance letter. The concerned bank appointed another auditor who accepted the appointment. 10. A chartered accountant in practice was appointed by a bank as a recovery consultant and the remuneration for the consultancy was fixed at 5% of the assets valued and recovered. 11. A chartered accountant in practice was a full time tutor in an educational institution in which his wife and mother were partners. 12. A chartered accountant in practice accepted appointment as statutory auditor of a company at a remuneration lower than what was charged by previously. A detailed audit was not necessary as was being done by the previous auditor since an internal auditor was appointed by the company 13. A and B, chartered accountants in practice, signed the Memorandum of Association of a company as promoter directors. The company was incorporated with the main object of providing advisory and consultancy services for public issues of companies. 14. A chartered accountant in practice had confirmed the normal working hours of his office and the hours during which his article was required to attend classes when submitting an application for permission to attend classes. On inquiry, the chartered accountant pleaded ignorance about the articled clerk attending classes even during office hours. 15. A chartered accountant in practice who was appointed as liquidator of a company, accepted appointment by the company to audit the statement of accounts to be filed for liquidation. 16. A firm of chartered accountants was appointed as auditor of a trust and one of the partners of the firm was a honorary trustee of the trust. 17. A chartered accountant in practice agreed to write the books of account of a partnership firm in addition to tax audit of the firm. 18. A chartered accountant in practice, relying upon the reports of a firm of chartered accountants who were the internal auditors of the client, issued a clean report on the accounts of the client. A major fraud was discovered subsequently and the chartered accountant was charged with negligence. 19. A firm of chartered accountants having 6 partners accepted audit of a provident fund trust located at Chennai on an annual remuneration of Rs.2500 excluding out of pocket expenses. 20. A firm of chartered accountants undertook design and conversion of the computer system of a client for Y2K compliance. After completion of the work a partner of the firm issued the Y2K compliance certificate, which was required by the bankers of the client. 21. A general insurance company appointed Mr. X, a chartered accountant in practice, as Surveyor and Loss Assessor of the company. Mr. X accepted the appointment without obtaining prior permission of the Council of ICAI. 22. While issuing a tax audit report of a firm, the tax auditor of the firm accepted the valuation of inventories of the firm as per provisions of the Income tax Act. However such valuation was not according to the provisions of the Guidance Note issued by ICAI on Modvat accounting. 23. An information technology company, developing a directory in an exclusive web site for general information on professionals, approached Mr. X, a chartered accountant in practice, for including his name and the name of his firm, address and other professional particulars. Mr. X responded to the offer and furnished the required particulars. 24. A chartered accountant holding 20% of the shares of a company was appointed as tax auditor of the company. He was also a full time director of the company. 25. A chartered accountant accepted appointment as auditor of a cooperative society, which was previously audited by another auditor who is a qualified diploma holder in co-operative accounts, without communicating with the previous auditor. 26. The auditor of a company resigned his appointment as an auditor of a company after communicating to the Board of Directors of the company, giving personal reasons for his resignation. The incoming auditor, considering the communication, accepted the audit without communicating with the previous auditor since there was no professional reason for the resignation of the previous auditor. The Committee on Ethical Standards of ICAI complained to the Council of ICAI that a copy of the communication sent to the Board was not received by it. On inquiry it was found that the previous auditor had left practice and taken up full time employment in a foreign country. 27. While qualifying the audit report of a company under the provisions of the Companies Act relating to non-compliance with the provisions of Accounting Standard-11 regarding accounting for forward exchange contracts, the auditor of the company quantified the effect of the qualification but did not quantify the overall effect of all the qualifications included in the audit report. 28. Due to professional commitments, the statutory auditor of a company did not complete the audit work and did not submit his audit report in time for filing income tax returns of the company. The company was charged with penalty for non-submission of returns in time and the company made a complaint against the auditor to ICAI. 29. The letterhead of a firm of chartered accountants contained a logo with the first letters of the names of the partners of the firm. The letterhead with the logo was being used for professional correspondence of the firm. 30. A chartered accountant in practice maintained a record of the tax audit assignments accepted by him for each financial year but did not retain such records of earlier years. However the number of assignments accepted in each financial year was within the prescribed limits. 31. The Central Excise department searched the branch office of a firm of chartered accountants and found that the books of accounts of the branch were not maintained at the branch and therefore initiated proceedings for penalty and prosecution against the firm. The firm contends that according to the provisions of the C. A. Act it was required to maintain books of account only relating to professional practice at the head office of the firm. 32. A chartered accountant was employed by a company for auditing the branch of the company. The statutory auditor of the company relied on the certificate issued by the said employee while reporting on the accounts of the company. The said branch was exempt from Branch Audit under the provisions of the Companies Act, 1956. 33. A partner in a firm of chartered accountants, who was in part-time employment in a company, agreed to share his remuneration from the company with the other partners of the firm. 34. The incoming auditor of a bank accepted appointment as auditor of the bank at a remuneration lower than that paid to the previous auditor. Will your answer be different if the appointment is made by a nationalised bank? 35. Mr. X , a chartered accountant in practice, is a karta of his HUF. The HUF, consisting of Mr. X, his wife, mother and two children, is carrying on a family business and Mr. X has signed the tax audit report of the HUF for filing income tax return. 36. A firm of chartered accountants has changed its professional address but the communication in change of professional address was made after three months. After change in the address and before communication of the change, communications regarding reminders for payment of fees were sent by the Institute to the partners of the firm and the same were returned to the Institute undelivered. The names of the members have been removed from the Register of members on account of non-payment of fees. 37. The article clerk of a chartered accountant in practice is a partner in a partnership firm carrying on business. The partnership deed contains a clear recital that the article clerk is a sleeping partner and is not taking active part in the management of the business. The deed also provides that the said sleeping partner is entitled to take active part in the management on completion of his articleship. COMPANY AUDIT REPORTING – Section 227 Reporting responsibilities by the auditor can be divided into: A) Matters to be inquired under Sec 227(1A) B) Matters to be reported under Sec 227(2) and 227(3) B) Matters to be stated under Sec 227(4A) - CARO MATTERS TO BE INQUIRED BY THE AUDITOR UNDER SECTION 227(1A): According to the views expressed by the Council, the auditor need not investigate into matters included in section 227(1A). The auditor shall inquire: (a) Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the company or its members; Duty of the auditor: 1. Inquire whether the value of the security covers the loan amount. If not whether the uncovered portion of the loan is disclosed as ‗unsecured‘. Non-compliance with Part-I of Schedule VI. 2. Inquire whether charge has been created on the security in favour of the company. 3. Examine whether the terms of secured loans are prejudicial to the interests of the company or its members. The auditor has to inquire into the propriety aspects of such loans. (b) Whether transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company; Duty of the auditor: 1. Inquire whether the transactions are supported by sufficient appropriate evidence 2. Inquire whether fictitious entries have been made which are prejudicial to the interests of the company. Examination of propriety aspects is involved. 3. Inquire whether transactions without substance have been recorded. (c) Where the company is not an investment company within the meaning of Section 372 or a banking company, whether, so much of the assets of the company, as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company; Duty of the auditor: 1. This provision does not apply to an investment company or a banking company 2. This provision applies any asset in the nature of shares, debentures and other securities whether held as investments or as stock-in-trade 3. Inquire whether the selling price is reasonable compared to market price or book value of the investment. 4. Examine the circumstances in which the investments were sold at a loss. Examination of propriety aspects in involved. 5. Examine whether any interested party is involved in the transaction. (d) whether loans and advances made by the company have been shown as deposits; Duty of the auditor: 1. Examine the items disclosed in the Balance Sheet of the company under ―deposits‖ and inquire whether they are in the nature of loans or advances. 2. Inquire the possibility of concealment or misappropriation of loans and advances (e) Whether personal expenses have been charged to revenue account; Duty of the auditor: 1. While vouching expenses examine whether any personal expenses have been accounted. Examine whether supporting evidence indicates personal expenses. 2. Expenses though personal in nature may be incurred out of contractual obligation or out of normal business practices or due to recognised policy or custom, which cannot be treated as personal expenses. 3. Examination of propriety aspects in involved. 4. Expenses in excess of the agreed remuneration or consideration or in excess of limits laid down in law, agreement or Articles will be treated as personal expenses. (f) Where it is stated in the books and papers of the company that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading. Duty of the auditor: 1. Examine Share allotment book and copies of letter of allotment and verify whether the allotment is for cash. 2. Verify evidence for actual receipt of cash. e.g. Bank deposit challan 3. Examine whether the allotment is covered by the decision in Spargo’s Case i.e. a bonafide debt repayable immediately in cash is discharged through allotment of shares is deemed to be allotment for cash even though cash has not been received at the time of allotment. 4. Examine disclosure of allotment in Balance Sheet. 5. Examine whether allotment for consideration other than cash has been wrongly made as allotment for cash. 6. Ensure that, the disclosure as stated in balance sheet regarding allotment is correct, allotment is regular and balance sheet is not misleading. AAS-28 - AUDIT STATEMENTS REPORT ON AUDIT OF FINANCIAL The opening paragraph of the Auditor‘s Report should include a statement that the financial statements are the responsibility of the entity‘s management and a statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. Scope paragraph: The auditor‘s report should describe the scope of the audit by stating that the audit was conducted in accordance with the auditing standards generally accepted in India. The auditor‘s report should also include a statement that the audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatement. The auditor‘s report should also describe the audit as including: a. examining, on a test basis, evidence to support the financial statement amounts and disclosures; b. assessing the accounting principles used in the preparations of the financial statements; c. assessing the significant estimates made by management in the preparation of the financial statements and d. evaluating the overall financial statement presentation. The auditor‘s report should also include a statement by the auditor that the audit provides a reasonable basis for the opinion. When there is a limitation on the scope of the auditor‘s work that requires expression of a qualified opinion or a disclaimer of opinion, the auditor‘s report should describe the limitation and indicate the possible adjustments to the financial statements that might have been determined to be necessary had the limitation not existed. The opinion paragraph of the Auditor‘s Report should clearly indicate the financial reporting framework used to prepare the financial statements in conformity with the accounting principles generally accepted in India. Matters to be reported under Sec 227(2) and 227(3): The auditor should report on every Balance Sheet and Profit and Loss Account to be laid in the general meeting during the tenure of office. The matters to be reported are: 1. Whether he has obtained all the information and explanations which to the best of his knowledge and belief were required for the purpose of audit 2. Whether, in his opinion, proper books of accounts as required by law have been kept by the company, so far as appears from his examination of those books and whether proper returns adequate for the purposes of his audit have been received from branches not visited by him. 3. Whether the report on the accounts of any branch office audited under section 228 by a person other than the company‘s auditor has been forwarded to him as required by clause (c ) of sub-section 3 of that section and how he has dealt with the same in preparing his report 4. Whether the company‘s Balance Sheet and Profit and Loss Account dealt with by the Report are in agreement with the books of accounts and returns 5. Whether, in his opinion, the profit and loss account and balance sheet comply with the accounting standards referred to in section 211(3C) 6. In thick type or in italics the observations or comments of the auditors which have any adverse effect on the functioning of the company 7. Whether any director is disqualified from being appointed as director under clause (g) of sub-section (1) of section 274. 8. Whether the cess payable under section 441A has been paid. If not, the extent of arrears of cess payable. 