Corporate Accounting

Corp. A/C (Paper-10)

ONLY FOR CMA

CMA Inter Group-2
by
Deepak sir

1
 Section : A
Corporate Account (P-10)
BOOK
BY

DEEPAK SIR
Fully based on
CMA INSTITUTE STUDY MATERIAL
&
PAST YEAR QUESTION (SCANNER)
Whatsapp Us :- 8510933803
Email id :- [email protected]
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SECTION A: CORPORATE ACCOUNTING
Module 1. Accounting for Shares and Debentures
Issue of Shares, Forfeiture of Shares, Rights Issue,Bonus Issue, Sweat Equity
Shares, Employee Stock Option and Stock Purchase Scheme, Buy-back of
Shares
Redemption of Preference Shares, Issue and Redemption of Debentures
Underwriting of Securities
Page No – 4 to 33
Module 2. Preparation of the Statement of Profit and Loss and
Balance Sheet
Statement of Profit and Loss (as per Division I of Schedule III)
Balance Sheet (As per Division I of Schedule III)
An Introduction to Division II of Schedule III
Page No – 34 to 77

Module 3. Cash Flow Statement

Page No – 78 to 120
Module 4. Accounts of Banking, Electricity and Insurance Companies
Page No – 121 to 135

Module 5. Accounting Standards

Page No – 136 to 151

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 Module -1 ACCounting for Shares and Debentures
Chapter = ISSUE OF SHARE

Illustration 1
AK Ltd. made an issue of 10,00,000 equity shares of ` 10 each, payable fully on
application. Subscriptions were received for 12,00,000 shares. Application money in
respect of 2,00,000 shares was refunded and shares were duly allotted to the rest. Pass
journal entries to give effect to these transactions.

Illustration 2
BK Ltd. made an issue of 10,00,000 equity shares of `10 each, payable @ `2 on
application, `4 on Allotment and `4 on first and final call. Subscriptions were received for
12,00,000 shares. Application money in respect of 2,00,000 shares was refunded and
shares were duly allotted to the rest. All the amounts were duly received. Pass journal
entries to give effect to these transactions.

Illustration 3
AB & Co. Ltd. issued 5,00,00,000 Equity shares of `10 each at a premium of `4 per share
payable on application. The shares were all subscribed and all money due was received.
Give the Journal entries to record the above transactions.

Illustration 4
CD & Co. Ltd. issued 5,00,00,000 Equity shares of `10 each at a premium of `4 per share payable
`1 per share on application, `6 per share on allotment (including premium), `3 on first call and

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the balance on final call. The shares were all subscribed and all money due was received. Give
the Journal entries to record the above transactions

Illustration 5
EF & Co. Ltd. issued 5,00,00,000 Equity shares of `10 each at a premium of `4 per share
payable `1 per share on application, `6 per share on allotment (including premium), `3 on
first call and the balance on final call. The shares were all subscribed and all money due
was received except the first call money on 1,00,000 shares and the Final call money on
1,50,000 shares. Give the Journal entries to record the above transactions.

Illustration 6
GH & Co. Ltd. issued 5,000 Equity shares of `10 each at par, payable `2 per share on
application, `4 per share on allotment, `4 on first call and final call. The shares were all
subscribed and all money due was received. One shareholder holding 200 shares paid
the call money along with the allotment money. The amount was subsequently adjusted.
Give the Journal entries to record the above transactions.

Illustration 7
B Ltd issued 2,000 shares of ` 100 each at a premium of 10% payable as follows:
On application ` 20 (1st April 2021). On allotment ` 40 (including premium) (1st June 2021). On
First Call `
30 (1st July 2021). On Second & Final call ` 20 (1st Aug 2021).
Applications were received for 1,800 shares and the directors made allotment in full. One
shareholder to whom 40 shares were allotted paid the entire balance on his share
holdings with allotment money and another share holder did not pay allotment and 1st
call money on his 60 shares but which he paid with final call. Interest should be received
@ 5% p.a. on calls-in-arrears and interest should be paid @ 6% p.a. on calls in Advance
(as per Articles of the company).
Required: Calculated the amount of interest paid and received on calls-in-advance and calls
in arrears
respectively on 1st Aug. 2021.

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Illustration 8:
A limited Company was registered with a capital of ` 5,00,000 in share of ` 100 each and
issued 2,000 such shares at a premium of ` 20 per share, payable as ` 20 per share on
application, ` 50 per share on allotment (including premium) and ` 20 per share on first
call made three months later. All the money payable on application, and allotment were
duly received but when the first call was made, one shareholder paid the entire balance
on his holding of 30 shares, and another shareholder holding 100 shares failed to pay
the first call money.
Required: Give Journal entries to record the above transactions.

