Audit of items of Financial Statements

  • By TeamKonceptBy TeamKoncept
  • 7 July, 2023
Audit of items of Financial Statements

Audit of items of Financial Statements

Table of Conent

1. INTRODUCTION

Companies prepare their financial statements in accordance with the framework of generally accepted accounting principles (Indian GAAP), also commonly referred to as accounting standards (AS).

A financial statement audit comprises the examination of an entity’s financial statements and accompanying disclosures by an independent auditor. The result of this examination is a report by the auditor, attesting to the truth and fairness of presentation of the financial statements and related disclosures. Preparation of Financial Statements Is the responsibility of the Management.

Definition of Assertion : It refer to the representations by management, explicit or otherwise, that are embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur.

In preparing financial statements, Company’s management makes implicit or explicit claims (i.e. assertions) regarding:
  • completeness;
  • cut-off;
  • existence/ occurrence;
  • valuation/ measurement;
  • rights and obligations; and
  • presentation and disclosure
of Assets, Liabilities, Equity, Income, Expenses and Disclosures in accordance with the applicable accounting standards.

Example
If Company X’s balance sheet shows Building with carrying amount of Rs. 50 lakh, the auditor shall assume that the management has claimed/ asserted that:
  • The building recognized in the balance sheet exists as at the period- end (existence assertion);
  • Company X owns and controls such building (Rights and obligations assertion);
  • The building has been valued accurately in accordance with the measurement principles (Valuation assertion);
  • All buildings owned and controlled by Company X are included within the carrying amount of Rs. 50 lakh (Completeness assertion).
The auditor then needs to draw an audit programme to verify the assertions made by the management by obtaining sufficient and appropriate audit evidences for each of the claims made on Account Balances, Class of Transactions and Related Disclosures.

ASSERTIONS MAY BE BROADLY CLASSIFIED INTO THE FOLLOWING TYPES


2. INCOME STATEMENT CAPTIONS COMPRISING REVENUE AND EXPENSE BALANCES

Assertions Expalnation Example : Employee benefit expenses and sales
Occurence Transactions recognized in the financial statements have occured and relate to the entity.
  1. Employee benefit expense has been incurred during the period in respect of teh personnel employed by the entity.
    Employee benefit expense does not include teh cost of any unauthorized personnel.
  2. Recorded sales represent goods which were ordered by valid customers and were dispatched and invoiced in the period.
Completeness All transactions that were supposed to be recorded ahve been recognized in the financial statements. Transactions have not been omitted.
  1. Employee benefit expenses in respect of all personnel have been fully accounted for.
  2. All the genuine sales have been recorded.
Cut-off Whether all income and expenses are reported in the correct accounting period. Cut-off is a seperate assertion because the substantive procedures to verify it are typically different from those applied to the other components of completeness.
  1. Employee benefit expenses recognized during the period relates to the current accounting period only.
  2. Sales shall include the dispatch of goods made at the year end as they belong to the relevant period.
Measurement Transactions have been recorded accurately at their appropriate amounts in the financial . There have been no errors while preparing documents or in posting transactions to ledger. The figures and explannations are not misstated.
  1. Employee benefit expense has been measure/calculated accurately.
    Any adjustement such as tax deduction at source have been correctly reconciled and accounted for.
  2. Sales are recorded correctly in the books based on the invoices. Discounts have been properly adjusted or accounted for.
Presentation and Disclosure Transactions have been classified are presented fairly in the financial statements. Transactions and events are appropriately segregated or disaggregated.
Presentation and disclosure assertions are considered during the course of the audit to determine that disclosures are complete and accurate. The disclosures that are most susceptible to material misstatementare those that require significant judgement and qualitative assessments. Audit teams assess the completeness and accuracy of disclosures provide information in a manner that does not materially omit, distort or mislead the user. The description and disclosure of transactions are relevant and easy to understand.		 i. Employee benefit expense ahs been fairly allocated between:
  • Operatting expenses incurred in production activities
  • General and administartive expenses
  • Cost of personnel relating to any self-constructed assets other inventory
ii. Revenue shall be disclosed seperately as revenue arising from:
  • Sale of products
  • Sale of service
  • Other operating revenues


3. BALANCE SHEET CAPTIONS COMPRISING ASSETS, LIABILITIES AND EQUITY BALANCES
Assertions Explanation Example : Inventory balance
Existence Assets, liabilities and equity balances exist as at the period end. Inventory recognized in the balance sheet actually existed as at all the period end.
Completeness All assets, liabilities and equity balances that were supposed to be recorded have been recognized in the financial statements. All inventory units held by the entity that should ahve been recorded, haev been recognized appropriately in the financial statements. Any inventory held by a third party on behalf of the entity has been included as part of the inventory balance inventory held by the entity as a consignee (on behalf of third party i.e. Consignor) shall be excluded.
Cut-off Whether all assets and liabilities are reported in the appropriate period. Inventory balnce as at teh year end does not include any element of next financial year. All items of inventory pertaining to teh relevant year shall be included regardless of teh location.
Valuation Assets, liabilities and equity balances have been valued appropriately i.e. the amounts at which they are recorded are appropriate. There has been no overstatement or understatement. Inventory has been recognized at teh lower of cost and net realizable value in accordance with AS 2 - Inventories. Any costs that could not be reasonably allocated to the cost of production (e.g. general and administrative costs) and any abnormal wastage have been excluded from teh cost of inventory. An acceptable valuation basis (e.g. FIFO, weighted average etc.) has been used to value inventory as at the period end.
Rights & Obligations Entity has the right to assets i.e. (whether the entity has ownership and legal title to assets) and the liabilities recognized in the financial statements represent all teh entity's obligations to repayment as at a given date. The entity owns or controls theinventory recorded i the financial statements i.e. the purchase invoices have been made in the name of client. Any inventory held by the entity on behalf of another entity has not been recognized as part of inventory of teh entity. (E.g.: Consignment agreements can be checked)
Presentation and Disclosure Whether particular items in the financial statements are properly classified, described and disclosed.
Presentation and disclosure assertions are considered during the course of the audit to determine that disclosures are complete and accurate.
The disclosures that are most susceptible to material misstatement are those taht require significant judgement and qualitative assessments. Audit teams asess the completeness and accuarcy of disclosures by determing that the disclosures provide information in a manner that does not materially omit, distort or mislead the user. The balances have been appropriately segregated or disaggregated. The related disclosures are understandable in accordance with applicable Financial Reporting framework.		 Example 1
Employee benefit expenses has been fairly allocated between:
  • Operating expenses incurred in production activities
  • General and administrative expenses
  • Cost of personnel relating to any self-constructed assets other than inventory
Example 2
Whether related party transactions have been disclosed appropriately as per the requirements of AS 18 - Related Perty Disclosures.

Example 3
For share capital, a reconciliation of teh number of share outstanding at the beginning and at the end of the reporting period.


4. BALANCE SHEET CAPTIONS

Share Capital

Every company’s lifecycle starts with raising of capital. Other than a private company, every other company issues a prospectus, which may be in the abridged form, or a Statement in lieu of Prospectus, before it proceeds towards allotment of share capital. The Prospectus defines the conditions on which allotment will be made (like minimum subscription), the projects on which the amount raised shall be spent (when these have been decided upon in advance) and to specify limits on certain expenses incidental to raising of capital. The receipt of applications for shares and allotment of shares in pursuance thereto are two important aspects of every issue of capital in the matter of purchase of shares. These, therefore, should receive a careful attention of the auditor. He must verify that each party, has performed his part of the contract, within the allotted time. For issue of shares, the companies also enter into certain underwriting contracts which become an important part of verification by the auditor.
 
Brief Description

To establish the existence of share capital as at the period end. Equity balances that were supposed to be recorded have been recognized in the financial statements. (Completeness)

Equity balances have been valued appropriately.

Required disclosure for equity have been appropriately made

Audit procedures
  • Tally the period end share capital balance authorised issued and paid up, to the previous year audited financial statements.
  • In case there in no chnge during the year, obtain a written confirmation/representation from the Company secretary that there were no changes to enity's capital structure during the year
  • In case there is any change, verify whether the paid up capital as at the period end is within the limits of authorised capital. Authorized capital should be verified by examining MOA.
  • Obtain the certified copies of relevant resolutions passed at the meetings of board of directors, shareholders authorising the increase/decrease in authorised share capital, if required or paid up share capital.
  • In case of fresh issue made in the current year check with compliance of Companies Act, 2013 with regard to return of allotment, minimum subscription, minimum application money to be collected, maintenance of seperate bank account, payment of underwriting commission as per Sec 40 etc.
  • No shares have been issued at Discount. (Sec. 53 of companies Act)
  • Check if shares are issued for cash or for consideration other than cash. (E.g.: To promoters for their services, underwriters for commission payable to them etc.)
  • Compliance with SEBI regualtions and Guidelines.
  • Also, obtain and verify copies of forms filed with Ministry of Corporate Affairs (MCA) (Form SH 7 for increase in authorised share capital, Form PAS 3 for increase in paid up capital) and with Reserve Bank of India (Form FCGPR in case of Foreign Direct Investment (FDI) by a NON-resident shareholder) and verify the number of securities issued along with the issue price.
  • In case there was increase in share capital, verify whether the Company has accurately calculated the required fee and stamp duty payable to MCA.
Share Issued at Premiuim: In case a company has issued shares at a premium, that is, at amount in excess of the normal value of teh shares, whether for cashor otherwise, Section 52 of the Companies Act, 2013 provides that a company shall transfer the amount received as premium to securities premium account and state the purpose for which the amount in the account can be applied.
There is no restriction or conditions prescribed in the Act for issue of shares at premium.
The provisions of this Act relating to reduction of share capital of a company shall apply as if the securities premium account where the paid up share capital of the company.

Application of securities premium account:
The securities premium account may be applied by the Company for the following purposes:
  1. toward the issue of unissued shares of the company to teh members of the company as fully paid bonus shares
  2. in writing off the preliminary expenses of the company
  3. in writing off the expenses of, or the commission paid or discount allowed on any issue of shares or debentures of the comany
The auditor needs to verify
  1. whether the premium received on shares, if any, has been transferred to a "securities premium account"
  2. whether the application of any amount out of teh said "securities premium account" is only for teh purposes mentioned above
Shared issued at discount:According to Section 53 of the Companies Act, 2013 a company shall not issue shares at a discount, except in the ccase of an issue of sweat equity shares given under Section 54 of the Companies Act, 2013.
Any share issued by a company at a discounted price shall be void. Where a company contravenes the provison of thsi section, the company shall be punishable with fine which may extend to an amount equal to the amount equal to the amount raised through the issue of shares at a discount or five lakhs, whichever is less. The company shall also be liable to refund all money received along with interest at the rate of 12% p.a. from the date of issue of such shares to the persons to whom such shares have been issued.