9. Whether, in his opinion, according to the best of his knowledge and belief and according to the information and explanations obtained, the said accounts give the information required by the Companies Act in the manner so required and give a True and Fair View: a) in the case of the Balance Sheet, of the state of company‘s affairs as at the end of the financial year and b) in the case of the Profit and Loss Account, of the Profit or Loss of its financial year. TYPES OF AUDIT OPINIONS The auditor may express different types of opinions in his report based on his judgement of the True and Fair view. Such opinions can be classified as follows: a) b) c) d) Clean opinion Qualified opinion Adverse opinion or negative opinion Disclaimer opinion Clean opinion means the auditor is fully satisfied with the True and Fair view and has no disagreement with the management or comments or reservations. The auditor reports that the Balance Sheet and Profit and Loss Account shows a True and Fair view. Qualified opinion means the auditor is not satisfied on certain matters and has certain reservations and comments on such matters. He is in active disagreement with the management on certain matters but such matters are not material enough to affect the True and Fair view of the financial statements. Such reservations, comments or matters are known as qualifications in the Auditor‘s report. The auditor uses the words ― subject to‖ and qualifies his report. Subject to the qualifications the Balance Sheet and Profit and Loss Account shows a True and Fair view. According to the Statement on Qualifications in Auditor’s Report issued by ICAI : The Auditor shall include all qualifications in the report itself and if any note in the accounts is the subject matter of a qualification then the note should be reproduced in the qualification but verbatim reproduction is not necessary. If the qualifications are so material so as to negate the expression of an opinion then the auditor should consider expressing an adverse or disclaimer opinion. Note: According to the recent amendment to the Statement on Qualifications in Auditor‘s Report, the auditor should quantify the effect of the individual qualifications and also quantify the overall effect of all the qualifications to enable users to understand the overall effect of such qualifications on the financial position of the entity. Aspects to be considered in qualifying report a. Ascertain the various items that require a qualification b. Decide whether the auditor is in active disagreement with the company or is merely unable to form an opinion c. Establish whether the matters in question are so material as to affect the presentation of true and fair view of the whole of the affairs of the company or are of such a nature as to affect only a particular item disclosed in the accounts and d. Examine whether the matters constituting the qualification involve a material contravention of any requirements of the Companies Act, 1956, which have a bearing on the accounts. Adverse or negative opinion means that the qualifications are material enough to affect the True and Fair view and the auditor is not satisfied with the True and Fair view of the financial statements. The auditor reports that considering the qualifications the Balance Sheet and Profit and Loss Account does not show a True and Fair view. Disclaimer opinion means the auditor is unable to express an opinion on certain matters or on the financial statements. The auditor is unable to express an opinion in the following circumstances a) Non-availability of information or evidence b) Limitation/ Restriction in the scope of audit c) Uncertainty BRANCH AUDIT – SEC 228 According to Section 2(9) of the Companies Act, 1956 Branch means any premises where the same or substantially the same activities of the head office is being carried on and includes a premises which has been designated as a Branch and the accounts of the branch have to be audited under the Companies Act. The company may appoint a branch auditor separately or the company may delegate the power to the Board and the Board may appoint the branch auditor in consultation with the statutory auditor. However if no branch auditor is appointed then the statutory auditor will be deemed to be the branch auditor. The branch auditor enjoys the same rights and duties as a statutory auditor except that branch audit is not included in the ceiling on audits under section 224(1B) and the branch auditor is not entitled to receive notice of GM or attend GM. The branch auditor also has to comply with the provisions of Sec 226 regarding qualification and disqualifications. The report of the branch auditor shall be forwarded to the statutory auditor who shall consider the same in preparing his report -section 228(3). Statutory auditor in relation to Branch Auditor The Statutory auditor of a company is entitled to visit branches and inspect the books and records of branches irrespective whether the accounts of such branches are audited by other auditors. The statutory auditor has been given full freedom and discretion to consider the report of the branch auditor in preparing his report since the statutory auditor is in substance, in overall supervision of the accounts of the company and is responsible for expressing his opinion on the accounts of the company, which includes the accounts of the branches. The statutory auditor is entitled to drop all or any of the qualifications made in the Branch audit report on the grounds that they are not material from the point of view of the accounts of the company or if he has any information in his possession which does not warrant such qualifications. However, if any qualification in the Branch audit report is concerned with material contravention of law, form of financial statements or disclosure requirements, the statutory auditor shall include such qualifications in his report. The provisions of AAS-10 are applicable to the statutory auditor when using the work of the branch auditor. EXEMPTION FROM BRANCH AUDIT: The Central Government has been empowered to make Rules so as to exempt branch offices from audit to extent as is specified in the rules [Section 228(4)]. In exercise of the powers conferred by section 228(4) the Central Government has framed certain rules, entitled, ―The companies (Branch Audit Exemption) Rules, 1961‖. These rules are summarised: (1) Exemption based on quantum of activity: If a company, carrying on any manufacturing, processing or trading activity, has a branch office whose average of the ‗quantum of activity‘ i.e. highest of the following: (i) the aggregate value of the goods and articles produced, manufactured or processed, or (ii) the aggregate value of the goods or articles sold and of service rendered, or (iii) the amount of the expenditure, whether of a revenue or capital nature, incurred by a branch office of a company during a financial year, (i.e., the financial year of the company in respect of which exemption from branch audit is to be determined) does not exceed Rs.2 lakhs or 2% of the average of the total turnover of the company including all its branches and other offices and the earnings from services rendered and from any source during the same period, whichever is higher, the branch office shall be exempted from the provision of section 228. It may be noted that in any such case, the auditors of the company shall have the right referred to in section 229(2) relating to the audit of accounts of the branch office (Rules 2 and 3). For this exemption there is no necessity to make any application. (2) Grant of exemption in certain other cases: When an application for exemption is made to the Central Government, it may, after making the necessary inquiry, exempt the branch office from the provision of audit in section 228 on any one of the following grounds, viz. (i) That the company carrying on activities other than those manufacturing, mining or processing, or trading, has made satisfactory arrangements for the security and check, at regular intervals, of the accounts of the branch office by a reasonable person competent to scrutinise and check the accounts; (ii) That the company has made arrangements for the audit of the accounts of the branch office by a person otherwise qualified for appointment as branch auditors, even though such a person is an employee of the company; (iii) That having regard to the nature and the quantum of activity carried on at the branch office or for any other reason a branch auditor is not likely to be available at a reasonable cost ; and (iv) That, for any other reason, the Central Government is satisfied that exemption may be granted. Important circulars issued by the Department of Company affairs regarding 1. 2. 3. 4. 5. 6. 7. 8. 9. Separate meeting to be held for consideration of auditor‘s qualifications Statutory auditor cannot accept appointment as internal auditor Reappointment of retiring auditors Guarantee companies not included in ceiling Material date for appointment of auditor by special resolution Appointment of proprietory firm Cost auditor not to accept appointment as internal auditor Audit of final accounts can be completed before approval of accounts Statutory auditor not to undertake writing books of accounts of the company. COMPANIES (AUDITOR’S REPORT) ORDER 2003 (AS AMENDED BY DCA NOTIFICATION DATED NOVEMBER 2004) 1. 25TH Short title, application and commencement. – (1) This Order may be called the Companies (Auditor’s Report) Order, 2003. It shall apply to every company including a foreign company as defined in section 591 of the Act, except the following :(i) A Banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949); (2) (ii) An insurance company as defined in clause (21) of section 2 of the Act; (iii) a company licensed to operate under section 25 of the Act; and (iv) a private limited company with a paid up capital and reserves not more than rupees fifty lakh and which does not have loan outstanding exceeding rupees twenty five lakh from any bank or financial institution and does not have a turnover exceeding rupees five crore at any point of time during the financial year. (3) 2. It shall come into force on the 1st day of July 2003. Definitions. – In this Order, unless the context otherwise requires, (a) “Act” means the Companies Act, 1956 (1 of 1956); (b) “chit fund company”, “nidhi company” or “mutual benefit company‖ means a company engaged in the business of managing, conducting or supervising as a foreman or agent of any transaction or arrangement by which it enters into an agreement with a number of subscribers that every one of them shall subscribe to a certain sum of instalments for a definite period and that each subscriber, in his turn, as determined by lot or by auction or by tender or in such other manner as may be provided for in the agreement, shall be entitled to a prize amount, and includes companies whose principal business is accepting fixed deposits from, and lending money to, members; 3. Auditor’s report to contain matters specified in paragraphs 4 and 5. – Every report made by the auditor under section 227 of Act, on the accounts of every company examined by him to which this Order applies for every financial year ending on any day on or after the commencement of this Order, shall contain the matters specified in paragraphs 4 and 5. Matters to be included in the auditor’s report– The auditor‘s report on the account of a company to which this Order applies shall include a statement on the following matters, namely: (a) whether the company is maintaining proper records showing full particulars, including quantitative details and situation of fixed assets; (b) whether these fixed assets have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of account; (c) if a substantial part of fixed assets have been disposed off during the year, whether it has affected the going concern; 4. (i) (ii) (a) whether physical verification of inventory has been conducted at reasonable intervals by the management; (b) are the procedures of physical verification of inventory followed by the management reasonable and adequate in relation to the size of the company and the nature of its business. If not, the inadequacies in such procedures should be reported; (c) whether the company is maintaining proper records of inventory and whether any material discrepancies were noticed on physical verification and if so, whether the same have been properly dealt with in the books of account; (iii) (a) has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and amount involved in the transactions; and (b) whether the rate of interest and other terms and conditions of loans given by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and (c) whether receipt of the principal amount and interest are also regular; and (d) if overdue amount is more than rupees one lakh, whether reasonable steps have been taken by the company for recovery of the principal and interest; (e) has the company taken any loans, secured or unsecured from companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and the amount involved in the transactions; and (f) whether the rate of interest and other terms and conditions of loans taken by the company, secured or unsecured; are prima facie prejudicial to the interest of the company; and (g) whether payment of the principal amount and interest are also regular. (iv) is there an adequate internal control procedure commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control; (a) whether particulars of contracts or arrangements referred to in section 301 of the Act have been entered in the register required to be maintained under that section;and (b) whether each of the transactions made in pursuance of such contracts or arrangements have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time; (This information is required only in case of transactions exceeding the value of five lakh rupees in respect of any party and in any one financial year) (v) (vi) in case the company has accepted deposits from the public, whether the directives issued by the Reserve Bank of India and the provisions of sections 58A and 58AA or any other relevant provisions of the Act and the rules framed there under, where applicable, have been complied with. If not, the nature of contraventions should be stated; If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any Court or any other Tribunal, whether the same has been complied with or not? (vii) in the case of listed companies and/or other companies having a paidup capital and reserves exceeding Rs.50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crore rupees for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business; (viii) where maintenance of cost records has been prescribed by the Central Government under clause (d) of sub-section (1) of section 209 of the Act, whether such accounts and records have been made and maintained; (ix) (a) is the company regular in depositing undisputed statutory dues including Provident Fund, Investor Education and Protection Fund, Employees‘ State Insurance, Income-tax, Sales-tax, Wealth tax, Service tax, Custom Duty, Excise Duty, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated by the auditor. (b) in case dues of Income tax/Sales tax/Wealth tax/Service tax/Custom duty/Excise duty/cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned (A mere representation to the Department shall not constitute the dispute). (x) Whether in case of a company which has been registered for a period not less than five years, its accumulated losses at the end of the financial year are not less than fifty per cent of its net worth and whether it has incurred cash losses in such financial year and in the immediately preceding financial year; Whether the company has defaulted in repayment of dues to a financial institution or bank or debenture holders? If yes, the period and amount of default to be reported; (xi) (xii) Whether adequate documents and records are maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities; If not, the deficiencies to be pointed out. (xiii) Whether the provisions of any special statute applicable to chit fund have been duly complied with? In respect of nidhi/ mutual benefit fund/societies; (a) Whether the net-owned funds to deposit liability ratio is more than 1:20 as on the date of balance sheet; (b) Whether the company has complied with the prudential norms on income recognition and provisioning against sub-standard/ doubtful /loss assets; (c) Whether the company has adequate procedures for appraisal of credit proposals/requests, assessment of credit needs and repayment capacity of the borrowers; (d) Whether the repayment schedule of various loans granted by the nidhi is based on the repayment capacity of the borrower; (xiv) If the company is dealing or trading in shares, securities, debentures and other investments, whether proper records have been maintained of the transactions and contracts and whether timely entries have been made therein; also whether the shares, securities, debentures and other investments have been held by the company, in its own name except to the extent of the exemption, if any, granted under section 49 of the Act; (xv) Whether the company has given any guarantee for loans taken by others from bank or financial institutions, the terms and conditions whereof are prejudicial to the interest of the company; (xvi) Whether term loans were applied for the purpose for which the loans were obtained; (xvii) Whether the funds raised on short-term basis have been used for longterm investment; if yes, the nature and amount are to be indicated; (xviii) Whether the company has made any preferential allotment of shares to parties and companies covered in the Register maintained under section 301 of the Act and if so whether the price at which shares have been issued is prejudicial to the interest of the company; (xix) Whether security or charge has been created in respect of debentures issued? (xx) Whether the management has disclosed on the end use of money raised by public issues and the same has been verified; (xxi) Whether any fraud on or by the company has been noticed or reported during the year; if yes, the nature and the amount involved are to be indicated. 