Illustration 9:
B Ltd purchase the assets of ` 10,80,000 from C Ltd. The consideration was payable in fully paid
equity shares of
` 100 each.
Required: Show the necessary journal entries in books of B Ltd. assuming that —
a. Such shares are issued at par
Such shares are issued at premium To Share Capital A/c
Note: The fact should also be disclosed in the Balance Sheet while showing the issued,
subscribed and paid-up capital.
Consider the following illustrations.
b. of 20% Solution:

Illustration 10:
D Ltd. issued 2,000 shares of `100 each credited as fully paid to the promoters for their
services and issued 1,000 shares of `100 each credited as fully paid to the underwriters
for their underwriting services. Journalise these transactions.

Illustration 11
On 1st May 2021 Superman Ltd. issued 5,000 Equity Shares of `100 each payable as follows:

` `

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On application 20 On 1st Call 20 (Last date fixed for payment 31st July)
On allotment 30 On Final Call 30 (Last date fixed for payment 30th
August)
Applications were received on 15th May 2021 for 6,000 shares and allotment was made
on 1st June 2021. Applicants for 2,500 shares were allotted in full, those for 3,000 shares
were allotted 2,500 shares and applications for 500 shares were rejected.
Balance of amount due on allotment was received on 15th June.
The calls were duly made on 1st July, 2021 and 1st August 2021 respectively. One
shareholder did not pay the 1st Call money on 150 shares which he paid with the final
call together with interest at 5% p.a. Another shareholder holding 100 shares did not
pay the final call money till end of the accounting year which ends on 31st October.
Required: Show the Cash Book and Journal Entries.

Illustration 12
ICC Ltd. forfeited 500 equity shares of `10 each fully called up which were issued at a
premium 20%. Amount payable on shares were: on application `2; on allotment `5; on
first and final call `5. Only application money was paid by the shareholders in respect of
these shares. 300 shares out of the above were reissued at `9 per share fully paid. Pass
journal entries for the forfeiture and re-issue.

Illustration 13
Priyanka Industries Ltd. has an authorised capital `2,00,000 divided into shares of `100
each. Of these, 600 shares were issued as fully paid for payment of machinery purchased
from Z Ltd. 800 shares were subscribed for by the public and during the first year `50 per
share was called up payable `20 on application, `10 on allotment, `10 on the first call and
`10 on second call.
The amounts received in respect of these shares were as follows:-
On 600 Shares Full amount called up
On 125 Shares ` 40 Per Share
On 50 Shares ` 30 Per Share
On 25 Shares ` 20 Per Share

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The directors forfeited the 75 shares, on which less than ` 40 per share had been paid.
Required: Give Journal Entries recording the above transactions (including cash
transactions) and show how Share Capital would appear in the Balance-Sheet of the
Company, in accordance with Part 1 of Schedule III to the Companies Act.

Illustration 14
SOS Limited issued a prospectus inviting applications for 6,000 shares of `10 each at a
premium of `2 per share, payable as follows;
On application `2 per share; On allotment `5 per share (including premium): On 1st call
`3 per share; On Second and Final Call `2 per share.,
Applications were receive for 9,000 shares and allotment was made prorate to the
applicants of 7,500 shares, the remaining applicants were refused allotment. Money
overpaid on applications were applied towards sums due on allotment.
D to whom 100 shares were allotted, failed to pay the allotment money and on his
subsequent failure to pay the first call, his shares were forfeited. Z, the holder of 200
shares, failed to pay both the calls, and his shares were forfeited after the second and
final call.
Of the shares forfeited 200 shares were sold to C credited as fully paid up for `8.50 per
share, the whole of D’s shares being included.

Illustration 15
Alpha Ltd issued a prospectus inviting applications for 2,000 shares of `10 each at a
premium of `2 per share, payable as follows:
On Application ` 2, On Allotment ` 5 (including premium)
On First Call ` 3, On Second & Final Call ` 2
Applications were received for 3,000 shares and pro rata allotment was made on the
applications for 2,400
shares. It was decided to utilise excess application money towards the amount due on
allotment.
Mohit, to whom 40 shares allotted, failed to pay the allotment money and on his subsequent
failure to pay the
first call, his shares were forfeited.

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Jagat, the holder of 60 shares failed to pay the two calls and on his such failure, his shares
were forfeited. Of the shares forfeited, 80 shares were sold to Rishav credited as fully
paid for ` 9 per share, the whole of Mohit’s shares being included.
Required: Give Journal Entries to record the above transactions (including cash transactions)

Illustration 16

Hero Limited issued 10,000 equity shares of `100 each at premium of `25 per share. Under the
terms of the
isue, the shares were to be paid for as follows:

2015 January 1, on application (including ` 25 premium on issue per 50

share)
February 1, on allotment 50
April 1, balance of 25

The issue was oversubscribed. The applications received are summarised below:

A B C
Number of applicants in categories 40 20 1
Applied for by each applicant in the three categories 200 2000 800
0
Issued to each applicant 100 200 200
0
One of the conditions of the issue was that amounts over-paid on application were to
be retained by the company and used in reduction of further sums due on shares allotted.
All surplus contributions were refunded on 1st February, 2014.