The auditor needs to check
  1. the movement in share capital during the year and wherever there is an issue.
  2. he should verify that the comapny has not issued any of its shares at a discount by reading the minutes of meeting of its directors and shareholders authorizing issue of share capital an the issue of price.
Issue of Sweat Equity Shares:
According to Section 54 of the Companies Act, 2013, the employees may be compensated in the form of ‘Sweat Equity Shares”.
“Sweat Equity Shares” mean equity shares issued by the company to employees or directors at a
  1. discount or
  2. for consideration other than cash
for providing know-how or making available right in the nature of intellectual property rights or value additions, by whatever name called. The auditor needs to verify that the Sweat Equity Shares issued by the company are of a class of shares already issued and following conditions have been complied with (as per Section 54):
  1. the issue is authorized by a special resolution passed by the company;
  2. the resolution specifies the number of shares, the current market price, consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued;
  3. not less than one year has, at the date of such issue, elapsed since the date on which the  company had commenced business; and
  4. where the equity shares of the company are listed on a recognised stock exchange, the sweat equity shares are issued in accordance with the regulations made by the Securities and Exchange Board in this behalf and if they are not so listed, the sweat equity shares are issued in accordance with such rules as may be prescribed.
  5. The rights, limitations, restrictions and provisions as applicable to equity shares shall be applicable to the sweat equity shares issued under this section and the holders of such shares shall rank pari passu with other equity shareholders.
The auditor also needs to verify :
  1. whether the fresh issue of shares was a rights issue or a preferential issue
  2. and whether the relevant requirements for issue of share capital as per provisions of Companies Act, 2013 have been complied with.
Reduction of Capital
For verifying reduction of capital, the auditor needs to examine whether the company has followed the specific requirements as required by Sec 66 of the Companies Act, 2013.  The auditor  shall  undertake  the  following audit procedures:
  1. Verify that the meeting of the shareholders held to pass the special resolution was properly convened and that the proposal was circularized in advance to all the shareholders;
  2. Verify that the Articles of Association authorises reduction of capital;
  3. Examine that there has been no default w.r.t repayment of deposits accepted by company or payment of interest on such deposits. Reduction of capital shall not be affected if such default exists.
  4. Examine the order of the Tribunal confirming the reduction and verify that a copy of the order and the minutes have been registered and filed with the  Registrar of Companies;
  5. Check the Registrar’s Certificate as regards to reduction of capital;
  6. Vouch the accounting entries recorded to reduce the capital and to write down the assets by reference to the resolution of shareholders and other documentary evidence; also check whether the requirements of Schedule III, Part I, have been complied with in relation to presentation;
  7. Confirm whether the revaluation of assets has been properly disclosed in the Balance Sheet;
  8. The company may reduce the capital by reduction in unpaid capital or cancellation of lost capital or paying off excess paid up capital. Verify the adjustment made in the members’ accounts in the Register of Members and confirm that either the paid up amount shown on the old share certificates has been altered or new certificates have been issued in lieu of the old, and the old ones have been cancelled;
  9. Confirm that the words “and reduced”, if required by the order of the Tribunal, have been added to the name of the company in the Balance Sheet.
  10. Check if the company have complied with all the terms and conditions imposed by the tribunal while confirming reduction of share capital.
  11. Verify that the Memorandum  of Association of the company has been suitably amended.
If the Company has made any buyback of securities, ensure compliance of specific requirements as given under sec 68 of Companies Act 2013.

Ensure whether the following disclosure requirements of Schedule III (Part 1) to Companies Act, 2013 have been complied with:

Issued and subscribed share capital
(Number of shares and value)
  • Balance at the beginning of the reporting period
  • Changes in equity share capital during the year
  • Balance at the end of the reporting period
For each class of capital
  • Rights attached
  • Preferences
  • Restrictions on the distribution of dividends
  • Restrictions on the repayment of capital
Shares held in Company by the following entities:
  • Holding company
  • Ultimate holding company
  • Subsidiaries of the holding company
  • Associates of the holding company
  • Subsidiaries of the ultimate holding company
  • Associates of the ultimate holding company
  • Shares held in the company held by each shareholder holding more than 5% shares specifying the number of shares held
  • Disclosure to be made for a period of five years immediately preceding the balance sheet date-
Aggregate number and class of shares:
  1. Allotted as fully paid up pursuant to contract(s) without payment being received in cash
  2. Allotted as fully paid up by way of bonus shares
  3. Bought back.
Reserves and Surplus

Reserves are the amounts appropriated out of profits that are not intended
  • to meet any liability,
  • contingency,
  • commitment or
  • diminution in the value of assets known to exist as at the date of the Balance Sheet.
Reserves are a vital source of financing by internal means. They are held for the purpose of distribution of dividend or financing the expansion of the company or strengthening the company financially. The company utilizes the reserves according to the nature and type of such reserve. The reserves can be segregated as revenue or capital reserves.

Revenue reserves represent profits that are available for distribution to shareholders or below purposes such as:
  • To supplement divisible profits in lean years,
  • to finance an extension of business,
  • to augment the working capital of the business or
  • to generally strengthen the company’s financial position.
Capital Reserve represents a reserve which does not include any amount regarded
as free for distribution. They can be utilized only for certain limited purposes.
 
Example
Securities premium, capital redemption reserve.

It may be noted that if a company appropriates revenue profit for being credited to the asset replacement reserve with the objective that these are to be used for a capital purpose, such a reserve shall also be in the nature of a capital reserve.

Capital Reserve is created from capital profits earned through sale of capital assets such as sale of fixed assets, profit on sale of shares.

A capital reserve, generally, can be utilised for writing down fictitious assets or losses or (subject to provisions in the Articles) for issuing bonus shares if it is realized.

But the amount of securities premium or capital redemption reserve account can be utilised only for the purposes specified in Sections 52 and 55 of the Companies Act, 2013, respectively.

Brief Description

To establish the existence of reserves and surplus as at the period-end

Reserves and Surplus balances that were supposed to be recorded have been recognized in the financial statements. (Completeness)

Reserves and Surplus balances have been valued appropriately.
 
Required disclosures for reserves and surplus have been appropriately made

Audit procedures

Trace and tally the opening balance of reserves and surplus to the previous year audited financial financial statements.

For addition/utilization in current year, in case of:
  • Profit and Loss balance –
  • Trace the movement to surplus/ deficit as per the Statement of profit and loss for the year under audit.
  • The movement should be traced in the Statement of Changes in Equity.
  • For adjustment related to dividend payment and the tax related thereto i.e. dividend distribution tax, verify the resolution passed by the board of directors regarding the recommendation of dividend, resolution passed by shareholders declaring the dividend.
  • Students should note that as per AS-4 (Revised)or IND AS 10, if dividends to holders of equity instruments are proposed or declared after the balance sheet date, an entity should not recognize those dividends as a liability as at the balance sheet date. It should, however, disclose the amount of dividends that were proposed or declared after the balance sheet date, but before the financial statements were approved for issue.
  • Securities Premium - It needs to be confirmed that the company has issued shares in excess of the nominal value of the shares and for the same, the auditor should obtain and verify the resolution passed by the board of directors.
  • As already discussed under the caption - ‘share capital’, the utilisation of securities
  • premium account could be done only for limited purposes; auditor needs to ensure the same. (Sec 52 of Companies Act 2013)
Ensure whether the following disclosure requirements of Schedule III (Part 1) to Companies Act, 2013 have been complied with: Has the company sub-classiffied reserves and surplus into the following:
  • Capital reserve
  • Capital redemption reserve
  • Securities premium
  • Debenture redemption reserves
  • Retained earnings
  • Revaluation surplus
  • Other Reserves (specify nature and purpose of the reserve )
  • Exchange difference on account of translation of financial statements of foreign operations
For each component of reserves and surplus, whether the company has disclosed the following (to the extent applicable):
  1. Balance at the beginning of the reporting period
  2. Changes, if any, due to changes in accounting policy or prior period error
  3. Total profit/ loss for the year
  4. Dividends
  5. Transfer to retained earnings
  6. Any other change (to be specified)
  7. Balance at the end of reporting period
Borrowings

Liabilities are the financial obligations of an enterprise other than owners’ funds. Liabilities include borrowings, trade payables and other current liabilities, deferred payment credits and provisions.

Verification of liabilities is as  important as that of assets, for, if any liability is omitted or understated or overstated, the financial statements would not show a true and fair view of the state of affairs of the company.

Borrowings are monies made available using external sources like bank loans, debentures, public fixed deposits etc.

Brief Description

All borrowings on the balance sheet represent valid claims by banks or other third parties. (Existence)
 
That all borrowings have been accounted for in the books of the company on a timely basis. (Completeness)
 
That liability is recorded at the correct amount. (Valuation)

That borrowings have been presented, classiffied and DISCLOSED in the financial statements in  accordance with the requirements of applicable financial reporting framework i.e. Companies Act, 2013 and applicable Indian GAAP
 
Audit Procedures
  • Review board minutes for approval of newlending agreements. During review, ensure that new loan agreements or bond issuances were authorized. Ensure that significant debt commitments were approved by the board of directors.
  • Agree details of loans recorded (interest rate, nature and repayment terms) to the loan agreement. Verify that borrowing limits, if any, imposed by agreements are not exceeded.
  • Roll out and obtain independent balance confirmations (SA 505) in respect of all the borrowings from the lender (banks/ financial institutions etc.).
  • Agree details of leases and hire purchase creditors recorded to underlying contracts/agreements.
  • In case of Debentures, Examine trust deed for terms and dates of redemption, borrowing restrictions and compliance with covenants.
  • When debt is retired, ensure that a discharge is received on assets securing the debt.
  • Obtain Written Representation that all the liabilities which have been recorded represent a valid claim by the lenders.
  • Obtain a schedule of short term and long term borrowings (including debts outstanding at the end of the previous year, as well as any new debt or renewal of debt) showing beginning and ending balances and borrowings taken and repaid during the year, and perform the following:
    (a) Consider any evidence of additional debt obtained through examination of minutes of the board of directors, significant contracts, confirmations from  banks/  lenders, support for subsequent cash disbursements (when testing payables) etc.
    (b) Trace the closing balances as per the schedules to the general ledger.
  • Review subsequent transactions after the end of the reporting period to determine if there are unrecorded liabilities at year-end and the transactions are recorded  in the correct period. ( Eg: Fresh loan taken near the balance sheet date)
Direct confirmation procedures

Roll out and obtain independent balance confirmations in respect of all the borrowings from the lender (banks/financial institutions etc.) and perform the following:
  1. Ascertain that the confirmation asks for all information likely to be relevant to the tests of debt and related interest balances (e.g., applicable interest rates, due dates, collateral and security interests).
  2. Send reminders for non-replies.
  3. Compare the balances are per the confirmations obtained to the books of the accounts. Ask for reconciliations, if there are any differences and test the supporting documents for the reconciling items on a test check basis.
Determine that the accounting policies and methods of recording debt are appropriate and applied consistently.

Agree loan balance and loan payables to the loan agreement.

Recompute the interest and discount or premium on redemption, if any.

Check computation of the amortization of premium or discount, if any.

For foreign currency loans, check the closing exchange rate(s) used and verify the computations of the restatements of foreign currency balances outstanding at year end. (As per AS 11)

Determine that the following items, if any, are properly recorded, classiffied, and/or disclosed, as appropriate:
  1. Bonds/debentures
  2. Term loans from banks and related parties.
  3. Deferred payment liabilities
  4. Deposits
  5. Loans and advances from related parties.
  6. Long term maturities of finance lease obligation.
  7. Other loans and advances.
Read the provisions in loan and debt agreements and perform the following:
  1. Test that the entity is in compliance with loan covenants and other significant provisions of the agreements.
  2. If there are any provisions with which the entity is not in compliance, determine whether the debt should be classiffied as current. If enforcement of the provisions has been waived by the lender in case of breach of any covenant by the entity, obtain confirmation of the waiver from the lender.
Examine the due dates on loans for proper classification between long-term and short- term.

Where instalments of long-term loans falling due within the next twelve months have been disclosed in the financial statements (e.g. in parentheses or by way of a footnote), verify the correctness of the amount of such instalments.

Examine the debt agreements for any restrictive covenants. Review restrictive covenant and provisions relating to default and ensure disclosure thereof in the financial statements.

Examine the important terms in the loan agreements and the documents, if any, evidencing charge in respect of such loans and advances.

Examine whether the requirements of the applicable statute regarding creation and registration of charges have been complied with including disclosure of the same to the extent mandated by statute and considered necessary for proper understanding of the user of financial statements.

In case the value of the security falls below the amount of the loan outstanding, examine whether the loan is classiffied as secured only to the extent of the market value of the security.

Examine the hire purchase agreements for the purchase of assets by the entity and ensure the correctness of the amounts shown as outstanding in the accounts, and
also examine the security aspect.

He should carefully review the borrowings from related parties and ensure compliance with AS 18 or IND AS 24.

Verify whether liabilities towards bank in respect of bills discounted, bills negotiated, cheques discounted, etc. are correctly reflected and disclosed in the financial statements.

The auditor should also verify that the amount borrowed is within the borrowing powers of the company as laid down by the Articles of Association and Memorandum of
Association.

Verify that the company has not contravened the restrictions laid down by Section 180 of the Companies Act, in respect of the borrowings of the company. Also, check compliance of Sections 185 and 186 of the Companies Act, 2013.

Examine the purpose for which the amount is borrowed and ensure that the amount is not used against the interest of the company.

Where the entity has accepted deposits, examine whether the directives issued by the Reserve Bank of India or other appropriate authority have been complied with.

Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 are made for each amount disclosed under the heading ‘long term borrowings’:
  • Sub-classification as secured and unsecured.
  • For secured borrowings, nature of security separately in each case.
  • Where loans are guaranteed by directors or others, whether the company has disclosed the aggregate amount of such loans under each head.
  • Terms of repayment for each loan unless the repayment terms of individual loans within a category are similar, in which case, they may be aggregated.
  • Repayment terms should include the period of maturity at the balance sheet date, number and amount of installments due, applicable interest rate and other significant relevant terms (if any).
In case of a default in repayment of borrowing and/ or interest on the balance sheet date, ensure that following disclosures have been made separately for each case:
  • Period of default
  • Amount of default
Trade Receivables

Trade receivable are an essential part of any organisation’s balance sheet, often referred to as debtors. Typically, an invoice is raised and issued to the customer with the invoice amount being recorded as a debtor balance. Until the invoice is paid, the invoice amount is recorded in the organization’s balance sheet as accounts receivable. If these balances are not recoverable later on, then these amounts need to be written off as bad and charged in the statement of profit and loss.

It is important to carry out Test of Controls for checking the effectiveness of internal control over sales as a part of the debtors’ audit procedure. Following points need to be considered in respect of trade receivables:
  • Only bonafide sales lead to trade receivables.
  • All such sales are made to approved customers.
  • All such sales are properly recorded in the books of accounts.
  • Once recorded, the debtors can be settled only by receipt of cash or on the authority of a responsible official.
  • Segregation of duties at every point in sales transaction. (accounting for debtors, collecting the payments, sending reminders etc)
  • Debtors are collected on time.
  • In case debtors are not collected in time, sending reminders and taking legal actions if required.
  • Balances are regularly reviewed.
  • A proper system of follow up exists and if necessary, adequate provision for bad debt should be made by preparing adequate ageing schedule of the debtors.
After performing Test of Controls over sales, the auditor will decide upon the audit procedure to be applied to verify debtors balance.

Brief Description

To establish Existence of receivables at the trade as period- end

All Trade receivable balances that were supposed to be recorded have been recognized in the financial statements. (Completeness)

Trade receivable balances have been Valued appropriately.

Required Disclosure for trade receivables have been appropriately made
 
Audit Procedures
  • Check whether there are controls in place to ensure that invoices cannot be recorded more than once and receivable balances are automatically recorded in the general ledger from the original invoice.
  • Ask for a period-end accounts receivable aging report and trace the balance as per the report to the general ledger.
  • Check whether realization is recorded invoice- wise or not. If not, check that money received from debtors is adjusted chronologically invoice-wise and on FIFO basis i.e. previous bill is adjusted first. If realization is made on account, verify whether the Company has obtained confirmations from debtors in respect of the same.
  • If any large balance is due for a long time, auditor should ask for reasons and justification for the same.
Direct confirmation procedures
  • A significant and important audit activity is to contact customers directly and ask them to confirm the amounts of unpaid accounts receivable as of the end of the reporting period under audit. This should necessarily be done for all significant account balances as at the period- end while certain random customers having smaller outstanding invoices should also be selected.
  • The auditor employs direct confirmation procedure with the consent of the entity under audit. There may be situations where the management of the entity requests the auditor not to seek confirmation from certain trade receivables. In such cases, the auditor should consider whether there are valid grounds for such a request. In appropriate cases, the auditor may also need to reconsider the nature, timing and extent of his audit procedures including the degree of planned reliance on management’s representations.
  • The trade receivables may be requested to confirm the balances either (a) as at the date of the balance sheet, or (b) as at any other selected date which is reasonably close to the date of the balance sheet. The date should be decided by the auditor in consultation with the Company.
  • The form of requesting confirmation from the trade receivables may be either (a) the form with balance outstanding amount as per the company, wherein the trade receivable is requested to respond whether or not he is in agreement with the balance shown, or (b) the form without any balance mentioned therein, wherein the trade receivable is requested to respond with the balance outstanding as per his records. The use of the form without any balance is preferable.
  • The method of selection of the trade receivables to be circularised should not be revealed to the Company until the trial balance of the trade receivables’ ledger is handed over to the auditor.
    A list of trade receivables selected for confirmation should be given to the entity for preparing request letters for confirmation which should be properly addressed. The auditor should maintain strict control to ensure the correctness and proper despatch of request letters. It should be ensured that confirmations as well as any undelivered letters are returned to the auditor and not to the client.
  • Any discrepancies revealed by the confirmations received or by the additional tests carried out by the auditor may have a bearing on other accounts not included in the original sample. The Company should be asked to investigate and reconcile the discrepancies, if any.
  • Where no reply is received, the auditor should perform alternate procedures regarding the balances. This could include:
    — Agreeing the balance to cash received subsequently;
    — Preparing a detailed analysis of the balance, ensuring it consists of identifiable transactions and confirming that these revenue transactions actually occurred. (examination in depth for those balances)
  • If there are any related party receivables, review them for collectability as well as whether they were properly authorized and the value of such transactions were reasonable and at arm’s length.
  • Check that receivables for other than sales or services are not included in the list.
  • Review a trend line of sales and accounts receivable, or a comparison of the two over time, to check if there are any unusual trends i.e perform analytical procedures. This will enable the auditor to check the reasonableness of balances.  Also, measure the average collection period. Make  inquiries about reasons for changes in trends with the management and document the same in audit work papers.
  • The auditor needs to satisfy himself of the cut- offs. Without a cut-off, sales could be understated or overstated, hence there is a need to perform the following cut off procedure:
    — For the invoices issued during the last few days (last 5 days of the reporting year) i.e. cut-off date and which have been included in the debtors; check that the goods should have been dispatched and not lying with the Company;
    — Ensure that all goods dispatched prior to the period/ year-end have been invoiced and included in debtors on a test check basis;
    — Ensure that no goods dispatched after the year- end have been invoiced and included in debtors for the period under audit.
  • Test invoices listed in receivable report. Select few invoices from the accounts receivable ageing report and compare them to supporting documentation to see if they were billed with the correct amounts, to the correct customers, and on the correct dates.
  • Match invoices to shipping/ dispatch log. Match invoice dates to the shipment dates for those items in the shipping/ dispatch log, to see if sales are being recorded in the correct accounting period. This can include an examination of invoices issued subsequent to the period being audited, to see if they should have been included in the period under audit.
  • Assess bill and hold sales. If there is a situation where the Company is billing customers for sales despite still retaining the goods on-site (known as “bill and hold”), examine supporting documentation to determine whether a sale has actually taken place or not.
  • Review the receiving log to see if the Company has recorded an inordinately large amount of customer returns after the audit period, which would suggest that the Company may have shipped more goods near the end of the audit period than what the customers had authorized to inflate the profits of the company;
  • Review the process of giving discounts/ incentives and check whether the same were given as per the Company’s policy/general industry trends.
  • Review credit memos, on a sample basis, issued during the audit period to see if they were properly authorized and whether they were issued in the correct period. Also, review credit memos issued after the period end to see if they relate to transactions belonging to the period under audit. Where any deduction has been made against a bill, check the reason and correspondence for the same.
  • Review the process followed by the Company to derive an allowance for doubtful accounts. This will include a consistency comparison with the method used in the last year, and a determination of whether the method is appropriate for the underlying business environment.
  • Obtain the ageing report of accounts receivable (both Dr/Cr balance), split between not currently due, 30 days old, 30 - 60 days old, 60 - 180 days old, 180 - 365 days old and more than 365 days old.
  • Also, obtain the list of debtors under litigation and compare with previous year.
  • Scrutinize the analysis and identify those debtors which appear doubtful; discuss with management about reasons as to why these debtors are not included in the provision for bad debts. Perform further testing where any disputes exist.
  • He should check if provisions are made at appropriate rates considering the recoverability of amounts due.
  • Prepare schedule of movements of bad debts – Provision accounts and debts written off and compare the proportion of bad debt expense to sales for the current year in comparison to prior years to see if the current expense appears reasonable.
  • Check that write-offs of the receivable balances have been approved by an appropriate authority i.e. the Board of Directors in case of a company.
  • Check that the restatement of foreign currency trade receivables has been done properly In accordance with AS 11
  • Verify that the split between more than 6 months and less than 6 months has been done from the due date and not from invoice date.
  • Proper disclosure of Related Party Transactions regarding receivables have been made as per AS 18 or IND AS 24.
  • Check classiffication of amount due is properly disclosed as:
    — Secured, considered good
    — Unsecured, considered good
    — Doubtful.
  • Verify that proper disclosure of amounts due from the following parties has been made:
    — Directors
    — Other officers of the company
    — Any of them either severally or Jointly with any other person
    — Firms orPrivate companies respectively in which any director is a partner or director or member.
  • Ensure that the transactions with parties covered under Section 189 of the Companies Act, 2013 are reported properly in Companies Auditors’ Report Order (CARO),2020.
Cash and Cash Equivalents

Cash and cash equivalents in the form of cash in hand, stamps in hand, balances held with bank in current accounts/ margin money accounts, cash credit accounts (debit balance), fixed deposits, cheques in hand etc. represent the most liquid assets of an enterprise i.e readily convertible into cash and subject to insignificant value risk.

Utmost professional skepticism needs to be exercised while auditing such balances as they are prone to misappropriation.

Brief Description
To establish the Existence of cash and cash equivalent balances as at the period- end. Cash and cash equivalent balances that were supposed to be recorded have been recorded in the financial statements. (Completeness)

Cash and cash equivalent balances have been Valued appropriately.

Required Disclosures for cash and cash equivalents have been appropriately made
 
Audit Procedures
  • Special care is necessary in regard to verification of cash balances. Unless they are checked by surprise, there can be no certainty that the cash produced for inspection was in fact held by the custodian. For this reason, the cash should be checked not only on the last day of the year, but  also checked  again sometime after the close of the year without giving notice of the auditor’s visit either to the entity or to his staff. (Surprise check)
  • If there are more than one cash balances, e.g., when there is a cashier, a petty cashier, a branch cashier and, in addition, there are imprest balances with employees, all of them should be checked simultaneously, as far as practicable so that the shortage in one balance is not made good by transfer of amount from the others.
  • It is desirable for the cashier to be present while cash is being counted and he should be made to sign the statement prepared containing details of the cash balance counted along with denomination of cash.. If he is absent at the time the cash is being verified, he may hold the auditor responsible for the shortage, if any, in cash.
  • If there is any rough Cash Book or details of daily balance are separately kept, the auditor should test entries from the rough Cash Book with those in the Cash Book to prove that entries in the Cash Bookare correct.
  • If the auditor finds any slip, chit or I.O.U.s in respect of temporary advances paid to the employees included as part of the cash balance, he should check whether those are approved by an authorized official and recorded in the appropriate accounts.
  • The auditor should also perform a cash sensitivity analysis by compiling a summary of total cash receiptsand payments each month and analyzing the trends to see if there have been variations in any specific month and request brief descriptions from the management.
  • The auditor needs to obtain bank reconciliation statements (BRS) for all bank accounts maintained by the entity as at the reporting period and additionally need to understand the client’s process and periodicity of making the BRS.
The auditor should ensure that BRS is signed by the authorized personnel so that he is able to assign responsibility in case of any errors.
  • Verification of BRS shall entail the following:
    — Tallying the balance as per bank book to the bank confirmation/ statement.
    — Checking of all material reconciling items included under cheques issued but presented for payment to the underlying bank book forming part of books of account. In addition, the auditor should request for bank statements of subsequent period and should verify if the cheques issued have subsequently been cleared by the bank. For all cases where cheques have become stale i.e. 3 months or more have lapsed since the issue date, the same should not appear in the BRS and should instead be taken back to liabilities.
    — Checking of all material reconciling items included under cheques deposited but not credited by bank by requesting for bank deposit slips, duly acknowledged by bank and verifying if the balances were credited by bank subsequently by tallying to the bank statement of subsequent period. For any instances related to cheques not cleared beyond reasonable time, the auditor should seek brief descriptions from the management and in case such explanations are found to be unsatisfactory, the auditor should verify the revenue recognition related to such parties was in order and as per the Company’s revenue recognition policy.
    — Checking of all material reconciling items included under amounts orcharges debited/ credited by bank but not accounted for by requesting for bank statements for the period under audit and tallying the same. If the amounts are found to be material, the auditor should ensure that the management records the adjustments for the same in its books of account. If management does not adjust, the auditor shall consider to qualify his report.
Direct confirmation procedure
  • A significant and important audit activity is to contact banks/financial institutions directly and ask them to confirm the amounts held in current accounts, deposit accounts, EEFC account, cash credit accounts, restrictive use accounts like dividend, escrow accounts as of the end of the reporting period under audit. This should necessarily be done for all account balances as at the period- end.
  • The Company should be asked to investigate and reconcile the discrepancies, if any, including seeking written explanations/ clarifications from the banks/financial institutions on any unresolved queries.
  • The auditor should emphasize for confirmation of 100% of bank account balances. In remote situations, where no reply is received, the auditor should perform additional testing regarding the balances. This testing could include:
    — Agreeing the balance to bank statement received by the Company or internet/ online login to account in auditor’s personal presence;
    — Sending the audit team member to the bank branch along with the entity’s personal to obtain balance confirmation from the bank directly.
In addition to the procedures performed above, the auditor should ensure that all bank accounts holding foreign currency have been restated at the closing exchange rates as per applicable Financial Reporting Framework.

Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:

Cash and cash equivalents
  1. Cash and cash equivalents shall be classiffied as:
    (a) Balances with banks;
    (b) Cheques, drafts on hand;
    (c) Cash on hand;
    (d) Others (specify nature)
  2. Earmarked balances with banks (for example, for unpaid dividend) shall be separately stated.
  3. Balances with banks to the extent held as margin money or security against the borrowings, guarantees, other commitments shall be disclosed separately.
  4. Repatriation restrictions, if any, in respect of cash and bank balances shall be separately stated.
  5. Bank deposits with more than 12 months’ maturity shall be disclosed separately.
Inventories

Inventories are a form of current assets held for sale in the ordinary course of business or in the process of production for sale or consumption in the production of goods or services for sale or in the form of materials or supplies to be consumed in the production process or rendering  of services. As per AS  2 – “Valuation  of  Inventories”,  Inventory  is valued at lower of cost and net realisable value. The basis for valuation shall be applied consistently year on year. Any change in Accounting policy shall have adequate disclosures in financial statements.

Brief Description

To establish the Existence of Inventories as at the period- end.

Only the inventories held by entity have been recorded in the financial statements and do not include any inventories that belong to third parties but does include inventories owned by the entity and lying with a third party

The entity has valid legal ownership rights over the inventories claimed to be held by the entity and recorded in the financial statements

Inventories have been Value appropriately and as per generally accepted accounting policies and practices

Required Disclosures for inventories have been appropriately made
 
Audit Procedures
  • Review entity’s plan for performing inventory count.
  • Ensure that consigned goods have been segregated.
  • Auditor should participate in the inventory count with the management.
  • Test counts of inventory by auditor should include:
    — observing employees are adhering to the agreed plan.
    — assuring that all items are properly tagged.
    — Assuring that there is appropriate supervision on the count procedure.
    — observing that proper amounts areshown on tags.
    — determining that tags and summary sheets are controlled and reconciled.
    — reconciliation of test counts with tags and summary sheets and discrepancies noted, if any, are summarized and agreed with client personnel.
    — Staying alert at all times and specifically being cautious about empty boxes, etc. and obsolete items.
    — Performing cut-off testing by documenting last 5-10 receiving reports and shipping documents as of the period end.
    — Ensuring exclusion of third party stock and damaged or obsolete stock.
    — Ensuring the accounting of all stock sheets.
    — Investigating any significant differences between the physical stock take and the stock records as per books. Further, the auditor should ask the entity’s personnel to sign all stock count sheets and also agree the variances observed, if any, to avoid any conflicts.
  • When the entity uses periodic system for inventory count, it should be undertaken at the end of the period. If the entity uses perpetual system with proper and adequate records, inventory may be counted at interim dates.
  • Confirm or investigate any inventory of the entity lying with a third party (specifically relevant for cases where the entity gets job work done in its process of production).
  • Perform analytical procedures (comparison tests with industry averages, budgets, prior years, trend analysis, etc.).
    — Compute inventory turnover ratio (COGS/ average inventory)
    — Perform vertical analysis (inventory/ total assets)
    — Compare budgetary expectations vis-à-vis actuals
  • Examine non-financial information related to inventory, such as weights and other measurements.
  • Perform purchase and sales cut-off tests. Trace shipping documents (bills of lading and receiving reports, warehouse records, and inventory records) to accounting records immediately before and after year-end.
  • With respect to tagged inventory, perform tests for omitted transactions and tests for invalid transactions.
  • Verify the clerical and arithmetical accuracy of inventory listings.
  • Reconcile physical inventory amounts with perpetual records.
  • Reconcile physical counts with general ledger control totals.
  • Reconcile inventories which belong to client but are held with third parties like transporters, warehouses, port authorities etc.
  • Goods received on consignment basis have been properly segregated from other items of inventory.
  • Vouch recorded purchases to underlying documentation (purchase requisition, purchase order, receiving report, vendor invoice and cancelled cheque or payment file).
  • Evaluate the consigned goods.
  • Examine client correspondence, sales and receivables records, purchase documents.
  • Determine existence of collateral agreements.
  • Review consignment agreements.
  • Review material purchase commitment agreements.
  • Examine invoices for evidence of ownership i.e the invoices shall be in the name of the client.
  • Auditor shall obtain confirmation for significant items of inventory as per SA 501.
  • For instances of inventory held by third party, the auditor should insist on obtaining declaration from the third party on its business letterhead and signed by an authorized personnel of that third party confirming that the items of inventory belong to the entity and are being held by such third party on behalf of and for the benefit of the entity under audit.
  • Depending on how the business operates, the management may value inventory using First-in first-out (FIFO) or weighted average basis accepted accounting policies and practices Consider the reasonableness of the method adopted.
  • For Raw materials and consumables
    Ascertain what elements of cost are included e.g. carriage inward,  non- refundable duties etc.
    If standard costs are used, enquire into basis of standards; how these are compared with actual costs and how variances are analyzed and accounted for/ treated in accounting records.
    Test check cost prices used with purchase invoices received in the month(s) prior to counting.
    Follow up valuation of all damaged or obsolete inventories noted during observance of physical counting with a view to establishing a realistic net realizable value.
  • For Work in progress
    Ascertain how the various stages of production/ value additions are measured and in case estimates are made, understand the basis for such estimates.
    Ascertain what elements of cost are included. If overheads are included, ascertain the basis on which they are included and compare such basis with the available costing and financial data/information maintained by the entity.
    Ensure that material costs exclude any abnormal wastage factors.
  • For Finished goods and goods for resale
    Enquire as to what costs are included, how these have been established and ensure that the overheads included have been determined based on normal costs and appear reasonable in relation to the information disclosed in the financial statements.
    Ensure that inventories are valued at net realizable value if they are likely to fetch a value lower than their cost. For any such items, also verify if the relevant semi/ partly processed inventories (work in progress) and raw materials have also been written down.
    Follow up for items that are obsolete, damaged, slow moving and ascertain the possible realizable value of such items. Carefully examine the valuation of obsolete and damaged inventory. For the purpose, request the client to provide inventory ageing split between less than 30 days, 30 - 60 days old, 60 - 90 days old, 90 - 180 days old, 180 - 365 days old and more than 365 days old
  • Compare recorded costs with replacement costs.
  • Examine vendor price lists to determine if recorded cost is less than current prices.
  • Calculate inventory turnover ratio. Obsolete inventory may be revealed if ratio is significantly lower.
  • In manufacturing environments, test overhead allocation rates and ensure that only direct labor, direct material and overhead have been included.
  • Verify the correct application of lower-of-cost- or-net realizable value principles.
Ensure whether the following disclosures as required under Schedule III (Part 1) to the Companies Act, 2013 have been made:
  • Whether mode of valuation has been stated separately for each class of inventory
  • Whether inventory has been classiffied as:
    — Raw materials
    — Work-in-progress
    — Finished goods
    — Stock-in-trade (goods acquired for trading)
    — Stores and spares
    — Loose tools
    — Others (specify nature).
  • Whether goods-in-transit have been disclosed separately under each sub-head of inventory.
TANGIBLE ASSETS COMPRISING LAND, BUILDINGS, PLANT & EQUIPMENT, FURNITURE & FIXTURES, VEHICLES, OFFICE EQUIPMENT, COMPUTERS ETC. REFERRED TO AS “PROPERTY, PLANT AND EQUIPMENT” (“PPE”)

The Valuation of PPE becomes a very important aspect of consideration by the auditor in the course of his audit. The auditor should analyze the expenditure incurred on PPE, whether they are of Revenue or Capital in nature. Capital expenditure should be added to the cost of PPE. The following expenses shall qualify as capital expenditure:
  1. Acquisition cost of the asset.
  2. Additions to the assets that increases the earning capacity.
  3. Benefits derived which are of long term in nature.
  4. Expenditure incurred to minimize the cost of production.
Certain revenue expenses also qualify as capital expenditure like wages on installation of machinery, legal expenses in purchase of land and building, freight inwards on purchase of assets etc.

These have to be analysed and properly classified. The revenue expense like regular repairs on assets have to be charged off to the Statement of Profit and Loss.

Brief Description

To establish the EXISTENCE of PPE as at the period-end

Additions to PPE during the period under audit have been recorded in the financial statements and do not include any PPE that belong to third parties but does include PPE owned and controlled by the entity although lying with a third party (Completeness)

PPE have been VALUED appropriately and as per generally accepted accounting policies and practices

The entity has valid legal ownership rights over the PPE claimed to be held by the entity and recorded in the financial statements (Rights and Obligation)

Required Disclosure for PPE have been appropriately made
 
Audit Procedures
 
  • Review entity’s plan for performing physical verification of PPE i.e. whether performed by own staff or by a third party and the policy regarding periodicity i.e. whether physical verification shall be done on annual basis or once in two years/ three years.
  • Evidence of appropriate supervision of those performing physical verification of PPE should be examined.
  • Obtain PPE physical verification report backed by the working sheets from the entity and perform the following procedures:
    — Assess if all items of PPE are properly tagged and carry identification marks/ numbers and physical verification work papers do capture the asset identification numbers for assets physically verified.
    — Reconciliation of  items  of  PPE  as physically verified with the fixed asset register maintained by the entity as at the date/period of undertaking physical verification. Specifically verify if the PPE additions up to the date of physical verification have been updated in thefixed asset register.
    — Verify the discrepancies noted, based on physical verification undertaken and the manner in which such discrepancies have been dealt with in the entity’s books and financial statements. For example, any identified shortages/ assets not in working  condition and/or active use should be accounted for as deletions in the books of account post approvals by the entity’s the management and depreciation should have ceased to be charged after the date of deletion.
  • Verify the movement in the PPE schedule (asset class-wise like building, Plant & machinery etc.) compiled by the management i.e. Opening balances + Additions during the period – Deletions during the period = Closing balances. Tally the closing balance to the entity’s books of account.
  • Check the arithmetical accuracy of the movement in PPE schedule. Tally the opening balances to the previous year audited financial statements. For additions during the period under audit, obtain a listing of all additions from the management and perform the following procedures:
    — For all material additions, verify if such expenditure meets the criteria of PPE as per AS 10 Revised. (Refer to Capital and Revenue expenditure)
    These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it.
    Verify that the cost of an item of property, plant and equipment is as per AS 10 Revised.
    Verify and ensure that items such as spare parts, stand-by equipment and servicing equipment are recognised as property, plant and equipment only when they are held for more than one period as per the requirements of AS 10 Revised.
    Ensure that the entity is not recognizing costs of the day-to-day servicing in the carrying amount of an item of property, plant and equipment.
    Test the purchase invoice, installation certificate or report or other similar documentation maintained by the entity to verify the date of addition, for all additions samples of PPE during the period under audit.
    Verify whether the PPE additions have been approved by authorized personnel.
    Verify whether proper internal processes and procedures like inviting competitive quotations/floating tenders etc. were followed prior to finalising the vendor for procuring items of PPE/ awarding of work contract for capital projects by checking the supporting documents of the samples selected.
  • In relation to deletions to PPE, understand from the management the reason and rationale for deletion (example could be new purchase of similar asset once the old asset was no longer fit to be used in production process) and the manner  of  disposal. Obtain the management approval and discard note authoring disposal of the asset from its active use. Verify the process followed for sale of discarded PPE, for example - inviting competitive quotes, tenders and the basis of calculation of sales proceeds. Verify that the management has accurately recorded the deletion of PPE (original cost and accumulated depreciation up to the date of disposal) and the resultant gain/loss on disposal of PPE item in the entity’s books of account.
It is a common understanding that the value of fixed assets/ PPE depreciates due to efflux of time, use and obsolescence. The diminution of the value represents an item of cost to the entity for earning revenue during a given period. Unless this cost in the form of depreciation is charged to the accounts, the profit or loss would not be correctly ascertained and the values of PPE would be shown at higher amounts. The auditor should:
  • Verify that the entity has charged depreciation on all items of PPE unless any item of PPE is non- depreciable like freehold land;
  • Assess that the depreciation method used reflects the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. It could be Straight line method, diminishing value method, unit of production method, as applicable.
  • The auditor should also verify whether the management has done an impairment assessment to determine whether an item of property, plant and equipment is impaired as per the requirements of AS 28 - Impairment of Assets.
  • In addition to the procedures undertaken for verifying completeness of additions to PPE during the period under audit, the auditor while performing testing of additions should also verify that all PPE purchase invoices are in the name of the entity that entitles legal title of ownership to the respective entity.
  • For all additions to land and building in particular, the auditor should check the conveyance deed/ sale deed to verify whether the entity is the legal and valid owner or not.
  • The auditor should insist and verify the original title deeds for all immoveable properties held as at the balance sheet date.
  • In case the entity has given such immoveable property as security for any borrowings and the original title deeds are not available with the entity, the auditor should request the entity’s management for obtaining a confirmation from the respective lenders that they are holding the original title deeds of immoveable property as security.
  • In addition, the auditor should also verify the register of charges, available with the entity to assess that any charge has been created against the PPE.
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:

Whether all items of property, plant and equipment have been classiffied as:
  • Land
  • Buildings
  • Plant and equipment
  • Furniture and fixtures
  • Vehicles
  • Office equipment
  • Others (specify nature)
Whether the entity has disclosed assets “under lease” separately under each class of asset. The term “under lease” means assets given on operating lease and assets taken on finance lease.

For each class of Property, Plant and Equipment, whether the entity has disclosed a reconciliation of the gross and net carrying amounts at the beginning and end of the
reporting period showing separately:
  • Opening balance of gross carrying amount
  • Additions
  • Acquisitions through business combinations
  • Disposals
  • Disposals through demergers
  • Other adjustments
  • Borrowing costs capitalized
  • Closing balance of gross carrying amount
  • For each class of property, plant and equipment, whether the entity has disclosed:
    Opening accumulated depreciation
    Charge for the year
    Deduction/ other adjustments for depreciation
    Closing accumulated depreciation
  • For each class of property, plant and equipment, whether the entity has disclosed:
    Opening accumulated impairment losses
    Impairment losses
    Impairment reversals
    Closing accumulated impairment losses.
IntangibleAssets (comprising Goodwill, Brand/Trademarks, Computer Software etc.)

An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. Enterprises frequently spend resources on the acquisition, development, maintenance or enhancement of intangible assets such as scientific or technical knowledge, design and implementation of new processes or systems, licenses, intellectual property, market knowledge and trademarks (including brand names and publishing titles).

Common examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licenses, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights. Goodwill is another example of an item of intangible nature which either arises on acquisition or may be internally generated.

As per AS 26 – Intangible Assets, internally generated goodwill is not recognized as an asset because it is not an identifiable resource controlled by the enterprise that can be measured reliably at cost.
 
Brief Description

To establish the Existence of intangible fixed assets as at the period- end

Additions to Intangible assets during the period under audit have been recorded appropriately in the financial statements

Intangible assets have been Valued appropriately and as per generally accepted accounting policies and practices

The entity has valid legal ownership rights over the Intangible Assets claimed to be held by the entity and recorded in the financial statements (Rights and Obligation)

Required Disclosure for Intangible Assets have been appropriately made

Audit Procedures

Since an intangible asset is an identifiable non-monetary asset, without physical substance, for establishing the existence of such assets, the auditor should verify whether such intangible asset is in active use in the production or supply of goods or services, for rental to others or for administrative purposes.

Example- for verifying the existence of software, the auditor should verify whether such software is in active use by the entity and for the purpose, the auditor should verify the sale of related services/goods during the period under audit, in which such software has been used.

Example- For verifying the existence of design/ drawings, the auditor should verify the production data to establish if such products for which the design/drawings were purchased, are being produced and sold by the entity.

In case any intangible asset is not in active use, deletion should have been recorded in the books of account post approvals by the entity’s management and amortization charge should have ceased beyond the date of deletion.

Verify the movement in the intangible assets schedule (asset class wise like software, designs/ drawings, goodwill etc.) compiled  by  the management i.e. Opening balances + Additions – Deletions = Closing balances. Tally the closing balances to the entity’s books of account.

Check the arithmetical accuracy of the movement in intangible assets schedule.

For additions during the period under audit, obtain a listing of all additions from the management and undertake the following procedures:
  • For all material additions, verify whether such expenditure meets the criterion for recognition of an intangible asset as per AS 26.
  • Ensure that no cost related to research (or from the research phase of an internal project) gets recognized as intangible asset.
  • Check the certificate or report or other similar documentation maintained by the entity to verify the date of use of the intangible which could be linked to date of commencement of  commercial production/ economic use to the entity, for all additions to intangible assets during the period under audit.
  • Verify whether the additions (acquisitions) have been approved by appropriate entity’s personnel.
  • Verify whether proper internal processes and procedures like inviting competitive quotations/ proper tenders etc. were followed prior to finalizing the vendor for procuring item of intangible assets by testing those documents on a sample basis.
  • In relation to deletions of intangible assets, understand from the management the  reason and rationale for deletion and the manner of disposal. Obtain the management approval and disposal note authoring disposal of the asset from its  active use. Verify the process followed for sale of discarded asset, example inviting competitive quotes, tenders and the basis of calculation of sales proceeds. Verify that the management has accurately recorded the deletion of intangible asset (original cost and accumulated amortization up to the date of disposal) and the resultant gain/ loss on disposal in the entity’s books of account.
The value of intangible assets may diminish due to efflux of time, use and/or obsolescence. The diminution of the value represents cost to the entity for earning revenue during a given period. Unless this cost in the form of amortization is charged to the accounts, the profit or loss would not be correctly ascertained and the values of intangible asset would be shown at higher amounts. The auditor should:
  • Verify that the entity has charged amortization on all intangible assets;
  • Verify that the amortization method used reflects the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.
  • The auditor should also verify whether the management has done an impairment assessment to determine whether an intangible asset is impaired. For this purpose, the auditor needs to verify whether the entity has applied AS 28 - Impairment of Assets for determining the manner of  reviewing the  carrying  amount  of  its  intangible asset, determining the recoverable amount of the asset to determine impairment loss, if any.
  • In addition to the procedures for verifying completeness of additions to intangible assets during the period under audit, the auditor while performing testing of additions should also verify that all expense invoices/ purchase contracts are in the name of the entity that entitles legal title of ownership to the entity.
Ensure that the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:

Whether all items of intangible assets have been classiffied as:
  • Goodwill
  • Brands/trademarks
  • Computer software
  • Mastheads and publishing titles
  • Mining rights
  • Copyrights, and patents and other intellectual property rights, services and operating rights
  • Recipes, formulae, models, designs and prototypes
  • Licenses and franchise
  • Others (specify nature).
For each class of intangible asset, whether the entity has disclosed a reconciliation of the gross and net carrying amounts at the beginning and end of the reporting period showing separately:
  • Opening balance of gross carrying amount
  • Additions
  • Disposals
  • Impairments
  • Other adjustments.
For each class of intangible assets, whether the entity has disclosed:
  • Opening accumulated amortization
  • Charge for the year
  • Deduction/ other adjustments for amortization
  • Closing accumulated amortization
  • Opening accumulated impairment losses
  • Impairment losses
  • Impairment reversals
  • Closing accumulated impairment losses
Trade Payables and Other Current Liabilities

Liabilities in addition to borrowings (discussed above), include  trade  payables  and other current liabilities, deferred payment credits and provisions. A liability is considered to be current if it is due to be paid within twelve months and held primarily for the purpose of being traded in the entity’s normal operating cycle. E.g Short term debt, dividends etc. Verification of liabilities is as important as that of assets, considering if any liability is omitted or understated or overstated, the financial statements would not show a true and fair view of the state of affairs of the entity.

Brief Description

To establish the Existence of trade payables and other current liabilities as at the period-end

Trade payables and liability balances that were  supposed to be recorded have been recognized in the financial statements. (Completeness)

Trade payables and other liability balances have been Valued appropriately.

Required Disclosures for trade payables and other liabilities have been appropriately made

Audit Procedures
  • Check whether there are controls in place to ensure that any purchase/ expense invoice does not get recorded more than once and payable balancesare automatically recorded in the general ledger at the time of recording of expense.
  • Obtain the accounts payable ageing report and trace its balances to the general ledger. If there are any differences, investigate reconciling items. Journal entries specially for large amounts should be carefully examined.
Direct confirmation procedure

An important audit activity is to contact vendors directly/independently and ask them to confirm the amounts of accounts payable as of the end of the reporting period under audit. This should necessarily be done for all significant account payable balances as at  the period-end and for parties from whom material purchases have been made during the period under audit even if period-end balance of such parties is not significant.

The auditor employs direct confirmation procedure with the consent of the entity under audit. There may be situations where the management of the entity requests the auditor not to seek confirmation from certain trade payables. In such cases, the auditor should consider whether there are valid grounds for such a request. In appropriate cases, the auditor may also need to reconsider the nature, timing and extent of his audit procedures including the degree of planned reliance on management’s representations.

The trade creditors may be requested to confirm the balances either (a) as at the date of the balance sheet, or (b) as at any other selected date which is reasonably close to the date of the balance sheet. The date should be decided by the auditor in consultation with the Company.

The form of requesting confirmation from the trade creditor may be either (a) the form with balance as at year end wherein the trade creditor is requested to respond whether or not he is in agreement with the balance shown, or (b) the form with no balance wherein the trade creditor is requested to respond the balance as per his records. The use of the form with no balance is preferable.

The method of selection of the trade creditors to be circularised should not be revealed to the Company until the trial balance of the trade payables’ ledger is handed over to the auditor. A list of trade creditors selected for confirmation should be given to the entity for preparing request letters for confirmation which should be properly addressed. The auditor should maintain strict control to ensure the correctness and proper dispatch of request letters. In the alternative, the auditor may request the client to furnish duly authorised confirmation letters and the auditor may fiill in the names, addresses and the amounts relating to trade creditors selected by him and mail the letters directly. It should be ensured that confirmations as well as any undelivered letters are returned to the
auditor and not to the client.

Any discrepancies revealed by the confirmations received or by the additional tests carried out by the auditor, may have a bearing on other accounts not included in the
original sample. The entity should be asked to investigate and reconcile the discrepancies. In addition, the auditor should also consider what further tests he can carry out in order to satisfy himself as to the correctness of the amount of trade payables taken as a whole.

Where no reply is received, the auditor should perform additional testing regarding the balances. This testing could include:
  • Testing of subsequent payments in respect of the trade payables to whom confirmations were rolled out but no replies received;
  • Agreeing the details of the respective balance to the underlying vendor invoices;
  • Preparing a detailed analysis of the balance, ensuring it consists of identifiable  transactions and confirming that these purchases/expense transactions actually occurred. (examination in depth)
If there are any related party payables, review whether they were properly authorized and the value of such transactions were reasonable and at arm’s length.

Review a trend line of purchases/ expenses and accounts payable, or a comparison of the two over time, to see if there are any unusual trends. Make inquiries about reasons for
changes in trends from the management.