3. Reasons to be stated for unfavourable or qualified answers. – Where, in the auditor‘s report, the answer to any of the questions referred to in paragraph 4 is unfavourable or qualified, the auditor‘s report shall also state the reasons for such unfavourable or qualified answer, as the case may be. Where the auditor is unable to express any opinion in answer to a particular question, his report shall indicate such fact together with the reasons why it is not possible for him to give an answer to such question NOTE: The Council of the Institute has issued a Statement on CARO, which deals with the following matters: a) In respect of exemption of a private limited company, the Statement has explained the terms ―Paid-up capital‖, ―Reserves‖, ―Loan‖ and ―Turnover‖. b) The Statement provides comments on each of the clauses on which the auditor has to report. c) Questions in the exam are based on the comments under the clauses QUESTIONS ON COMPANY AUDIT Give your views on the following matters 1. After re-appointment of the retiring auditor in the annual general meeting of the company, it was found that the auditor had borrowed Rs. 10,000 from the company. The Board filled up the casual vacancy. A firm of chartered accountants having three partners hold 100 company audits including audit of 15 private companies, 10 branch audits, 5 foreign companies and 2 companies limited by guarantee not having share capital. A Ltd. holds 40% of the shares (both equity and preference) of B ltd., which were pledged, to a nationalised bank for a term loan. The retiring auditor of B Ltd. was re-appointed in the AGM of B Ltd. by ordinary resolution. The auditor of a government company was appointed by the Central Government on the advice of the Comptroller and Auditor General of India. The statutory auditor of a company was appointed as a full time consultant of the company for advising the company on taxation and company law matters. A firm of chartered accountants was appointed as statutory auditor of a company having paid-up capital of 50 lakhs and one of the partners of the firm was later appointed as internal auditor of the company. The auditor of a private company, where the directors of the company are its only shareholders, has reported to the directors about a material weakness in the internal control system in respect of cash transactions but has not qualified his report to the shareholders. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. The statutory auditor of a company dropped all the qualifications given in the branch audit report even without consulting the branch auditor. The quantum of activity of a branch of a company was Rs. 15 lakhs for the year ended 31st March 2000 and the branch was exempt from audit under the Rules made under the Companies Act, 1956. In the current year the company has not appointed the branch auditor since the directors of the company were advised that the exemption of branch from audit is permanent. The auditor of a company refuses to issue his audit report on the ground that the directors of the company have not signed the audited financial statements. The statutory auditor of a company requested the directors to produce the books of account of the branches at the head office for his examination. The directors have refused to comply with the request that audit of branch accounts should be conducted at the branch office and books of accounts of the branches cannot be shifted to the head office. A company has transferred 15% of the profits of the current year before declaring dividend on its shares. Surplus in Revaluation Reserve after sale of the asset was utilised by a company for declaration of dividend. Fixed deposits accepted from public and remaining unclaimed for seven years were transferred to the profit and loss account of the company. A company has paid dividend without making provision for corporate dividend tax in its accounts. A company has declared dividend without writing off the balance in Preliminary expenses. Will your answer be different if the company has declared the dividend out of surplus arising from sale of a capital asset? A company has been consistently providing excess depreciation, which has not been separately disclosed in the Balance Sheet. Certain shares were issued to a creditor of the company in settlement of his claims. A portion of the claim so settled was overdue while for the balance, the normal credit period is not yet over. The company has issued a letter of allotment to the creditor stating that the allotment is for cash. Mr. X, the sole proprietor of X & Co., was appointed as auditor of a company in the proprietory firm name. He has given audit of the company on assignment to his friend Mr. Y, a chartered accountant in practice. After completing the audit, Mr. Y has signed the audit report on behalf of the firm. 20. A company, on the basis of legal opinion obtained, has not provided for a material tax liability, which has been disputed by the company. However the auditor of the company, on the basis of legal opinion obtained by him that the company will not succeed in the case, has qualified his report without referring to the legal opinions obtained while expressing the qualification in his report. Subsequently it was found that the legal opinion obtained by the auditor was erroneous in interpretation. The company has filed a case against the auditor for negligence. 21. The auditor of a company has expressed an adverse comment in his report under CARO relating to irregular payments made by the company towards provident fund dues. The Board‘s Report is silent on this matter since the directors are of the opinion that the adverse comment does not constitute a qualification. 22. The Managing Director of a company has committed a fraud involving a loss of Rs. 5 lakhs to the company. On the fraud being detected by the auditors, the Managing Director has repaid the misappropriated amount to the company. The auditor‘s report is silent on this matter. 23. The auditor of a company, while verifying investments made by the company, accepted a certificate issued by the stockbrokers of the company relating to investments held by the stockbrokers on behalf of the company. 24. A company sold certain investments during the financial year at a price less than its purchase price due to depressed market conditions. 25. A company has been consistently following the policy of conducting physical verification of its fixed assets such that all fixed assets are verified once in every three years. 26. A company has adjusted the carrying cost of its foreign currency fixed assets due to exchange fluctuation in foreign currency liabilities incurred for acquisition of such assets. The auditor‘s report is silent on the revaluation of such assets. 27. A company has taken a loan from a finance company in which a director of the company is a shareholder. The auditor of the company finds that the company has not maintained any details regarding such finance company. 28. A large manufacturing company having several departments with separate payrolls takes time to collect data regarding PF and ESI dues. Therefore the company makes lump sum deposits of estimated amounts and adjusts the excess or deficit against the following month‘s deposit consistently. The auditor‘s report is silent on this matter. 29. The auditor of a company while reporting that the company is not a sick industrial company has considered the accumulated losses of Rs. 40 lakhs disclosed in the balance sheet which is less than the net worth of the company by Rs. 10 lakhs. The company has not made a provision for a significant liability of Rs. 15 lakhs and a qualification has been made in the audit report regarding the non-provision. 30. The auditor of a company while expressing qualifications in his report has quantified the effect of each such qualification but has not quantified the overall effect of all such qualifications. 31. A public company, which was incorporated by three promoter companies in April, 1999, raised Rs. 10 crores as equity capital from its promoter companies. The funds raised are yet to be utilised for the business of the company and is kept in term deposits with banks. The said investment has not been disclosed separately in the Balance sheet of the company as on 31st March, 2000 since the directors are of the opinion that the amount was received from promoters through allotment of shares and not through public issue and therefore need not be disclosed separately in the balance sheet. However, the auditor of the company has expressed an adverse comment in his report regarding non-compliance with statutory disclosure requirements. GUIDANCE NOTE ON SECTION 227(3)(e) AND (f) OF THE COMPANIES ACT, 1956 The Companies (Amendment) Act, 2000 has introduced additional reporting requirements for the auditors vide newly inserted clauses (e) and (f) in section 227(3) of the Companies Act, 1956. This guidance note provides guidance to the auditors in reporting on the aforesaid clauses. Clause (e) “in thick type or in italics the observations or comments of the auditors which have any adverse effect on the functioning of the company”. The auditor makes various qualifications, which have an impact on the financial statements of the company. Such qualifications, however, may or may not contain matters, which have any adverse effect on the functioning of the company. The words ―observations‖ or ―comments‖ appearing in clause (e) are construed to have same meaning as referring to ―qualification‖ since only those ―observations‖ or ―comments are required to be stated in thick type or in italics which have any adverse effect on the functioning of the company. The Companies Act does not specify the meaning of the phrase ―adverse effect on the functioning of the company‖. The objective and scope of an audit as contemplated under AAS-2 remains and cannot be changed. According to Para 3 of AAS-2, ―The user, however, should not assume that the auditor‘s opinion is an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise‖. Therefore the auditors need not express any observations or comments on the efficiency and effectiveness of the management but should evaluate his qualifications or adverse comments to make judgement as to which of them deal with matters that have any adverse effect on the functioning of the company within the overall objective and scope of audit outlined in AAS-2. Examples of such qualifications or adverse comments, which have an adverse effect on the functioning of the company, include a situation where the going concern assumption is considered inappropriate or significant impairment of the assets etc. The auditor may also consider comments expressed under sections 227(1A) or 227(4A) of the Companies Act, 1956 and report such comments, which, in his opinion, will have any adverse effect on the functioning of the company. Example of such comment is where an auditor reports that the company is a sick industrial company under MAOCARO (This reporting requirement is different in CARO) Clause (f) Whether any director is disqualified from being appointed as a director under clause (g) of sub-section (1) of section 274” The auditor has to report on whether any of the directors of the company, whether public or private, are disqualified from being appointed as a director in terms of section 274(1)(g). The auditor should consider the disqualification as on the balance sheet date. It may be noted that a person who was a director of a public company which has defaulted in terms of section 274(1)(g) and ceased to be a director of the public company would not be disqualified from being appointed as a director of a private company since on the date of such appointment, he is not a director of such public company and moreover proviso to section 274(1)(g) is only applicable to appointment of such director in another public company. A person is disqualified from being appointed as a director of a company (any company) for a period of five years, where any public company of which also he is a director, has a. not filed annual accounts and annual returns for any continuous three financial years commencing on and after 1.4.1999 or b. failed to repay its deposit or interest thereon on due date or c. failed to redeem its debentures on due date or d. failed to pay dividend and such failure continues for one year or more. Section 303(1) of the Companies Act, requires every company to keep a register of directors at its registered office. The said register contains various particulars relating to all the directors of the company, which particulars can be verified by the auditor for ascertaining details of directors of the company holding directorships in other companies including public companies. The auditor should require each director to submit a written representation in respect of each such public company as on the balance sheet date as to whether or not such public companies have defaulted in terms of section 274(1)(g). There is a practice amongst many companies that the directors obtain a legal compliance report, periodically, to ensure that the companies have complied with all the legal requirements. The auditor should insist that written representation or the legal compliance report, as the case may be, should be taken on record by the Board of Directors of the auditee company. GUIDE TO QUESTIONS IN REVISION MATERIAL QUESTIONS ON COMPANY AUDIT (Reference to sections given below are sections of the Companies Act, 1956 unless otherwise stated) 1. The appointment is defective. Section 224(3) is attracted. The auditor was disqualified at the time of appointment itself. 2. Ceiling on audits under section 224(1B) does not include audit of branches and audit of private companies. However, under the Code of Ethics, the notification under clause (ii), Part-II of Second Schedule includes audit of branches and private companies. Audit of foreign companies and companies limited by guarantee not having share capital are not included within the ceiling under section 224(1B). However, companies limited by guarantee are included under the Code of Ethics notification. 3. Appointment by special resolution under section 224A. Clarification by the Dept. of Company Affairs regarding this case. 4. Companies Amendment Act, 2000- Auditor of a Government company is appointment by C&AG after the amendment. 5. Accepting engagements to perform other services in addition to audit is not prohibited and does not by itself mean that the auditor could have sacrificed his independence. 6. Circular of Dept. of Company Affairs- Statutory auditor should not accept appointment as internal auditor of the company due to CARO reporting requirement. 7. Pendleburys vs. Ellis Green & Co.- This case deals with facts similar to the question. It was held in this case that the auditor is not guilty of professional negligence since the directors of the company are the only shareholders but the decision will not hold good if public shareholding is involved. 8. 9. 10. 11. 12. 13. 14. 15. 