The auditor needs to perform the following cut off procedures:
  • For the last 5 invoices received/ recorded at the end of the reporting date (cut off date) and which have been included in the trade payables; the goods should have been received/ risk and rewards of ownership in goods should have been transferred in favour of the entity;
  • All goods received prior to the period/ year- end should have been booked in the form of purchases and included in trade creditors.
Test purchases/ expenses on a sample basis selecting the same from the accounts payable ledgers and checking their supporting documents to ensure that the purchases were recorded at the correct amounts and correct dates.

Match purchase invoice dates to the gate entry (inward) dates to check whether the purchases are being recorded in the correct accounting period. This can include an examination of purchase/ expense invoices received subsequent to the period being audited, to see if they should have been included in the period under audit.

Review subsequent expense vouchers. Review all material expense vouchers recorded post the balance sheet date to see if they relate to transactions from within the audit period.

For advance received from customers/ revenue received in advance, obtain the customer wise listing along with its ageing and the nature. Verify if any advances are outstanding beyond 6 months. Enquire from the entity’s management if there has been any dispute with the customer and if there is any additional liability to be recorded. For all  such advances, the auditor should verify the underlying documentation based on which the entity had received the advance.

In relation to statutory dues liability like withholding tax (TDS) payable, GST payable, luxury tax payable, professional tax payable, PF and ESI payable etc., prepare a reasonability with respect to sales/purchases/employee benefit expenses. Example- GST liability for last month may be calculated by applying the applicable rate to the sales made and in case of any variance with the GST liability recorded by the entity, reasons for variance should be requested from client and in case found satisfactory, the same should be maintained as part of audit documentation.

Similarly, Provident Fund liability for last month may be calculated by applying the applicable rate to the employee benefit expense and in case of any variance with the liability recorded by the entity, reasons for variance should be requested from client and in case found satisfactory, the same should be maintained as part of audit documentation.

Further, the auditor should obtain and verify the challans for deposits made subsequent to the period-end for all statutory liabilities as at the balance sheet date and also analyse the reasons, if any, in consultation with the management for any variance between the amounts deposited subsequently vis-à-vis the liability recorded in books of account.
  • He shall prepare a complete list of all statutory dues and consider his reporting requirements under CARO,2020.
  • Review the process followed by the Company to identify if any old creditor balance/ liability needs to be written back. This will include a consistency comparison with the method used in the last year, and a determination of whether the method is appropriate for the underlying business environment.
  • Obtain the ageing of payable balances, split between current, less than 30 days old, 30-60 days old, 60-180 days old, 180- 365 days old and more than 365 days old. Also, obtain the list of vendors with whom the Company has disputes and any claims from customers, under litigation and compare with previous year.
  • Check that write backs in the liability balances assessed as no longer payable have been approved by an appropriate and authorised member of senior management, for example – CEO/MD.
  • Check that the restatement of foreign currency trade payables has been done properly In accordance with AS 11.
    Understand management’s process to identify the principal amount and the interest due thereon (if any) remaining unpaid to any Micro, Small and Medium Sized Enterprises suppliers at the end of accounting year. Test check the management process to assess if the auditor could rely on the management process.
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:

Whether the Company has classiffied a payable as a trade payable if it is in respect of the
amount due on account of goods sold or services rendered in the normal course of business.

Whether the Company has disclosed the following details relating to micro and small enterprises in the notes:
  • the principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier at the end of each accounting year.
  • the amount of interest paid by the buyer in terms of section 16 of the Micro, Small and Medium Enterprises Development Act, 2006, along with the amount of the payment made to the supplier beyond the appointed day during each accounting year.
  • the amount of interest due and payable for the period of delay in making payment (which have been paid but beyond the appointed day during the year) but without adding the interest specified under the Micro, Small and Medium  Enterprises  Development Act, 2006.
  • the amount of interest accrued and remaining unpaid at the end of each accounting year.
  • the amount of further interest remaining due and payable even in the succeeding years, until such date when the interest dues above are actually paid to the small enterprise, for the purpose of disallowance of a deductible expenditure under section 23 of the Micro, Small and Medium Enterprises Development Act, 2006.
Whether the amount disclosed under other current liabilities are classified as below:
  • Current maturities of long-term debts.
  • Current maturities of finance lease obligations
  • Interest accrued
  • Income received in advance
  • Unpaid Dividends
  • Unpaid matured deposits/debentures and interest accrued thereon
  • Income received in advance
  • Others (specify nature).
Loans and Advances and Other Current Assets

Loans and advances include loans and advances to related parties, security deposits, capital advances, amounts recoverable in cash or in kind or for value to be received, e.g., rates, taxes and insurance paid in advance/ prepaid.

Other current assets primarily include balances with statutory/ government authorities etc.

Brief Description

To establish the Existence of loans and advances and other current assets as at the period-end

Loans and advances and other current asset balances that were supposed to be recorded have been recognized in the financial statements. (Completeness)

Loans and advances and other current asset balances have been Valued appropriately.

Required Disclosure for loans and advances and other current assets have been appropriately made

Audit Procedures
  • For establishing existence of loans and advances, direct confirmation procedures, similar to those performed for Accounts receivable balances are should be performed with the only difference that while performing circularisation of direct confirmations, in addition to the principal amount, interest receivable, if any, as per the agreed terms between the parties, may also be included as part of the balance to be confirmed.
  • Obtain a list of all advances and other current assets and compare them with balances in the ledger.
  • Verify loan agreements and acknowledgements of parties in respect of outstanding loans. A loan or an advance, if material, is granted only if authorised by the Memorandum and Articles of Association in the case of Company.
    In addition, the auditor should confirm that the loans advanced were within the competence of persons who had advanced the same, directors in the case of a Company, partners in the case of a firm and trustees in the case of a trust.
  • Inspect the minutes of meeting of board of directors to confirm if all material loans and advances were approved by the board of directors.
  • Verify that the loan has been acknowledged by the party and in addition, inspect if any security has been deposited against due repayment of the loan. Ascertain if loans are being recovered regularly as per agreed instalments.
  • If there are any related party loans and advances, review whether they were properly authorized and the value of such transactions were reasonable and at arm’s length.
  • In relation to balances with statutory authorities like GST input credit, prepare a reasonability with respect to purchases/ expenses by applying the applicable rate to the purchases/ expenses and in case of any variance with the asset recorded by the entity, reasons for variance should be requested from the entity.
  • Further, the auditor should obtain statutory returns filed with the authorities like GST returns and verify whether the amount recorded as per books of account tallies with the claim made with the authorities.
  • Assess the allowance for doubtful accounts. Review the process followed by the Company to derive an allowance for doubtful accounts. This will include a consistency comparison with the method used in the last year, and a determination of whether the method is appropriate for the underlying business environment.
  • Obtain the ageing report of loans and advances, split between not currently due, 30 days old, 30- 60 days old, 60 - 180 days old, 180 - 365 days old and more than 365 days old. Also, obtain the list of loans and advances under litigation and compare with previous year.
  • Scrutinize the analysis and identify those loans and advances that appear doubtful; discuss with management about the reasons as to why these loans/ advances are not included in the provision for doubtful balances.
  • Assess bad loans/ advances write-offs. Prepare schedule of movements on Bad loans/ advances – Provision Accounts and loans/ advances written off.
  • Check that write-offs or other reductions in the recoverable  balances  have  been  approved  by the authorsied and appropriate senior authority
  • Check that the restatement of foreign currency loans and advances/ other current assets has been done properly in accordance with AS 11
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:
  • Whether loans have been classified as:
  • Security deposits
  • Loans to related parties (giving details thereof)
  • Capital advances
  • Other loans (specify nature).
Whether all the above loans have been further sub-classiffied as:
  • Secured, considered good
  • Unsecured, considered good
  • Doubtful.
Whether allowance for bad and doubtful loans has been disclosed separately under the relevant heads i.e. separately for each category of loans

For loans, whether separate disclosure has been made for amounts due by:
  • Director(s) of the company
  • Director(s) of the company jointly with other persons
  • Other officer(s) of the company
  • Other officer(s) of the company jointly with other persons
  • Firm(s) in which director is a partner
  • Private company(ies) in which director is a director or a member.
Provisions and Contingent Liabilities

A provision is a liability which can be measured only by using a substantial degree of estimation.

A provision is recognised when:
  1. an entity has a present obligation (legal or constructive) as a result of a past event;
  2. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
  3. a reliable estimate can be made of the amount of the obligation. If the above conditions are not met, no provision is recognised.
If these conditions are not met, no provision should be recognised

Example
Provision may include provision for litigation, provision for warranties etc.

A contingent liability is:

(i) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or
(ii) a present obligation that arises from past events but is not recognized because:
  • it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
  • the amount of the obligation cannot be measured with sufficient reliability.
Brief Description

To establish the Existence of provisions as at the period- end

Provisions that were supposed to be recorded have been recognized in the financial statements. (Completeness)

Provision balances have been valued appropriately. (Valuation)

Required Disclosure for provisions have been appropriately made

Audit Procedures
  • Obtain a list of all provisions and compare them with balances in the ledger.
  • Inspect the underlying agreements like agreement with customers to assess warranty commitments, any legal and other claims on the entity i.e. litigations.
  • Obtain the underlying working and the basis for each of the provisions made, from the management and verify whether the same is complete and accurate.
  • Wherever required, obtain expert’s report, calculation and underlying working for the provision amount, example for warranty involving complex calculations, some entities get that valued through an actuary. In such a case, the auditor may request the management to share the actuarial valuation report and in case of any matter under legal dispute, the auditor should  request for  assessment made by a legal expert in relation to likelihood of a liability devolving on the entity i.e. whether probable or possible or remote as defined above. The auditor should then verify the underlying assumptions used by the expert with the data shared by the management.
As per SA 500 – “Audit Evidence”, issued by ICAI, when using the work of  a management’s expert, audit evidence that the auditor should obtain include:

Evaluate the competence, capabilities and objectivity of that expert:
  • Whether the expert is employed by the entity or is an outside party.
  • Whether the expert is independent in respect of the entity.
  • Auditor’s previous experience of the work of the expert.
  • Knowledge of the expert, his qualification, membership of a professional body or industry association, etc.
Obtain an understanding of the work of that expert:
  • Whether the auditor has expertise to evaluate the work of the expert.
  • Evaluating the assumptions and methods used by the management.
  • Evaluating the nature of internal or external data used by the expert.
Evaluate the appropriateness of his work as audit evidence for the relevant assertion:
  • Relevance and reasonableness of the expert’s findings or conclusions
  • Evaluating the relevance, completeness and accuracy of the source data used by the expert.
The auditor shall obtain written representation from the management that it has made all the provisions which were required to be made as per the recognized accounting principles.

Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:

Whether current and non-current portions have been split for
  • Provision for employee benefits
  • Others (specify nature)
Whether for each class of provision, disclosure has been made for:
  • the carrying amount at the beginning and end of the period;
  • additional provisions made in the period, including increases to existing provisions;
  • amounts used (i.e. incurred and charged against the provision) during the period;
  • unused amounts reversed during the period.
Whether for each class of provision, disclosure has been made for:
  • a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits;
  • an indication of the uncertainties about the amount or timing of those outflows. Where necessary to provide adequate information, an entity shall disclose the major assumptions made concerning future events; and
  • the amount of any expected reimbursement, stating the amount of any asset that has been recognized for that expected reimbursement.
Unless the possibility of any outflow in settlement is remote, whether disclosure has been made for each class of contingent liability at the end of the reporting period a brief description of the nature of the contingent liability and, where practicable:
  • an estimate of its financial effect
  • an indication of the uncertainties relating to the amount or timing of any outflow; and
  • the possibility of any reimbursement.


5. STATEMENT OF PROFIT AND LOSS- CAPTIONS

Sale of Products and Services

The sales and collections cycle in a business refers to the set of processes that begin when a customer purchases goods or services and ends when the entity receives complete payment against the sales. Sales is one of the most important item in the financial statements which will have a considerable effect on the profit generated, closing stock etc. As per SA 315, the risk of material misstatement in case of revenue items is generally high.

As part of the year-end audit of an entity’s financial statements, auditors test sales transactions and the internal controls over those transactions to ensure that the entity is not materially misstating its revenues or accounts receivable.

Auditor needs to obtain a clear understanding about the organisation and its revenue centres.

Example
Type of services or products the entity provides, demand for the services or products, major selling product/service, introduction of new products/service line, discontinuance of products/services, major customers, sales term (Credit or cash sales).