16. Section 228(3)- Branch auditor shall forward his report to the statutory auditor who shall consider the same in preparing his report. Section 227(3)-Statutory auditor has duty to report on this matter. AAS-10 (recently revised)- Principal auditor has to perform the procedures prescribed in the AAS but the statutory auditor need not consult the branch auditor regarding consideration of branch audit report. The Companies Act gives autonomy to the statutory auditor to decide as to how he should consider the report of the branch auditors. Branch Audit (Exemption) Rules, 1961- Determination of exemption based on quantum of activity should be made for each financial year. Exemption for one financial year does not result in permanent exemption from branch audit. AAS-2- Para 4- Management is responsible for financial statementsAudit does not relieve the management from its responsibilities. The statutory auditor should issue his report only after the Board has approved the financial statements. Section 215(3) provides that the Board shall approve the accounts before submission of accounts to auditors for reporting. Circular of the Dept. of Company Affairs- The statutory auditor can access the books of the branch at the Head office. It is the duty of the directors to produce branch accounts to the auditor at the head office. Section 205 read with Companies (Transfer of Profits to Reserves) Rules, 1975- Company has to comply with certain conditions in case of transfer of profits to reserves exceeding 10%. AS-10-Para 14- Surplus in revaluation reserve account after sale of fixed asset may be transferred to General Reserve. Therefore the company can declare dividend out the surplus. If the company transfers the surplus to general reserve and utilises it for declaration of dividend, the company will have to comply with the conditions prescribed under the Companies (Declaration of Dividends out of Reserves) Rules, 1975. Section 205C- Fixed deposits remaining unclaimed for seven years should be transferred to Investor Education and Protection Fund. Provision for corporate dividend tax is a statutory liability and nonprovision of the tax liability will result in non-compliance with statutory requirements. The auditor should qualify his report. There is no specific requirement to write off ‗Miscellaneous Expenditure‘ before declaration of dividend under the Companies Act. However, the concept of prudence will apply. Preliminary expenses to the extent not written off should be disclosed in the balance sheet under ‗Miscellaneous Expenditure‘. Surplus arising from sale of capital asset 17. 18. 19. 20. 21. 22. 23. is a capital profit and dividends can be distributed only out of divisible profits under the Companies Act. However, as per decisions in certain cases, if certain conditions are satisfied, capital profit can be utilised for distribution of dividend. Part-III, Schedule VI- Any provision made in excess of the amount, which in the opinion of the directors is reasonably required, should be disclosed as a reserve. Section 227(1A)(f)- Allotment for cash- Spargo‘s case decision applies in this case to the extent of settlement of a bonafide debt which is due for repayment through allotment of shares. Only to the extent of debt, which is due for repayment immediately, will be treated as allotment for cash. The balance allotment will be treated as allotment for consideration other than cash. Section 229 read with clause (13), Part-I, First Schedule to the C.A. Act- Signing audit report only by the auditor. AAS-1 and 9-Work performed by others-Using the work of an expertThe auditor is entitled to use the work of an expert provided he evaluates the work of he expert. If there are conflicting views between the management and the auditor based on legal opinions, it would advisable for the auditor to state such views in his report. However, the auditor is entitled to qualify his report on the basis of the expert opinion obtained by him provided he has performed the required audit procedures. Hence the auditor is not guilty of negligence. Section 217(3)- Board‘s report should give information and explanations for every observation and comment made in the auditor‘s report. Comments made in the CARO report are also covered under the section. AAS-4 read with Statement on Qualifications in Auditor‘s ReportEven though the fraud detected by auditors has been regularised, the auditor should report this matter because the fraud could have taken place due to a material internal control weakness and it may have an impact on other areas of the audit and on the true and fair view of the position as on the balance sheet date. City Equitable Fire Insurance Company case-It was held that an auditor cannot escape negligence, if he omits to personally inspect the investments of a company. The auditor cannot rely upon the certificate of stockbrokers because investments should be held by the company or should be held for safe custody only by a person who is trustworthy and reputed and who is in the business of holding securities for safe custody 24. 25. 26. 27. 28. 29. 30. i.e. a banker. Investments of a company should not be left with stockbrokers. Section 227(1A)(c) – The auditor should inquire into sale of investments at a loss and satisfy himself whether such sale is proper. Statement on MAOCARO issued by the Institute- Paras 20 and 21Applicability of MAOCARO to certain companies. However the requirement of CARO applies to all companies and therefore this question is irrelevant in the context of CARO. CARO reporting requirement-The auditor should report whether the management has conducted physical verification of fixed assets at reasonable intervals. Guidance Note on Audit of Fixed Assets-If fixed assets are numerous, all fixed assets should be physically verified within a period of three years. MAOCARO reporting requirement-The auditor should report on the basis of revaluation of fixed assets. However, adjustment of exchange differences in the carrying cost of fixed assets arising due to foreign currency liabilities does not constitute revaluation of fixed assets. AS11 has been recently revised. According to the revised standard, such exchange differences should not be capitalised with the cost of fixed assets because it is in conflict with the provisions of AS-10. There is no such reporting requirement in CARO. CARO reporting requirement-Whether the company has taken loans from parties listed in the Register maintained under section 301? The company should maintain the said register in which details of parties in which the directors of the company are interested should be given. Non-compliance with the statutory requirements will attract an adverse comment in the CARO report-AAS-21, the auditor should consider compliance with laws and regulations in audit of financial statements. CARO reporting requirement-The auditor should report whether the company is regular in depositing PF and ESI dues. MAOCARO reporting requirement-The auditor has to report whether the company is a sick industrial company with the meaning of SICA. Even though SICA has been repealed, the reporting requirement continues. According to the Statement on CARO issued by the Institute, the auditor should while reporting on this matter consider whether the effect of his qualifications together with the accumulated losses disclosed in the balance sheet is equal to or exceeding 50% of the net worth of the company. 31. Statement on Qualifications in Auditor‘s Report- According to a recent amendment to the Statement, the auditor should not only quantify the effect of individual qualifications but should also quantify the overall effect of all the qualifications made in the auditor‘s report. 32. Part-I-Schedule VI of the Companies Act, 1956- Form of Balance Sheet- Disclosure requirements under ―Investments‖- Money raised through issue of shares and not used for the purpose for which issue was made should be disclosed separately under ―Investments‖. QUESTIONS ON CODE OF ETHICS 1. Clause (6)-Part-I- First Schedule-Council clarification regarding global tenders even relating to audit field – condition regarding fees in foreign exchange. No misconduct. Clause (6)-Part-I – First Schedule- Council clarification regarding applying for empanelment for allotment of professional workApplication should not be made if empanelment involves payment of non-refundable registration fees or deposit. The member is guilty of professional misconduct if the fees is non-refundable. Clause (7)-Part-I – First Schedule- Use of designation other than ―Chartered Accountant‖ in visiting cards attracts professional misconduct. Clause (7)-Part-I – First Schedule- Guidance Note issued regarding publishing details of directorships in prospectus- Publishing details of expertise, specialization and knowledge in prospectus will attract professional misconduct. Clause (8)-Part-I – First Schedule- and Clause (ii)-Part-II – Second Schedule- Notification of the Council- Dispute regarding exorbitant fees is not a ground for change of auditor and it is an unjustified removal- The incoming auditor should not accept appointment ignoring the objection in case of unjustified removal because the fees of the auditor of a company would have been fixed by resolution at the time of appointment and subsequently removing the auditor by disputing the fees is unjustified. If undisputed fees of the previous auditor is unpaid, the incoming auditor will be guilty of professional misconduct if he accepts appointment. ―Undisputed fees‖ has been defined in the said notification. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. Clause (1)-Part-I – Second Schedule and AAS-21, Para 39-The previous auditor is guilty of professional misconduct for breach of confidentiality. Clause (9)-Part-I – First Schedule- Accepting audit of a company without ascertaining compliance with sections 224 and 225 will attract professional misconduct. What is the meaning of the word ‗ascertain‘ is explained in para 8 given under the clause. Clause (9)-Part-I – First Schedule- Para 10.2 under the clause- Intention of section 190(1) of the Companies Act, 1956- Unjustified removalNon-compliance with section 225- Incoming auditor is guilty of professional misconduct. Clause (6)-Part-I – First Schedule- Read the case of cancellation of branch audits of banks brought to the notice of the Council. Clause (10)-Part-I – First Schedule- Acting as Recovery consultant to banking sector is covered by the definition of ―Management Consultancy Services‖ and therefore the member can accept the engagement. However, the member is guilty of professional misconduct for accepting fees contingent upon results. This case is not covered by Regulation 192. Clause (11) –Part-I- First Schedule- Regulation 190A- Prior and specific permission of the Council required- It is immaterial whether the wife and mother are partners. Clause (12)-Part-I-First Schedule-Council‘s decision under the clause. It was held that in a similar case, there was no undercutting. Clause (11)-Part-I-First Schedule-Council‘s decisions under the clause regarding permission for a member to become Director, Promoter/Promoter director-There is no restriction in this case even if the object of the company includes areas which fall within the scope of the profession. Clause (1)-Part-III-First Schedule-Case under the clause deals with similar facts-Submitting any particulars knowing them to be false. Clause (4)-Part-I-Second Schedule-This case is based on the example given under the clause. Members must take care to see that they do not land themselves in situations where there could be conflict of interest and duty. Clause (4)-Part-I-Second Schedule-Council‘s decision regarding accepting audit of a trust when a partner is either an employee or a trustee. 17. Clause (4)-Part-I-Second Schedule-Council‘s clarification is that members are not permitted to write books of account of their auditee clients. 18. Clauses (6) and (7)-Part-I-Second Schedule-Failure to report a material misstatement-AAS-7 requires the auditor to evaluate the work of the internal auditors before relying upon the work of internal auditors. If the C.A. relied upon the reports of the internal auditors without complying with the requirements of the AAS, he is guilty of professional negligence. The firm of Chartered Accountants who are internal auditors of the client is also guilty of professional negligence. 19. Clause (ii)-Part-II-Second Schedule-Notification regarding minimum fees to be charged by an audit firm based on the number of partners and the place in which the client is located. 20. Clause (ii)-Part-II-Second Schedule-Notification regarding accepting assignments relating to design and conversion of the computer system and certification of Y2K compliance. 21. Clause (11)-Part-I-First Schedule-Surveyor and Loss Assessor is included under general permission. 22. Clause (7)-Part-I-Second Schedule-Gross professional negligence-Noncompliance with the Statement issued by the Institute. 23. Clause (6)-Part-I-First Schedule-Publication of particulars in Directories- Electronic media is included in the Notification under the clause. 24. Clause (4)-Part-I-Second Schedule-Holding substantial interestdisclosure in audit report-Clause (11)-Part-I-First Schedule-Holding full-time directorship in a company requires prior and specific permission of the Council. However, in a clarification under the clause, if the member or his partner or relative holds substantial interest, the member cannot accept or hold full-time directorship in a company. 25. Clause (8)-Part-I-First Schedule-Clause is not attracted-Previous auditor is not a Chartered accountant. 26. Clauses (8) and (9)-Part-I-First Schedule-Communication with the previous auditor is required under all circumstances-CESURA Committee guidelines regarding unjustified removal of auditors. 27. Clause (7)-Part-I-Second Schedule-Gross professional negligence-not complying with the requirements of the Statement on Qualifications in Auditor‘s Report. 28. Clause (7)-Part-I-Second Schedule-Gross professional negligence in not completing the work and not submitting the report in time. 29. Clauses (6) and (7)-Part-I-First Schedule-Use of Logos in any form is banned. 30. Clause (ii)-Part-II-Second Schedule-Notification regarding ceiling on accepting tax audit assignments-maintaining record of assignments accepted is mandatory31. Clause (ii)-Part-II-Second Schedule-Notification regarding maintenance of books by members in practice. 32. Clause (4)-Part-I-Second Schedule-Members in employment certifying accounts of employers or group concerns will attract professional misconduct according to Council‘s decision. Exception arises in case of branches of companies exempt from audit under Branch Audit (Exemption) Rules, 1961. 33. Clause (1)-Part-II-First Schedule- Sharing of emoluments-Member in service whether or not also in practice also is covered by the clause. 34. Clause (12)-Part-I-First Schedule-Clause is applicable even to audit of banks including nationalised banks. 35. Clause (11)-Part-I-First Schedule-Regulation 190A-Specific permission-interest in family business provided no active part is taken in the management of such business-Clause (4)-Part-I-Second Schedule-Substantial interest held by the member and his relatives in the business-Disclosure of interest in member‘s report. 36. Clause (i)-Part-II-Second Schedule-Contravenes the provisions of the C.A. Act or C.A. Regulations. Communication of change in address should be made within 30 days- Non-payment of fees is also a contravention. 37. Clause (i)-Part-II-Second Schedule-Article clerk engaged in businessCouncil‘s guidelines regarding the conditions to be complied with an article clerk to be engaged in business. E.D.P. AUDIT EDP audit is the process of auditing in a computerised environment. The overall objective and scope of an audit does not change in an CIS environment. However, the use of a computer changes the processing and storage of financial information and may affect the organisation and procedures employed by the entity to achieve adequate internal control. Accordingly, the procedures followed by the auditor in his study and evaluation of the accounting system and related internal controls and nature, timing and extent of his other audit procedures may be affected by an CIS environment. Specific problems of EDP relating to Internal Control 1. Separation of duties: As a basic control, separation of duties prevents or detects frauds or errors. In a computer system, the traditional notion of separation of duties does not always apply. 2. Delegation of authority and responsibility: In a computer system delegating authority and responsibility in an unambiguous way may be difficult because some resources are shared among multiple users. When multiple users have access to the same data it is not easy to trace who is responsible for corrupting the data and who is responsible for identifying and correcting the error. 3. Competent and trustworthy personnel: Highly skilled personnel are needed to develop, modify, maintain and operate computer systems. Moreover it is not always easy to assess the competence and integrity of the EDP staff. High turnover has been prevalent and rapid evolution of technology inhibits management‘s ability to evaluate an employee‘s skills. 4. System of authorisations: Management issues two types of authorisations to execute transactions. General authorisations establish policies. For e.g. a fixed price list. Specific authorisations apply to individual transactions; for e.g. acquisition of capital assets. In a computer system authorisation procedures often are embedded within a computer program. 5. Adequate documents and records: In computer systems, documents may not be used to support the initiation, execution and recording of transactions. Similarly, some transactions may be activated automatically by the computer system. Thus, no visible audit or management trail may be available to trace the transaction. 6. Physical control over assets and records: Computer systems concentrate the data processing assets and records and this concentration increases the loss that can arise from computer abuse or disaster. If the organisation does not have suitable backup, it may be unable to continue operations. 7. Adequate management supervision: In computer systems data communications may be used to enable employees to be closer to the customers they service. Thus, supervision of employees may have to be carried out remotely. Supervisory controls must be built into the computer system to compensate for the controls that usually can be exercised through observation and inquiry. 8. Comparing recorded accountability with assets: Periodical comparison of data and physical assets is necessary to determine whether any discrepancies exist. In a computer system programs are used to prepare this data. If unauthorised modifications occur to the programs or data files, an irregularity may not be discovered. Auditing in CIS Environment CIS means ‗Computer Information System‘ and a CIS environment exists when a computer of any type or size is involved in the processing of financial information of significance to the audit, whether that computer is operated by the entity or a third party. The CIS environment affects all aspects of the audit including the: a. consideration of inherent risks and control risk; b. procedures followed by the auditor to obtain a sufficient understanding of the internal control structure; and c. auditor‘s design and performance of audit procedures. Skills and Competence The auditor should consider whether specialised CIS skills are needed in an audit. It may be needed to: a. determine the effect of the CIS environment on the assessment of overall audit risk and of risk at the account balance or class of transaction levels; b. obtain an understanding of the internal control structure affected by the CIS environment and its effect on the business operations; and c. design and perform appropriate tests of control and substantive procedures; and d. evaluate the results of procedures performed. When using the work performed by a CIS expert, the auditor should obtain sufficient appropriate audit evidence that such work will be adequate for the purposes of the audit. Knowledge of Business Matters the auditor would ordinarily consider in obtaining this knowledge include: a. the entity‘s use and attitude towards information technology and the effect of this on the nature and source of systems applications. b. usage of CIS by the entity compared with general usage within the industry, the local environment, information technology trends, generally available information about CIS usage by competitors and trading partners. c. recent and planned changes to the entity‘s CIS and CIS environment Planning The auditor should obtain an understanding of the significance and complexity of the CIS activities and the availability of data for use in the audit. This understanding would include such matters as: a. the organisational structure of the entity‘s CIS activities; b. extent of concentration or distribution of computer processing and development the significance of computer processing in each significant accounting application. c. the complexity of computer processing in each significant accounting application plans by the entity to replace or significantly change a CIS where these changes will affect the internal control structure. d. the availability of data, source documents, computer files and other evidences that may be required by the auditor which may exist only for a short period or only in machine readable form. Assessment of Risk The auditor should make an assessment of inherent and control risks for material financial report assertions. a. the risks may result from deficiencies in pervasive CIS activities such as program development and maintenance, systems software support, operations, physical CIS security and control over access to special privilege utility programs. b. the risks may increase the potential for errors of fraudulent activities in specific applications, in specific databases or master files or in specific processing activities. Audit procedures Because of the characteristics of a CIS environment, the nature, timing and extent of audit procedures may differ from those audit procedures conducted in a manual environment. For example: a. the nature, timing and extent of audit procedures on the performance of computer controls and processes can be restricted to cover the key processes. These tests may be performed using, for example, test data. Their effectiveness is, however, subject to: i) conducting audit procedures which provide audit evidence as to the continuing and consistent operation of specific systems throughout the period; ii) obtaining an understanding regarding the various alternative processes which contribute to the process or control being tested and clearly defining these; and iii) assessing the effect of the key processes being affected by other processes or information b. the auditor may use the results of audit procedures conducted in prior periods when the auditor has obtained sufficient appropriate audit evidence that no changes to the CIS environment have been identified INTERNAL CONTROL IN A COMPUTER BASED SYSTEM The internal controls over computer processing, which help to achieve the overall objectives of internal control, include both manual procedures and procedures designed into computer programs. Such manual and computer control procedures comprise the overall controls affecting the CIS environment (general CIS controls) and the specific controls over the accounting applications (CIS application controls). General CIS Controls: The purpose of general CIS controls is to establish a framework of overall control over the CIS activities and to provide a reasonable level of assurance that the overall objectives of internal control are achieved. General CIS controls may include: a. Organisation and management controls designed to establish an organisational framework over CIS activities includes: Policies and procedures relating to control functions Appropriate segregation of incompatible functions b. Application systems development and maintenance controls Testing, conversion, implementation and documentation of new or revised systems Changes to application systems Access to systems documentation Acquisition of application systems from third parties c. Computer operation controls The systems are used for authorised purposes only Access to computer operations is restricted to authorised personnel Only authorised programs are used Processing errors are detected and corrected d. Systems software controls Authorisation, approval, testing, implementation and documentation of new systems software and systems software modifications. Restriction of access to systems software and documentation to authorised personnel. e. Data entry and program controls An authorisation structure is established over transactions being entered into the system Access to data and programs is restricted to authorised personnel Other safeguards include: i) Offsite back-up of data and computer programs ii) Recovery procedures for use in the event of theft, loss or intentional or accidental destruction. iii) Provision for offsite processing in the event of disaster. CIS Application controls Purpose is to establish specific control procedures over accounting applications to provide reasonable assurance that all transactions are authorised and recorded and are processed completely, accurately and on a timely basis. They are: 1. Controls over Input a. Transactions are properly authorised before being processed by the computer b. Transactions are accurately converted into machine-readable form and recorded in the computer data files. c. Transactions are not lost, added, duplicated or improperly changed. d. Incorrect transactions are rejected, corrected and, if necessary, resubmitted on a timely basis. 2. Controls over processing and computer data files a. Transactions, including system generated transactions are properly processed by the computer b. Transactions are not lost, added, duplicated or improperly changed. c. Processing errors are identified and corrected on a timely basis 3. Controls over output a. Results of processing are accurate. b. Access to output is restricted to authorised personnel c. Output is provided to appropriate authorised personnel on a timely basis Review of Internal Controls General CIS controls are inter-dependent controls and their operation is essential to the effectiveness of CIS application controls. Review of general controls is necessary before review of CIS application controls. Review of CIS Application controls 1. Manual controls exercised by the user: If manual controls exercised by the user of the application system are capable of providing reasonable assurance that the systems output is complete, accurate and authorised, the auditor may decide to limit tests of control to these manual controls. In this case, the auditor may wish to test only the manual controls exercised by the user. 2. Controls over system output: If in addition to manual controls exercised by the user, the controls to be tested use information produced by the computer or are contained within computer programs, it may be possible to test such controls by examining the system‘s output using either manual or computer-assisted audit techniques. Such output may be in the form of magnetic media, microfilm or printouts. Alternatively, where the reconciliation is performed by computer, the auditor may wish to test the reconciliation by performing the control with the use of computerassisted audit techniques. 3. Programmed control procedures: In the case of certain computer systems, the auditor may find that it is not possible or in some cases, not practical to test controls by examining only user controls or the system‘s output, the auditor may want to test control procedures contained within the application program. Tests of control by using CAAT may be performed such as test data, reprocessing transactions data or in unusual situations, examining the coding of the application program. Evaluation of Controls: General controls may have an adverse effect on the processing of application systems. If these controls are ineffective, there may be a risk of failure to detect material misstatements. Manual procedures may provide effective control at the application level. Loss of, or change in, audit trail Audit trail refers to the books, documents, records, master files and other information, which enables the auditor to trace a transaction from its source till its summarised total in an accounting report. Conventional audit of manual systems rely on establishing the audit trail, which is necessary for application of substantive procedures. However, in advanced computer applications, losses of, changes in audit trail, are being encountered increasingly and instances where conventional audit tests cannot be carried out occur mainly in: a. testing computer-generated totals, analyses and balances when details are not printed out; b. testing the completeness of output where there are no control totals (e.g. exception reports) Management does not print out details because it does not exercise control through verification of the individual items processed. Therefore, audit trail is not clearly visible during processing due to lack of print out of details. Techniques used in such circumstances include: a. arranging for special printouts of additional information for the auditor‘s use. b. programmed interrogation facilities whereby records held on magnetic or card files are printed out on a selective basis by means of direct request to that file c. clerical re-creation d. testing on a total basis an ignoring individual items e. relying on alternative tests Regarding testing the completeness of output, where visible evidence that all items have been processed is not available and assurance is required that the programs are functioning correctly in respect of the specific items, it will be necessary to use special audit techniques. SPECIAL AUDIT TECHNIQUES Computer-Assisted Audit Techniques: There are two types of CAAT‘s: a. audit software b. test data Audit software Audit software consists of computer programs used by the auditor, as part of his auditing procedures, to process data of significance from the entity‘s accounting system. It may consist of : a. Package programs: are generalised computer programs designed to perform data processing functions which include reading computer files, selecting information, performing calculations, creating data files and printing reports in a format specified by the auditor. b. Purpose-written programs: are computer programs designed to perform audit tasks in specific circumstances. These programs may be prepared by the auditor, by the entity or by an outside programmer engaged by the auditor. In some cases, existing entity programs may be used by the auditor in their original or in a modified state because it may be more efficient than developing independent programs. c. Utility programs: are used by the entity to perform common date processing functions such as sorting, creating and printing files. These programs are generally not designed for audit purposes and therefore may not contain such features as automatic record counts or control totals. Test Data Test data techniques are used in conducting audit procedures by entering data (e.g. a sample of transactions) into an entity‘s computer system and comparing the results obtained with predetermined results. Test data is used to test specific controls in programs, such as online password and data access controls. When test data is processed with the entity‘s normal processing, the auditor should ensure that the test transactions are subsequently eliminated from the entity‘s accounting records. Uses of CAAT’s CAAT‘s may be used in performing various auditing procedures, including: a. Tests of details of transactions and balances- for example, the use of audit software to test transactions in a computer file b. Analytical review procedures- for example, the use of audit software to identify unusual fluctuations or items c. Compliance tests of general CIS controls- for example, the use of test data to test access procedures to the program libraries d. Compliance tests of CIS application controls- for example, the use of test data to test the functioning of a programmed procedure. Considerations in the use of CAAT’s When planning the audit, the auditor should consider an appropriate combination of manual and computer-assisted audit techniques. In determining whether to use CAAT‘s, the factors to be considered include: a. Computer knowledge, expertise and experience of the auditor b. Availability of CAAT‘s and suitable computer facilities c. Impracticability of manual tests d. Effectiveness and efficiency Controlling the CAAT application The use of a CAAT should be controlled by the auditor to provide reasonable detailed specifications of the CAAT have been met, and that the CAAT is not improperly manipulated by the entity‘s staff. The specific procedures necessary to control the use of a CAAT will depend on the particular application. In establishing audit control, the auditor should consider the need to: 1. Approve the technical specifications and carry out a technical review of the work involving the use of the CAAT 2. Review the entity‘s general CIS controls, which may contribute to the integrity of the CAAT. The auditor may consider processing the CAAT application at another suitable computer facility 3. Ensure appropriate integration of the output by the auditor into the audit process. 