1. An auditor needs to obtain an understanding of the management control (internal control) in respect of sales process.
 
Example
Whether segregation of duties exist, who checks the credit limit (if applicable), who authorizes sales orders, who raises sales invoice, when and how the goods are delivered/despatched or services are provided, who collects and records the amounts received from debtors, who ensures that the risks andrewards are transferred to the customer, how the sales have been recognised in the system.

2. An auditor tests the controls the entity has set up for the sales cycle to determine how strong and reliable they are. If they are strong and operating effectively, the auditor can reduce the extent of substantive testing. Any deficiencies in the internal control shall be communicated as per SA 265.

Example
Common internal controls over the sales cycle include pre -numbered sales invoices, proper authority for approval of orders, execution of sales order, customer purchase order authorization over a certain limit and authorization over receivables write-offs.

3. The auditor selects a random sample of transactions and examines the related customer purchase orders, invoices and customer statements to ensure that the control being tested is a numbered sales invoices. This will enable the auditor to determine the nature, timing and extent of his substantive procedures to be applied.

Example
The auditor ensures that all numbers in a section are accounted for and that none are missing.

4. Performing substantive audit procedures is a must. Substantive analytical procedures will consist of sales trend analysis, comparison with previous accounting period, category-wise sales analysis, any analysis the auditor may find relevant and most important of all, building a sales expectation and comparing that with the client’s sales records. The auditor will need to know the sales prices of the products or services over the year, monthly average sales price per product or service, discount policy.

Example
For a manufacturing company, if the average sales price of product X is Rs. 10 and 1,500 units were sold in that month, the auditors expected sales will be Rs. 15,000. The auditor should compare this figure with the client’s data and see what they have recorded against Product X. The auditor should consider discussing any variances (see if there were discounts or sales were wrongly booked in the system) between his expectations and client’s records. The auditor will have to also identify and understand how the entity accounts for their sales discounts and sales return in the system and how those affect the gross sales.

Brief Description

Recorded sales represent goods shipped/services performed during the period (Occurrence)

All sales made during the period were recorded and there is no understatement or overstatement. (Completeness)

All sales are accurately measured as per applicable accounting standards and correctly journalized, summarized, and posted (Measurement)

Required Disclosures for sales have been appropriately made

Audit Procedures

Ensure revenue is not overstated by performing following audit procedures:
  • Check whether a single sales invoice is recorded twice or a cancelled sales invoice could also be recorded.
  • Test check few invoices with their relevant entries in sales journal.
  • Obtain confirmation from few customers to ensure genuineness of sales transaction
  • Whether any fictitious customers and sales have been recorded.
  • Whether any shipments were done without the consent and   agreement of the customer, especially at the year end to inflate the sales figure
  • Whether unearned revenue recorded as earned.
  • Whether any substantial uncertainty exists about collectability.
  • Whether customer obligations are contingent on other actions (financing, resale, etc.).
  • Review sequence of sales invoices
  • Review journal entries for unusual transactions
  • Calculate the ratio of sales return to sales and compare it with previous year and enquire for the reasons for increase/ decrease.
  • Check the sales return with sales invoice, challan, credit note, stock register, etc.
  • Perform cut-off procedures to ensure that revenues are recognised in the current accounting period and sales were not tampered towards the period end.
  • Cut-off errors will usually arise when companies recognise revenue based on the date on which the sales invoices are generated rather than the date on which the risks and rewards are transferred to the buyer. In order to perform a robust sales cut-off test, auditors need to understand and consider the specific cut-off error risk of each engagement.
  • Auditors should also verify the credit notes issued after the accounting period. Sometimes sales team or sales personnel can make fictitious  sales before the year-end to meet performance target and cancel out those sales with a post year end credit note.
  • Trace from the shipping documents to the sales journal.
  • Check whether quantity is appearing in sales register or not and check reconciliation of total sales/goods dispatched as per stock records and financial records and statutory records like GST.
  • Review GST tax and GST returns and ensure that the same are reconciled with revenue reported in the profit and loss account. Verify reasonability say of GST by applying the applicable rate to the gross sales value and compare the amount of GST as per statutory returns and analyze the reasons for variance, if any.
  • Trace a few transactions from inception to completion. (Examination in depth)
    E.g: Take few sales transaction, and check from the receipt of sales order to the payment of receivable balance, every underlying document to ensure if it is properly recorded at every stage and measured accurately taking into consideration all the incentives, discounts, if any. The recognition shall be according to the revenue recognition policy of the entity.
  • if the client is engaged in export sales, then compliance with AS 11 shall be ensured.
  • Auditor must understand client’s operations and related GAAP issues e.g. point of sale revenue recognition vs. percentage of completion, wherever applicable.
  • Compare the rate of sales affected with related parties and review them for collectability, as well as whether they were properly authorized and the value of such transactions were reasonable and at arm’s length.
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:
  • Whether disclosure of sales in respect of each class of goods has been made.
  • Whether revenue from operations is disclosed separately in the notes as revenue arising from:
    Sale of products (including excise duty)
    Sale of services
    Other operating revenues.
  • Whether brokerage and discount on sales other than usual trade discount has been disclosed.
  • Whether the transactions with related parties are appropriately disclosed in notes to accounts.
Other Income comprising interest income, dividend income, Gain/ Loss on sale of investments etc.

Any form of income earned by an entity which is not linked to the entity’s core business operations is generally classified as other income. Examples – interest on excess funds parked in fixed deposits with banks (the entity not being a bank or financial institution), interest on loans given to third parties/ within the group, return on mutual fund investment etc.

Interest income on fixed deposits is recognized on a time proportion basis taking into account the amount outstanding and the applicable interest rate.
 
Dividends are recognised in the statement of profit and loss only when:
  1. the entity’s right to receive payment of the dividend is established;
  2. it is probable that the economic benefits associated with the dividend will flow to the entity; and
  3. the amount of the dividend can be measured reliably.
Gain/(loss) on sale of investment in mutual funds is recorded as other income on transfer of title from the entity and is determined as the difference between the redemption price and carrying value of the investments.

Brief Description

Recorded other income was earned during the Period (Occurrence)

Other income earned during the period was appropriately recorded and there in no understatement or overstatement. (Completeness)

Other income has been measured appropriately as per the applicable accounting standards (Measurement)

Required Disclosures for other income have been appropriately made

Audit Procedures

For verifying interest income on fixed deposits:
  • Obtain a listing of fixed deposits opened during the period under audit along with the applicable interest rate and the number of days for which the deposit was outstanding during the period.
  • Verify the arithmetical accuracy of the interest calculation made by the entity by recomputing i.e. multiplying the deposit amount with the applicable rate and number of days during the period under audit.
  • For deposits still outstanding as at the period- end, trace the same to the direct confirmations obtained from the respective bank/ financial institution.
  • Obtain a confirmation of interest income from the bank and verify that the interest income as per bank reconciles to the calculation shared by the entity.
  • Also, obtain a copy of Form 26AS (TDS withholding by the bank/financial institution) and reconcile the interest reflected therein to the calculation shared by client.
For Dividends, verify that the same are recognised in the statement of profit and loss only when the entity’s right to receive payment of the dividend is established.

Verify that Gain/(loss) on sale of investment in mutual funds is recorded as other income only on
  • transfer of title from the entity AND
  • is determined as the difference between the redemption price and carrying value of the investments.
For the purpose, obtain the mutual fund statement and trace the gain/loss as recorded in the books of account to the gain/loss as reflected in the statement.
 
Ensure whether the following disclosures as required under Schedule III (Par 1) to Companies Act, 2013 have been made:

Whether ‘other income’ has been classiffed as:
  • Interest income
  • Dividend income
  • Other non-operating income (net of expenses directly attributable to such income).
Purchases

Purchases is another significant process of an entity. Similar to sales as discussed above, purchases and disbursement cycle in a business refers to the set of processes that begin when an order for buying goods or services is placed based on requirements of the production/ user department and ends when the entity receivesthe product and makes complete payment to the vendor. As part of the year-end audit of an entity’s financial statements, auditors test purchase transactions and the internal controls over those transactions to ensure that the entity is not materially misstating its purchases or accounts payables.
 
Auditor needs to obtain a clear understanding about the organisation and its production centres e.g. type of services or products they procure that are used in the production/ rendering of services, sources of procurement whether domestic or overseas, general availability and terms and conditions of purchase of the service or products, major vendors, credit period, quality checks, purchase terms (Credit or cash purchase) etc.
  1. An auditor needs to identify the control points over purchases e.g. whether segregation of duties exist, whether competitive quotes are invited, whether a purchase committee exists who authorises purchase price, issues and authorizes purchase orders, when and how the goods are received and acknowledged, who checks the quality, quantity and specifications of the goods received and prepares Goods Receipt Note (GRN), who approves the vendor invoice, whether a 2 way/ 3 way match process exists (i.e. tally between purchase order, GRN and vendor invoice), how the purchases have been recognised in the system.
  2. An auditor tests the controls the entity has set up for the purchase cycle to determine whether they are effective or not. If the controls are effective, the auditor can reduce the extent of substantive testing. Common internal controls over the purchase cycle include inviting competitive quotations for shortlisting the vendors, numbered purchase orders, purchase order authorization over a certain limit, generation of GRN on receipt of goods, quality inspection of goods, 2 way/ 3-way match, authorization of purchase invoices ,appropriate authority to recognise the purchases in the system
  3. The auditor selects a random sample of transactions and examines the related purchase orders, GRN, purchase invoices, inward gate entry register and vendor reconciliation/ statements.
  4. Performing substantive audit procedures is must. Substantive analytical procedure will consist of purchase trend analysis, comparison with previous accounting period, category wise purchases, any analysis auditor may find relevant and most important of all setting a purchase expectation in relation to the sales made during the period under audit and compare that with the client’s purchase records. The auditor would need to know the purchase prices of the products or services over the year, monthly average purchase price per product or service etc. E.g: If the purchase price is 100 and if 15000 units were received under multiple orders during the year, the auditor expects the purchases to be 15,00,000. If there is a variance in the amount recorded in the books, he shall check for additional details like discounts received, change of purchase price for few orders due to excess demand etc.
Brief Description

Recorded purchases represent goods actually received/ services availed during the period (Occurrence)

All purchases made during the period were recorded and there in no understatement or
overstatement. (Completeness)
 
All purchases have been measured appropriately (Measurement)

Required Disclosures for purchases have been appropriately made

Audit procedures

Ensure purchases are not understated/overstated by performing following audit procedures:
  • Whether any fictitious vendors have been booked or purchases have been recorded by reviewing the vendor selection process followed by the entity and also performing procedures to ensure existence of the vendors.
  • Whether the goods were received at the factory gate and whether there exists an entry in the security gate inward register
  • Whether quality inspection of goods was done.
  • Whether a goods receipt note was prepared and signed by an appropriate client personnel.
  • Whether the purchase invoice was approved as per delegation of authority and whether a 3 or 2-way match (as discussed above) was done.
  • Whether stock record has been updated by the stores personnel.
Special considerations during audit of purchases
  • The purchase invoice received should be the “Original” copy (and not photocopy/carbon copy) against which the entity has recorded the purchase in its books of account.
  • Purchase invoice should have been booked only once risk and reward incidental to  ownership has been transferred to the entity. Specific consideration for cases where the terms of delivery as agreed with vendor are F.O.B., C.I.F. etc.
  • Purchase invoice should be in the name of entity. However, in case of different branches, it should be addressed to the appropriate branch.
  • Input tax component should have been booked in the input tax ledger. The auditor should obtain tax returns filed with the authorities and tally the input tax as reflected in the books to the amount disclosed in the returns.
  • In case of purchases made from related parties or allied and associated concerns, the auditor needs to verify if requisite approval from Board of Directors (appropriate authority) has been obtained and should verify the selected samples and perform analytical procedures in relation to price of goods to confirm that the price charged is at arm’s length.
  • The auditor should review whether purchases should be capitalized or expensed off in Statement of Profit and loss according to his professional judgement.
  • Review journal entries for unusual transactions.
In addition to the procedures for establishing occurrence of purchases as discussed above, the auditor should:
  • Perform cut-off test to ensure that purchases are recognised in the correct accounting period. For the purpose, the auditor should examine material inward records, say, last 5 transactions at at the period end to check that all corresponding invoices have been duly entered in the Purchases book and none have been omitted.
  • Ensure correct accounting treatment of goods – in – transit as per the agreed terms with the vendor regarding transfer of risk and reward of ownership in goods.
  • Obtain written representation from the management that all the purchases that took place during the year have been properly recorded in the books.
  • Perform analytical procedures to obtain audit evidence as to overall reasonableness of purchase quantity and price which may include:
    Consumption Analysis: Auditor should scrutinize raw material consumed as per manufacturing account and compare the same with previous years with closing stock and ask for the reasons from the management, if any significant variations are found.
    Stock Composition Analysis: Auditor to collect the reports from management for composition of stock i.e. raw materials as a percentage of total stock and compare the same with previous year and ask for reasons from management in case of significant variations.
  • Ratios: Auditor should compare the creditors turnover ratios and stock turnover ratios of the current year with previous years. Auditor should review quantitative reconciliation of closing stocks with opening stock, purchases and consumption.
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:
  • Whether purchases of stock-in-trade have been specifically disclosed.
  • Whether changes in inventories of finished goods, stock–in-trade and work- in-progress have been specifically disclosed.
  • Whether the transactions with related parties are appropriately disclosed in notes to accounts.
Employee Benefits Expenses

Employee benefits expenses or commonly called as payroll expenses represent the aggregate sum an entity pays as a consideration to its employees for their labour/ efforts along with associated expenses such as perquisites/ benefits, post-employment benefits like gratuity, superannuation, leave encashment, provident fund contribution etc. as well as towards their hiring, their welfare and training. In many industries, employee benefits expense is the biggest expense category and hence it is critical for businesses to manage this expenditure shrewdly and for the auditors to verify and ensure that such expenditure is appropriate and has been accounted as per applicable accounting standards and generally accepted accounting principles.

Auditor needs to obtain a clear understanding about the organisation and its hiring, appraisal and retirement process in the following manner:
  1. An auditor tests the controls the entity has set around employee benefit payment process to determine how effective they are. If they are effective, the auditor can reduce the substantive testing. Common internal controls over the employee benefit payment cycle includes maintaining of attendance records, employee master, authorisation and approval of monthly payroll  processing and disbursement, computation of employee deductions like payroll taxes, accrual of other benefits like gratuity, leave encashment, bonus etc.
  2. The auditor selects a random sample of transactions and examines the related appointment letters, appraisal letters, attendance records, HR policies, employee master etc.
  3. Performing substantive audit procedures is must. Substantive analytical procedure will consist of monthly expense reasonability, comparison with previous accounting period, any analysis auditor may find relevant and most important of all setting an expectation in relation to the expense incurred during the period under audit and compare that with the client’s business operations and overall trend in the industry.
Brief Description

Recorded employee benefit expenses were actually incurred during the period
(Occurence)
 
Employee benefit expenses pertaining to the period have been recorded appropriately (Completeness)
 
Employee benefit expenses have been measured appropriately. There in no understatement or overstatement. (Measurement)

Required Disclosures for employee benefit expenses have been appropriately made

Audit Procedures
  • Obtain an understanding of entity’s process of capturing employee attendance. There is always a risk that an entity could record expense for fictitious employees. To address this risk, the auditor may choose to meet the employees in person, on a sample basis. Further, the auditor may choose to select a sample of  employees and ask the payroll department to share their bank details/ identity proofs of the employees.
  • Obtain a list of employees as at the period- end along with a monthly movement split between new hires, leavers and continuing employees.
  • For a sample (selected randomly) of new hires, obtain the appointment letter and verify whether the salary for first month and subsequent months was processed as per the agreed terms.
  • For a sample (selected randomly) of resigned employees, obtain their full and final computation and verify whether all their dues including post-retirement benefits like gratuity, leave encashment have been paid and whether the respective employee’s acknowledgement on final computation has been obtained.
  • Obtain the monthly salary registers for all 12 months. Compile a monthly payroll reasonability by calculating the average salary per employee per month and compare with the previous year and preceding month and analyse the reasons for variance which could be attributable to annual increments, an employee at senior level joining/ leaving the entity, bonus pay-out etc.
  • Verify if accrual/ provision has been made for all employee benefits and obligations like bonus, gratuity, leave encashment, etc.
  • In case provident fund (PF), employee state insurance (ESI) are applicable to the entity, compile a reasonability by applying the rate to the basic wages and comparing to the amount recorded in books and analyse reasons for variance, if any. Also, obtain monthly deposit challans to verify if the month on month liability was subsequently deposited with the authorities and within the defined timelines.
  • Perform analytical procedures to obtain audit evidence as to overall reasonableness of employee benefit expenses which may include production per employee analysis. Auditor should analyse units produced per employee and compare the same with previous years and prevent industry trends and ask for the reasons from the management, if any significant variations are found.
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:

Whether employee benefit expense has been classiffied as:
  • Salaries and wages.
  • Contributions to provident and other funds.
  • Staff welfare expenses.
Depreciation and Amortisation

One of the key principles of accrual basis of accounting requires that an asset’s cost is proportionally expensed based on the period over which the asset is expected to be used. Both depreciation and amortization are methods that are used to prorate the cost of a specific type of asset over its useful life. Depreciation represents systematic allocation of the depreciable value of an item of PPE over its useful life while amortisation represents systematic allocation of the depreciable amount of an intangible asset over its useful life.

Depreciation and amortisation generally constitute an entity’s significant part of overall expenses and have direct impact on the profit/loss of the entity, hence auditors need to verify and ensure that such expenditure is appropriate, accurately calculated and has been accounted as per applicable provisions of Companies Act or other statutes, to the extent applicable on the respective industry and as per generally accepted accounting principles.

Auditor needs to consider the following attributes while verifying for depreciation and amortisation expenses:
  • Obtain the understanding of entity’s accounting policy related to depreciation and amortisation.
  • Ensure the Company policy for charging depreciation and amortisation is as per the relevant provisions of Companies Act/ applicable accounting standards.
  • The accounting policy has been applied consistently year on year. Any change in the accounting policy has been adequately disclosed.
  • Whether the depreciation has been calculated after making adjustment of residual value from the cost of the assets.
  • Whether depreciation and amortisation charges are valid.
  • Whether depreciation and amortisation charges are accurately calculated and recorded.
  • Whether all depreciation and amortisation charges are recorded in the appropriate period.
  • Ensure the parts (components) of each item of property, plant and equipment that are to be depreciated separately have been properly identified.
  • Whether the most appropriate depreciation method for each separately depreciable component has been used.
Brief Description

Depreciation and amortization expenses pertaining to the period have been recorded appropriately and there in no understatement/overstatement

Depreciation and amortisation expenses have been measured appropriately Recorded depreciation and amortisation expenses were actually incurred during the period

Required disclosures for depreciation and amortisation have been appropriately made

Audit Procedures
  • Obtain an understanding of entity’s process of charging depreciation and amortization.
  • Obtain the fixed asset register maintained by the entity. There is always a risk that an entity could capitalize expense of revenue nature to increase its profit or charge capital expenditure directly in income and expense statement to reduce its profit. To address this risk, the auditor may choose to check the nature of asset from fixed asset register and further, there is always a risk that fake asset has been capitalized in the books and to mitigate this risk, auditors should physically verify the fixed assets, at least the ones that are material in value. Obtain a list of all additions/ deletions along with their proper approval from the authorised person for the same.
  • Select the sample of assets from the Fixed Assets Register, on materiality considerations and verify the rates of depreciation and depreciation calculations.
  • Obtain the list of all the components identified by the management.
  • Ensure Intangible assets like patents, goodwill, copy rights have been properly amortized over the period.
  • Ensure depreciation is charged on the assets from the date when it is ready to use and not from the date of actual usage
  • Ensure depreciation on revalued amount has been properly accounted from revaluation reserve.
  • Depreciation computation as per Income tax Act, 1961- Ensure that additions are tallying with the additions as per Companies Act and the opening WDV to the Tax audit schedule for the assessment year preceding the previous year under audit.
  • Perform analytical procedures to obtain audit evidence as to overall reasonableness of depreciation and amortisation expense - check the arithmetical accuracy of records and perform independent calculations. For ex- Re-compute the depreciation expense for the year
  • Ensure that the depreciation and amortization has been charged as per the useful lives of PPE and intangible assets.
  • Ensure that residual values have been properly verified as that impacts the computation of depreciation.
  • Ensure that the depreciation and amortization has been computed prospectively whenever there is any change in useful lives of PPE and intangible assets.
Ensure whether the following disclosures as required have been made:
  • Accounting policy for depreciation and amortization.
  • Useful lives of assets as per Schedule II to the Companies Act, 2013.
  • Residual value of assets.
  • Depreciation method.
Other Expenses like Power and Fuel, Rent, Repair to Building, Plant and Machinery, Insurance, Travelling, Legal and Professional, Miscellaneous Expenses

An entity in addition to making purchases and incurring employee benefit expenses, also incurs other expenditures like rent, power and fuel, repairs and maintenance, insurance, travelling, miscellaneous expenses etc., that are essential and incidental to running of business operations.

While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel, an auditor generally prefers to vouch for other expenses to verify following attributes:
  • Whether the expenditure pertained to current period under audit;
  • Whether the expenditure qualified as a revenue and not capital expenditure;
  • Whether the expenditure had a valid supporting documents like travel tickets, insurance policy, third party invoice etc.;
  • Whether the expenditure has been classified under the correct expense head;
  • Whether the expenditure was authorised as per the delegation of authority matrix;
  • Whether the expenditure was in relation to the entity’s business and not a personal expenditure.
Brief Description

Recorded other expenses were actually incurred during the period

Other expenses pertaining to the period have been recorded appropriately and there in no understatement or overstatement

Other expenses have been measured appropriately

Required Disclosure for other expenses have been appropriately made

Audit Procedures

Rent expense-
  • Obtain a month wise expense schedule along with the rent agreements.
  • Verify if expense has been recorded for all 12 months and whether the rent amount is as per the underlying agreement.
  • Specific consideration should be  given to escalation clause in the agreement to verify if the rent was required to be recorded on a straight- line basis during the period under audit.
  • Also, verify if the agreement is in the name of the entity and whether the expense pertains to premises used for running business operations of the entity.
Power and fuel expense -
  • Obtain a month wise expense schedule along with the power bills.
  • Verify if expense has been recorded for all 12 months.
  • Also, compile a month wise summary of power units consumed and the applicable rate and check the arithmetical accuracy of the bill raised on monthly basis.
  • In relation to the units consumed, analyse the monthly power units consumed by linking it to units of finished goods produced and investigate reasons for variance in monthly trends.
Insurance expense -
  • Obtain a summary of insurance policies taken along with their validity period.
  • Verify whether the expense has been correctly classified between prepaid and expense for the period based on number of days.
Legal and professional expenses -
  • Obtain a month-wise and consultant-wise summary.
  • In case of monthly retainership agreements, verify whether the expenditure for all 12 months has been recorded correctly.
  • For non- recurring expenses, select a sample and vouch for the attributes discussed above.
  • The auditor should be cautious while vouching for legal expenses as the same may highlight a dispute for which the entity may not have made any provision and the matter may also not have been discussed/ highlighted to the auditor for his specific consideration.
Travel, repair and maintenance, printing and stationery, miscellaneous expenses –
  • The auditor should select a sample and vouch for the attributes discussed above. Wherever possible, the auditor should try to prepare a summary of expenditure on monthly basis and then analytically compare the trends.
  • Perform analytical procedures to obtain audit evidence as to overall reasonableness of other expense which may include expenditure per unit of production analysis.
  • Auditor should analyse expense per unit produced and compare the same with previous years and prevent industry trends and ask for the reasons from the management, if any significant variations are found.
Ensure other expense have been classified under:
  • Rent.
  • Insurance.
  • Power and fuel.
  • Repairs and maintenance- Building, Plant and machinery, others.
  • Legal  and professional.
  • Printing and stationary.
  • Travel expenses.
  • Miscellaneous expenses.
Ruchika Saboo An All India Ranker (AIR 7 - CA Finals, AIR 43 - CA Inter), she is one of those teachers who just loved studying as a student. Aims to bring the same drive in her students.

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