4. Procedures carried out by the auditor to control audit software applications may include: a. Participating in the design and testing of the computer programs b. Checking the coding of the program to ensure that it conforms with the detailed program specifications c. Requesting the entity‘s computer staff to review the operating system instructions to ensure that the software will run in the entity‘s computer installation d. Running the audit software on small test tiles before running on the main data files. e. Ensuring that the correct files were used f. Obtaining evidence that the audit software functioned as planned. g. Establishing appropriate security measures to safeguard against manipulation of the entity‘s data files. Procedures carried out by the auditor to control test data applications may include: a. Controlling the sequence of submissions of test data where it spans several processing cycles b. Performing test runs containing small amounts of test data before submitting the main audit test data. c. Predicting the results of the test data and comparing it with the actual test data output, for the individual transactions and in total d. Confirming that the current version of the programs was used to process the test data e. Obtaining reasonable assurance that the programs used to process the test data were used by the entity throughout the applicable audit period. Documentation of CAAT The auditor should keep technical papers relating to the use of the CAAT separate from other working papers. The working papers should contain sufficient documentation to describe the CAAT application, such as: Planning: CAAT objectives, specific CAAT to be used, controls to be exercised, staffing, timing and cost. Execution: CAAT preparation and testing procedures and controls, details of the tests performed, details of input, processing and output, relevant technical information about the entity‘s accounting system, computer file layouts Audit evidence: Output provided, description of work performed, audit conclusions Other: Recommendations to entity management. Suggestions for using the CAAT in future years. Using CAAT’s in Small Business Computer Environments The following points should be given special consideration in these environments: a. The level of general CIS controls may be such that the auditor will place less reliance on the system of internal control. This will result in greater emphasis on substantive procedures and application of audit procedures to ensure proper functioning of the CAAT and validity of the entity‘s data. b. If small volumes of data are processed, manual methods may be more cost effective c. Adequate technical assistance may not be available to the auditor from the entity and thus making the use of CAAT impracticable d. Certain audit package programs may not operate on small computer, thus restricting the auditor‘s choice of CAAT‘s. However the entity‘s data files may be copied and processed on another suitable computer. Requirements for a computer audit program system Review of generalised computer audit program should be made prior to selecting a computer audit package. The following are some characteristics of an effective system: a. Simplicity b. Understandability c. Adaptability d. Vendor technical support e. Statistical sampling capability f. Acceptability g. Processing capabilities h. Report writing Audit Considerations relating to Service Bureau Practical requirements in establishing or evaluating a system of internal control for applications processed at a service bureau: a. Clearly defined liaison between bureau and user b. systems testing involving clerical procedures c. adequate file conversion checking procedures d. additional controls over the physical movement of data e. carefully planned rejection procedures f. output distribution controls g. additional clerical controls to verify accuracy of processing h. significant program checks and review by user i. control over maintenance of data on master files due to no physical control over files MANAGEMENT AUDIT AND OPERATIONAL AUDIT Management audits are concerned with appraising management‘s accomplishment of organisational objectives, the management functions of planning, organising, directing and controlling and the adequacy of management decisions and actions in moving towards its stated objectives. Hence, the accent is on evaluating managers‘ ability to manage. Distinction between management audit and operational audit 1. Management audit is concerned with the quality of managing, whereas operational audit centers on the quality of operations. 2. The basic difference between the two audits is not in method, but in the level of appraisal. 3. Thus, the two audits are complementary and supplementary to one another. 4. In management audit, the auditor is to make his tests to the level of top management, its formulation of objectives, plans and policies and its decision-making. In operational audit the auditor verifies the operations of control and procedures and fulfillment of plans in conformity with the prescribed policies. 5. The management auditor has to reach the root i.e., the functions of top management which lay down objectives and policies, provide means and procedures of implementation and control and which actually engage in direction and control on a continuous basis. 6. In addition what would normally be covered in an operational audit, management audit would also encompass the relevance and effectiveness of the aims, duties and decisions of management at various levels. DESIRABILITY OF MANAGEMENT AUDIT Management audit is a tool to improve management performance by recognising facts and information about management presented after appropriate examination, verification and evaluation, by professionally qualified and competent people. Management audit focuses attention on a comprehensive and constructive examination of the organisational structure, its components such as, divisions, departments, ventures, plans, policies, its financial control system, its method of operation, its appropriate use of human, physical and financial resources. The principal reasons for undertaking management audit are: Need for detecting and overcoming current managerial deficiencies (and resulting operational problems) in ongoing operations. The benefit of management audit is that managerial problems and related operational difficulties can be spotted before the fact rather than after the fact as with a financial audit. 1. It represents another management tool to assist the organisation in accomplishing desired objectives. 2. It is helpful in the case of ailing industries, to isolate the problems and account for their ailments. Before committing public funds, it is important to properly diagnose the financial health and possibilities of a business undertaking and know the specific reasons that have caused or contributed to the decline of the business. 3. Even a sound entity may also benefit from a periodical management audit through further improvements in its operations and the brewing and latent problems may be detected and analysed and opportunities or difficulties created by changing circumstances can be known. 4. Public sector undertakings losses can be minimised to a great extent by introduction of management audit. Audit by professional auditors and audit by C& AG is not aimed to cover the entire area that can be reasonably be covered by management audit. Independence of Management Auditor Independence of the management auditor is not necessarily related to the person he reports. His independence is entirely dependent on the management‘s attitude towards audit, the credibility the management auditor has with the management and the management'‘ positive will to listen to criticism for self-betterment. Complete independence implies freedom from all dependence including financial dependence. The management auditor‘s goal, therefore, is to achieve independence, which will protect him from having to compromise his audit objectives. Management Audit Questionnaire Management audit questionnaire aims at a comprehensive and constructive examination of an organisation‘s management and its assigned tasks. The questionnaire is concerned with the appraisal of management actions in accomplishing organisation objectives. Its primary objective is to highlight weaknesses and deficiencies of the organisation for possible improvements. It includes a review of how well or badly the management functions of planning, organising, directing and controlling are being performed. It evaluates how effective the decision-making process is in accomplishing stated organisation objectives. The questionnaire provides a means for evaluating an organisation‘s ongoing operations by examining its major functional areas. A management audit questionnaire does not answers; it simply asks questions. The questions asked are designed to aid the manager to sort out those factors, forces and effects that are relevant to the situation being studied and is designed to evaluate management policies. There are three possible answers to the management audit questions: ―Yes‖, ―No‖ and ―NA‖. If the answer is ―Yes‖, operations are proceeding as desired; if the answer is ―No‖, difficulties are being experienced and must be explained in writing. Thus the management audit questionnaire not only serves as a management tool to analyse the current situation, more importantly, it enables the management auditors to synthesise those elements that are causing organisational difficulties and deficiencies. Difficulties encountered in a Management Audit The biggest difficulty involved during the course of management audit is that people working in the organisation do not wish to accept any change. At the time of actual implementation they come up with stiff resistance to proposals on account of various behavioural problems. This situation can be avoided by building a positive approach to management audit and involving the personnel right from the initiation of the audit. Executives working in the organisation fear that the management auditors‘ recommendations may lead to their removal or reshuffling. This can be overcome by explaining to these executives that the auditor is there to help them in achieving the results rather acting against their interests. Behavioural aspects of Management/Operational Audit Management auditors deal mainly with people. Management auditors will come into contact with the following: a. Colleagues in their own department b. Staff of the department whose functioning they audit c. Top management who authorise them to perform audits. Management auditors must develop and maintain good relations with auditee to gain information and to ensure corrective action on audit findings. The general image is that he is a critic, fault finder or private spying authority of the top management. Nature and Causes of Behavioural problems 1. Staff/ Line conflict: Management auditors are staff and line people are likely to regard the management auditor the same way as they regard other staff people. Management auditors may think that their approach and solutions are the only answers and they tend to discount the difficulty people may face. Management auditors feel that they must point out defects to prove themselves to top management. Line personnel will most likely regard staff with antagonism. 2. Control: There is an instinctive reaction from the auditee that his actions when reported are likely to cause adverse effect. There is a fear that top management‘s opinion of their performance or implementation of control procedures is likely to be affected by the auditor‘s report. According to a research study, the causes of antagonism are as follows: a. Fear of criticism b. Fear of changes in day-to-day working habits c. Punitive action by superiors d. Insensitive audit practices- reports are overly critical, focusing only on deficiencies and the perception that auditors gain personally from reporting deficiencies. e. Hostile audit style- lack of understanding of the auditee‘s problems, absence of empathy, air of superiority, excessive concentration on insignificant errors, prosecutorial tone and greater concern with parading defects than helping constructively to improve conditions. f. Existing systems and procedures may give room for recommendations for changes of systems. Solution to behavioural problems Relations between the auditor and the auditee may improve if the auditor acts and is perceived as a professional advisor and consultant. There is a need to confirm the following: a. The audit is part of an overall programme required to meet organisational needs for protection and constructive benefit. b. The objective of the review is to provide maximum service c. The review will be conducted with minimum interference with regular operations d. The responsible officers will be kept fully informed and will have an opportunity to review findings and recommendations before any audit report is formally released. It is essential to create an atmosphere of trust and friendliness so that audit reports will be understood in their proper perspective. Constructive criticism The auditor should make obvious in his report the value of his comments in tangible terms. Only then the suggestions will be objectively. If the auditors were to adopt a fault finding role, the auditee would be constrained to become defensive and will justify their position. The auditor‘s reports should concentrate on areas, which need improvement rather than listing inefficiencies and deficiencies in performance of the auditee. The auditor‘s reports would have better acceptability if the improvements suggested are discussed with those who have to implement them and make them fees that they have participated in the recommendations made for improvements. OPERATIONAL AUDIT According to Cadmus ―Operational auditing is not different from internal auditing, it is merely an extension of internal auditing into operational areas‖. Therefore to understand operational auditing better, it is necessary to understand internal auditing. According to the Institute of Internal Auditors, ― the overall objective of internal auditing is to assist all members of management in the objective discharge of their responsibilities, by furnishing them with objective analysis, appraisals, recommendations and pertinent comments concerning the activities reviewed. The internal auditor, therefore, should be concerned with any phase of business activity wherein he can be of service to management‖. According to Lindberg and Cohn ―Operations auditing as a technique for regularly and systematically appraising unit or function effectiveness against corporate and industry standards by utilising personnel who are not specialists in the area of study with the objective of assuring a given management that its aims are being carried out and in identifying conditions capable of being improved‖. Objectives of Operational Auditing The main objective of operational auditing is to verify the fulfillment of plans and sound business requirements as also to focus on objectives and their achievement. Performance yardsticks can be found in the management objectives, goals and plans, budgets, records of past performance, policies and procedures. Industry standards can be obtained from the statistics provided by industry, associations and government sources. However the concept of modern internal auditing suggests that there is no difference in internal and operational auditing. The scope of internal auditing is broad enough to embrace the areas covered by operational auditing as well. Need for Operational Auditing The need for operational auditing has arisen due to the inadequacy of traditional sources of information for an effective management. Operational auditing arose from the need of managers responsible for areas beyond their direct observation to be fully, objectively and currently informed about conditions in the units under control. Operational audit is considered as a specialised management information tool to fill the void that conventional information sources fail to fill. Conventional sources of management information are: a. departmental managers, b. routine performance report c. internal audit reports d. periodic special investigation and survey. The shortcomings of these sources which operational audit has overcome are: 1. Executives and managers are too preoccupied with implementation of plans and achieving of targets. They have very little time to collect information and locate problems. Operational auditing would be able to find out the possibilities of such problems happening. 2. Managers or their aides are generally relied upon for transmitting information than for looking for information or for analysing situations. 3. The information that is transmitted by managers is not necessarily objective; often it may be biased for various reasons. 4. Conventional internal audit reports are often routine and mechanical in character and have a definite leaning towards accounting and financial information. They are historical in nature. 5. Other performance reports and routine reports have their own limitations. They are good in so far as an overall evaluation is connected in monetary items. But they may not bring to light specific problems in different operational areas. The other routine departmental reports are not always objective and have a definite tendency to colour the departmental performance favourably. 6. Operations of controls cannot be relied upon to bring to light the environmental conditions. Controls are specific and their operation is related to the specific situation under control. Also monitoring of the controls is a periodic phenomenon. 7. Surveys and special investigations are at best occasional in character and are costly, time consuming and keep the personnel busy. They are basically an attempt to carry out a post-mortem rather than to enlighten the management about the ways on improvement or for better performance or to give a signal for dangers and disasters to come. Operational auditing has to come to provide the management with inexpensive, continuous and objective appraisal of activities, operations and controls to inform the management about achievement of standards and to inform the management about what has gone wrong and how it has gone wrong. Also, it enlightens the management about possible dangers, constraints and opportunities that may be of immense value to the management. Objectives of Operational Audit Generally, operational audit objectives include: a. Appraisal of controls b. Evaluation of performance c. Appraisal of objectives and plans and d. Appraisal of organisational structure Appraisal of controls Operations and the results in which the management is interested are largely a matter of control. If controls are effective in design and are faithfully adhered to, the result that can be attained will be subject to the other limiting constraints in the organisation. Operational auditing deals with administrative controls exercised over all phases of the business and its purpose is to determine whether the controls are adequate and are proving effective in accomplishing management‘s objectives or plans or operations. Evaluation of performance In performance appraisal, the operational auditor is basically concerned not so much with how well technically the operations are going on, but with accumulating information and evidence to measure the effectiveness, efficiency and economy with which the operations are being carried on. The principal basis of performance evaluation can be productivity, personnel, work load, cost and quality. Appraisal of objectives and plans The aim of operational auditing is to appraise operations and controls and their adherence to prescribed or laid down policies and not to go into the question of appropriateness of plans and objectives. However, the operational auditor may look into the aspects like whether objectives are clearly spelt out and properly communicated to the personnel responsible for implementation and whether the personnel have understood the objectives in the sense meant by the management. Also, he can take note of any apparent conflict in the objectives for its effect on operations. Appraisal of organisational structure In evaluating organisational structure, the aspects that may be considered by the operational auditor may be as follows: a. is the organisational structure in conformity with management objectives? b. whether the organisational structure is drawn up on the basis of matching of responsibility and authority? c. whether the line of responsibility is clearly discernible from the structure? d. whether the delegation of responsibility and authority at each stage is clear and overlapping is avoided? AUDIT OF BANKS Important areas to be covered in study material from examination point of view: 1. 2. 3. 4. 5. Auditor‘s Report in case of Nationalised Banks and Banking companies Verification and valuation of investments and RBI Guidelines Verification of loans and advances Income Recognition, Asset classification and Provisioning Norms Verification of: a. b. c. d. e. 6. Bills discounted and purchased Bills for collection Inter-office adjustments Credit card operations Contingent liabilities New Guidelines for concurrent Audit System in commercial banks a. Coverage of business/branches b. Types of activities to be covered c. Reporting system APPOINTMENT OF AUDITOR The auditor of a banking company is to be appointed at the annual general meeting of the shareholders, whereas the auditor of a nationalised bank is to be appointed by the bank concerned acting through the Board of Directors. In either case, approval of the RBI is require before the appointment is made. AUDITOR'S REPORT In case of nationalised bank, the auditor is required to make a report to the Central Government in which he has to state the following: a. whether, in his opinion, the balance sheet is a full and fair balance sheet containing all the necessary particulars and is properly drawn up so as to exhibit a true and fair view of the affairs of the bank, and in case he had called for any explanation or information, whether it has been given and whether it is satisfactory. b. c. d. whether or not the transactions of the bank, which have come to his notice, have been within the powers of that bank. whether or not the returns received from the offices and branches of the bank have been found adequate for the purpose of his audit. whether the profit and loss account shows a true balance of profit or loss for the period covered by such account; and any other matter, which he considers, should be brought to the notice of the Central Government. In case of other banks, in addition to matters on which the auditor is required to report to the shareholders under the Companies Act, 1956, the auditor of a banking company is required to state in his report: a. whether or not the information and explanations required by him have been found to be satisfactory. b. whether or not the transactions of the company, which have come to his notice, have been within the powers of that bank. c. whether or not the returns received from the branch offices of the company have been found adequate for the purpose of his audit. d. whether the profit and loss account shows a true balance of profit or loss for the period covered by such account and e. and any other matter, which he considers should be brought to the notice of the shareholders or the company. NOTE: It may be noted that in the case of a banking company, by virtue of he provisions of section 227(3)(d) of the Companies Act, 1956, the auditor has to specifically report whether, in his opinion, the profit and loss account and balance sheet of the banking company comply with the Accounting Standards referred to in section 211(3C). Every banking company shall prepare a balance sheet and a profit and loss account in the forms set out in the Third Schedule to the Banking Regulation Act, 1949 or as near thereto as the circumstances admit. NOTE: The requirements of the Companies Act, 1956, relating to the balance sheet and profit and loss account of a company, in so far as they not inconsistent with the Banking Regulation Act, 1949, also apply to the balance sheet or profit and loss account, as the case may be, of a banking company [section 29(3)] NOTE: In the context of banks, the expression 'indebtedness' in section 226 of the Companies Act, 1956, with regard to disqualifications, would cover, inter alia, the amounts outstanding, in respect of credit cards issued by a bank. Thus, where the credit card outstandings exceed the prescribed limit of Rs. 1000, the chartered accountant in whose name the card is issued as well as the firm of which he is a partner would be disqualified for appointment as auditor of the issuing bank. BOOKS OF ACCOUNTS A banking company is required to maintain the books of account in accordance with section 209 of the Companies Act, 1956. There are, however, certain imperatives in banking business to maintain accurate and always up-to-date accounts. INCOMPLETE RECORDS In case it is found that the general ledger, the main cash book or a trial balances are in arrears or that they do not tally, the auditor should consider expressing a qualified opinion, adverse opinion or disclaimer of opinion, as may be appropriate. In case any subsidiary ledgers are in arrears, the auditor should consider the impact of such arrears on the financial statements of the bank. It may be pointed out that in the absence of balanced and up-to-date subsidiary ledgers, verification of transactions or of year-end balances may become difficult. In such cases also, the auditor should consider expressing an appropriate opinion as mentioned above. OFF-SITE SURVEILLANCE SYSTEM RBI has introduced an off-site surveillance system for commercial banks on various aspects of operations including solvency, liquidity, asset-quality, earnings, performance, insider trading etc. and has indicated such reports should be submitted at periodic intervals. COMPUTERISED ENVIRONMENT In a computerised environment the audit procedures may have to be appropriately tuned to the circumstances, particularly as the books are not authenticated as in manually maintained accounts and the auditor may not have in-house computer facility to test the software programs. The emphasis would have to be laid on internal control procedures related to a. inputs b. security in the matter of access to CIS systems c. use of codes, passwords d. data-inputs being prepared by persons independent of key operators and other built-in procedures for data validation and system controls so as to ensure completeness and correctness of the transactions keyed in. System documentation of the software may be obtained and examined. CONCEPT OF MATERIALITY In preparing the audit report, the auditor should keep in mind the concept of materiality. Thus item, which do not materially affect the view presented by the financial statements, may be ignored. However, if in the judgement of the auditor, an item though not material, is contrary to accounting principles or any pronouncements of ICAI or is such as would require a review of the relevant procedures, it would be appropriate for him to draw the attention of the management to this aspect in his long form audit report. In all cases, matters covering the statutory responsibilities of the auditors should be dealt with in the main report. The LFAR should be used to further elaborate matters contained in the main report and not as a substitute thereof. Similarly, while framing his main report, the auditor should consider, wherever practicable, the significance of various comments in his LFAR, where any of the comments made by the auditor therein is adverse, he should consider whether a qualification in his main report is necessary by using his discretion on the facts and circumstances of each case. It may be emphasised that the main report should be self-contained document. Guidelines of the RBI on Income Recognition, Asset Classification Provisioning and other Related matters With effect from 31st March, 2004, a Non-Performing Asset shall be an advance where: i. interest and/or instalment of principal remain overdue for a period of more than 90 days in respect of a Term Loan ii. the account remains 'out of order' for a period of more than 90 days, in respect of an Overdraft / Cash Credit. iii. the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted. iv. interest and/or instalment of principal remain overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes and v. any amount to be received remains overdue for a period of more than 90 days in respect of other accounts. Important decisions based on RBI Circulars regarding NPA classification 1. Regularisation of Account by Year-end 2. Temporary deficiencies 3. Determination of NPAs - Borrower-wise 4. Advances under On-lending Arrangement 5. Exemption from NPA classification and provision- RBI Circulars 6. Take-out Finance Income Recognition Banks recognise income on accrual basis. In view of the significant uncertainity regarding ultimate collection of income arising in respect of non-performing assets, the guidelines require that banks should not take to income interest on NPAs until it is actually realised. When a credit facility is classified as NPA for the first time, income credited in earlier years, which have not been realised should either be reversed or provided for. (According to AS-9, income once recognised should not be reversed and a provision to the extent of income unrealised is more appropriate) CLASSIFICATION OF ADVANCES RBI guidelines require banks to classify their advances as follows: 1. 2. Standard Assets - Not a Non-Performing Asset Sub-standard Assets - An NPA outstanding for a period not exceeding 12 months Doubtful Assets - An NPA outstanding for a period exceeding 12 months Loss Assets - A Loss asset is one where loss has been identified by: a. Bank b. the internal or external auditors c. RBI inspectors but the amount has not been written off, wholly or partly. In other words, such an asset is considered uncollectable and of such little value that its continuance as an asset is not warranted although there may be some salvage or recovery value. 3. 4. THREAT TO RECOVERY It has been clarified that, in respect of accounts where there are potential threats of recovery on account of erosion in the value of security or nonavailability of security and existence of other factors such as frauds committed by borrowers, it will not be prudent to classify them first as substandard and thereafter as doubtful. Such accounts should be classified straightaway as doubtful or loss assets, whichever is appropriate irrespective of the period for which the account has remained NPA. It has been clarified that where the realisable value of security is significant, the credit facility should not be treated as loss asset and should be treated as doubtful. Renegotiation or Reschedulement after Commencement of Commercial Production Credit facility renegotiated or rescheduled after commencement of commercial production should be classified as sub-standard and should remain in such category for at least one year of satisfactory performance. The earlier classification should not be upgraded merely as a result of rescheduling or renegotiation. If, in the opinion of the bank, the borrowal unit, having commenced production has not reached the level and volume of production which is adequate to generate the required cash flow and the bottleneck in achieving regular commercial production is of a temporary nature and not indicative of any long-term impairment of the unit's economic viability and it is likely to achieve break-even if some time is allowed, the bank may reschedule the loan and treat the same as standard. PROVISIONING REQUIREMENTS Standard Assets: 0.25% of gross standard advances on a global basis not only on domestic advances. Substandard advances: General provision of 10% on gross advance amount Doubtful advances: 100% provision of unsecured portion and gradual provision for secured portion depending upon the time period of holding of security. a) If security is held for a period upto one year- 20% provision b) If security is held for a period more than one year and upto 3 years- 30% provision c) If security is held for a period more than 3 years- 50% provision Doubtful assets held as on 31st March 2004- 60% provision and gradually the provision shall be made upto 100%. Loss Assets: 100% provision or write-off CLASSIFICATION OF INVESTMENTS Investments of a bank have to be classified as follows: 1. Held to maturity: Intended to be held till maturity- to be valued at cost of acquisition and if cost exceeds nominal value, the excess should be amortised over the remaining life of the investment – any decline in the market price other than temporary should be provided – Any profit on sale should be transferred to profit and loss account and thereafter may be appropriated to Capital Reserve. 2. Held for trading: Intended for short-term trading – to be Marked to Market – Net depreciation or appreciation should be transferred to profit and loss account. 3. Available for sale: Investments, which do not fall in the above categories - to be Marked to Market – Net depreciation should be transferred to profit and loss account – net appreciation to be ignored. CAPITAL ADEQUACY NORMS Capital adequacy ratio = Capital Funds / Risk weighted assets and Off balance sheet items The norm for CAR is 9%. Capital Funds are divided into Tier- I capital and Tier-II capital. Tier-II capital should be maximum 100% of Tier-I capital for CAR. Excess if any will be ignored. AUDIT OF GENERAL INSURANCE COMPANIES Important areas to be covered in study material from examination point of view: Amendments to Insurance Act, 1938 after enactment of the Insurance Regulatory and Development Authority Act, 1999. a. Requirements as to Capital: Minimum 100 crores – in case of reinsurance business –200 crores b. Accounts and Audit- As per IRDA (Preparation of Financial Statements and Auditor‘s Report) Regulations, 2000- Compliance with the Accounting Standards issued by ICAI except in case of : i) AS-3 – Cash flow statement to be prepared only under Direct Method ii) AS-13- Accounting for investments will not apply since IRDA regulations have been issued and sections 27B, 27C and 27D of the Insurance Act, 1938 will apply. iii) AS-17- Irrespective of the applicability clause of the Standard, the Standard will apply to General Insurance companies. c. Prohibition for investment of Policy holders funds outside India d. Manner and conditions of investment- Responsibility to social sector and balance of investment between infrastructure and social sector. e. Valuation of assets and liabilities- inclusions and exclusions as per section 64V of the Insurance Act. f. Solvency margin- Excess of Assets over liabilities- Highest of the following: a. 50 crores b. 20% of net premiums c. 30% of net claims subject of maximum credit for re-insurance of 50% of gross premiums or claims. 2. Verification of: a. b. c. d. e. f. Premiums Claims Provisions Claims Paid Commission Expenses of management Investments 3. Short Notes on: a. b. Co-insurance- Incoming co-insurance and Outgoing co-insurance Unexpired risks reserve- As per Insurance Act, 50% reserve of net premiums, in case of fire, marine cargo and other general insurance policies and 100% reserve of net premiums in case of marine hull insurance policies. As per IT Act, deduction of 50% of net premiums, in case of fire and other general insurance business and deduction of 100% of net premiums in case of marine insurance business. Reinsurance- reinsurance ceded and reinsurance accepted. c. SPECIAL AUDITS TAX AUDIT Audit under the Income Tax Act, 1961 (hereinafter referred to as the ‗Act‘) is applicable under various provisions of the Act to meet specific objectives of the Act. The following questions are important concerning tax audit. 1. Who can audit the Accounts under the Income Tax Act? 2. What are the matters covered by the Annexure to the Audit Report in case of audit of a trust or an institution under section 12A of the Act? 3. In what circumstances, audit under any other law is sufficient compliance with the provisions of section 44AB of the Act? 4. Does the Act prohibit a relative or an employee of the assessee being appointed as a tax auditor ? Can the tax auditor maintain the books of account of the assessee? 5. What is the ceiling applicable for tax audits? 6. Are Accounting Standards issued by ICAI applicable to tax audits? 7. What are the implications of non-compliance with AS and AS(IT)? 8. Do tax auditors enjoy the rights provided in section 227(1) of the Companies Act? 9. How should a principal tax auditor, while submitting his consolidated tax audit report of the entity, report on the consideration of tax audit reports of other auditors dealt with by him in his report? 10. If the tax auditor is called upon to give his report only in respect of one of the businesses of the assessee and the accounts of the other businesses are not required to be audited under the Act, how should the tax auditor report in such circumstances? 11. Does a change in an accounting policy amount to a change in the method of accounting for the purpose of certification in Form 3CD? 12. What are the adjustments to be made in valuation of purchases, sales and inventories while computing the income under the provisions of the Act? AUDIT OF ACCOUNTS OF MEMBERS OF STOCK EXCHANGES 1. Short Notes on the following is important from the examination point of view: a. Odd-lot dealers b. Margins c. Rolling settlements d. Proprietary Trading e. Circuit Filters and Circuit Breakers 2. In what circumstances audit of accounts of a member of a stock exchange is mandatory? – Answer: Active member of a recognised stock exchange in India 3. What are the books of account and other documents to be compulsorily maintained by a member of a recognised stock exchange? Rule 15 of SCR Rules, 1957 AUDIT OF CO-OPERATIVE SOCIETIES 1. Special points to be considered in audit of co-operative societies are: a. Qualifications of Auditors b. Appointment of Auditor c. Restrictions on share holdings, loans, borrowings and investments d. Appropriation of profits 2. Special features of Co-operative Audit a. Examination of overdue debts b. Overdue interest c. Certification of bad debts d. Valuation of Assets and Liabilities e. Adherence to co-operative principles f. Observance of the provisions of the Act and Rules g. Verification of Members‘ Register and examination of their pass books h. Special report to the Registrar i. Audit classification of society j. Discussion of draft report with managing committee k. Rights and Duties of Co-operative auditors COST AUDIT Objective of Cost Audit To Report on the adequacy of cost accounting records and express an opinion on the true and fair view of the cost of production, mining or processing and marketing of the product. Duty of the Cost Auditor The cost auditor shall report in the manner prescribed in Cost Audit Report Rules, 1968 as amended in 1996 and shall furnish the information required in the Annexure to the said Rules including his observations and conclusions. Statutory Cost Audit under section 233B of the Companies Act, 1956 Appointment of cost auditor by Board of Directors of the company with the previous approval of the Central Government. 2. Qualification of a cost auditor is that he should be a ‗Cost Accountant‘ within the meaning of the Cost and Works Accountants Act, 1959. 3. Disqualifications under section 226 apply to a cost auditor. 4. Appointment shall be in accordance with the provisions of section 224(1B). 5. Cost auditor enjoys the rights under section 227(1) namely Right of access to books, documents and vouchers and Right to obtain all information and explanations required for the purpose of audit. 6. The cost auditor shall verify compliance with section 209(1)(d) regarding maintenance of cost accounting records. 7. Statutory auditor of a company cannot accept appointment as cost auditor according to the notification of the Council of ICAI under the CODE OF ETHICS. 8. The company shall furnish the cost accounts to the cost auditor within 90 days from the end of the financial year. 9. The cost auditor shall report to the Central Government within 180 days from the end of the financial year. 10. Copy of the cost audit report is to be sent to the company. 11. The cost auditor shall furnish the information required by Company Law Board within 30 days. 12. The cost auditor can be removed only with the previous approval of the Central Government. 1. AUDIT OF PUBLIC SECTOR UNDERTAKINGS Audit of Government Companies Appointment of Statutory Auditors of a Government company is to be made by the C & AG as per Companies Amendment Act, 2000 c. The C & AG has the power to conduct a supplementary or test audit under section 619(4) d. The C & AG has the right to comment upon or supplement the audit report submitted by the statutory auditors in such manner as he may think fit. e. The provisions of section 217(3) do not apply to comments made by C & AG in his supplementary report. f. What is Comprehensive audit of public enterprises? What are the important issues examined in the comprehensive audit? g. What are the contents of the audit report of the C & AG? h. What is the role of Committees on Public Undertakings in audit of public enterprises? i. State the information to be included in the Report under section 619(3)(a) of the Companies Act, 1956 by the statutory auditors of government companies regarding: a. System of Accounts b. System of Financial Control PROPRIETY AUDIT According to E.L. Kohler, ―Propriety is that which meets the tests of public interest, commonly accepted customs and standards of conduct and particularly as applied to professional performance, requirements of law, Government regulations and professional codes‖. Important questions on Propriety Audit 1. What are the general principles of financial propriety? 2. What are the matters under sections 227(1A) and 227(4A) of the Companies Act, 1956, which are in the nature of propriety aspects? 3. ―Propriety has an inherent element of subjectivity‖. Comment. ( Refer Problems in conducting Propriety Audit) 4. ―Propriety audit dampens the initiative of the management in taking commercial decisions‖. Comment. a. b. INVESTIGATION E.L.Kohler defined the term “investigation” as, ―an examination of books and records preliminary to financing or for any other specified purpose, sometimes differing in scope from the ordinary audit‖. Investigation implies, ― systematic, critical and special examination‖ of the accounts and records of a business for a specific purpose. Auditing and investigation are fact finding techniques but their basic nature and objectives differ as regards scope, frequency, basis, thrust, depth and conclusiveness. Difference between auditing and investigation Auditing 1. General examination 2. Primary objective is to express an opinion 3. It does not proceed with suspicion 4. Relies more on judgement and inquiry and materiality 5. Is test natured 6. Examination of financial information 7. Examines the true and fair view of the financial information 8 Relies more on observation and confirmation for obtaining evidence Steps in Investigation 1. Determination of objectives and establishment of scope of investigation 2. Formulation of the investigation programme 3. Examination and study of various records by reference to appropriate evidence 4. Analysis, processing and interpretation of findings 5. Preparation of report and drawing up of conclusions Investigation Specific examination To establish a fact Suspicion is the foundation Relies more on evidence and Involves in-depth checking Examination of financial and non-financial facts Focus on true and correct view Uses inspection and inquiry Special Issues in Investigations 1. Whether an investigator is required to undertake a cent per cent verification approach or whether he can adopt selective verification? 2. Whether the investigator can place reliance on the existing auditing statement of account? 3. Views and opinions of experts 4. Independence and due professional care 5. Reporting based on facts and not on speculative opinion 6. No future projections 7. Maintenance of proper documentation Types of Investigation 1. Statutory investigation 2. Non-Statutory investigation Statutory Investigation Investigation under the Companies Act, 1956, can be broadly divided into: a. Investigation into the affairs of a company b. Investigation of ownership of a company Non-Statutory Investigation 1. Investigation on behalf of an incoming partner 2. Investigation for valuation of shares in private companies 3. Investigation on behalf of a bank proposing to advance loan to a company 4. Investigation of frauds 5. Investigation on behalf of an individual or firm proposing to buy a business 6. Investigation in connection with review of profit/financial forecasts PEER REVIEW The peer review mechanic was established by the Council of the Institute of Chartered Accountants of India with the issuance of the Statement on Peer Review (hereinafter referred to as 'the Statement') in March 2002. Peer review will help in reassuring the stakeholders and the society at large that the profession is conscious of its responsibilities and strives its best to ensure that the highest standards are observed by all practicing members rendering audit and attestation services to the society. The peer review process is an endeavour to enhance the quality of services rendered by members of the Institute of Chartered Accountants of India in public practice Peer review means an examination and review of the systems and procedures to determine whether they have been put in place by the PU for ensuring the quality of attestation services as envisaged and implied/mandated by the Technical Standards and whether these were effective or not during the period under review. In other words, the peer review involves examination of the systems and procedures of the PU but does not aim to identify isolated cases of engagement failure. The main objective of peer review is to ensure that in carrying out their professional attestation services assignments: the members of the Institute: (a) Compliance with the Technical Standards laid down by the Institute; and (b) have in place proper systems (including documentation systems) for maintaining the quality of the attestation services work they perform. Essentially, through review of records, peer review identifies areas where a member may require guidance in improving the quality of his performance aid adherence to various requirements as per applicable technical standards. Technical Standards in relation to which peer reviews are to be carried out, and which the peer review process seeks to enforce, are specified as under: (i) (ii) Accounting Standards issued by the Institute of Chartered Accountants of India; Auditing and Assurance Standards issued by the Institute of Chartered Accountants of India; (iii) Framework for the Preparation and Presentation of Financial Statements and Framework of Auditing and Assurance Standards and Guidance Notes on Related Services issued by the Institute of Chartered Accountants of India; Statements issued by the Institute of Chartered Accountants of India; Compliance of the Guidance Notes issued by the Institute of Chartered Accountants of India; Notifications/Directions issued by the Institute of Chartered Accountants of India, including those of a self-regulatory nature; and (iv) (v) (vi) (vii) Compliance of the provisions of the various relevant Statutes and/or Regulations, which are applicable in the context of the specific engagements being reviewed.