Ramesh who had subscribed 100 on an application for 200 shares was unable to meet the
claim due on April 1. On May 5, the directors forfeited his shares. All other shareholders
paid the sums requested on the due dates. On June 10, 2014 the directors re-issued the
forfeited shares as fully paid to Mohan, on receiving a payment of `10,500.

To prepare a statement as on February 1, 2014, showing the over-payment, under-

payment to in respect of category of applicants: and

To show how the above transactions would appear in the journal of the company.

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Illustration 17
JK Ltd is a company with an authorized capital of `10 lacs in equity shares of `10 each, of
which 600000 shares had been issued and fully paid on 30th June, 2020. The company
proposed to make a further issue of 100000 of these ` 10 shares at a price of `14 each
the arrangements for payment being:
` 2 per share payable on application, to be received by 1st July 2020.
Allotment to be made on 10th July and a further `5 per shares (including the
premium) to be payable. The final call for the balance to be made, and the money
received by 31st January 2021.
Applications were received for 355000 shares and were dealt
with as follows: Applicants for 5000 shares received allotment in
full.
Applicants for 30000 shares received an allotment of one share for every 2 applied for, no money
was returned
to the applicant, the surplus on application being used to reduce the amount due on allotment.
Applicants for 320000 shares received an allotment of one share for every four applied for, the
money due on
allotment was retained by the company, the excess being
returned to the applicant. The money due on final call was
received on the due date.
You are required to record these transactions in the journal of JK Limited.

Illustration 18:
A Company invited the public to subscribe for 100,00,000 Equity Shares of `100 each at
a premium of `10 per share payable on allotment. Payments were to be made as follows:
On application `20; on allotment `40; on first call `30 and on final call `20.
Applications were received for 130,00,000 shares; applications for 20,00,000 shares
were rejected and allotment was made proportionately to the remaining applicants.
Both the calls were made and all the moneys were received except the final call on
3,00,000 shares which are forfeited after due notice. Later 2,00,000 of the forfeited
shares were re-issued as fully paid at `85 per share. Pass Journal entries.

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Illustration 19
Give journal entries for the following:
(1) PK Ltd. forfeited 10,000 equity shares of `10 each for nonpayment of first call
of `2 and final call of `3 per
share. These shares were reissued at a discount of `3.50 per share.
(2) KP Ltd. forfeited 20,000 equity shares of `15 each (including `5 per share as
premium), for non-payment of
final call of `3 per share. Out of these 10,000 shares were reissued at a
discount of `4 per share.
(3) KP Ltd. forfeited 15,000 equity shares of `15 each (including `5 per share
as premium), for non-payment of allotment money `8 (including
premium money) and first & final call of `5 per share. Out of these 10,000
shares were reissued at `14 per share.

Illustration 20:
X Ltd. issued 10,000 Equity shares of `10 each at a premium of `2 per share, payable : `3
on application (including premium of `1); `4 on allotment (including the balance of
premium) and the balance in a call. Public subscribed for 12,000 shares. Excess
application money was refunded. One shareholder Mr. A holding 50 shares paid the call
money along with allotment. Another Mr. B failed to pay allotment & call on 30 shares.
These shares were forfeited after the call and 25 of those were
reissued at `9 each. Pass Journals Entries.

Illustration 21:
JB Ltd. issued 60000 equity shares of `10 each at a premium of `2.50 per share. The
amount payable on application is ` 4.50 (including premium). The amount payable on
allotment was fixed at ` 4 per share and an equivalent sum was due on a call to be made.
Total applications received were for 110000 shares and after consulting the stock

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exchange, the following scheme for allotment was decided upon:

Categor A B C
y
Grouping of shares 1 to 100 101 to 500 Over 500
No of applications received 1200 175 5
No of shares applied for 70000 35000 5000
No of shares allotted 42000 14000 4000

It was decided that the excess amount received on applications would be utilised in
payment of allotment money and surplus if any would be refunded to the applicant.
Sanjay who was one of the applicants belonging to category A and had applied for 100
shares defaulted in payment of allotment money. Vivek, who belonged to category c,
and who had been allotted 800 shares failed to pay the call money. Their shares were
forfeited, after the respective calls were made and re-issued as fully paid up for `8 and
`6 per share respectively. Show the necessary journal entries in the books of the
company to record the above transactions.

Illustration 22
A Company is planning to raise funds by making rights issue of equity shares to finance
its expansion. The existing equity share capital of the company is `50,00,000. The market
value of its share is `42. The company offers to its shareholders the right to buy 2 shares
at `11 each for every 5 shares held. You are required to calculate:
(i) Theoretical market price after rights issue;
(ii) The value of rights; and
(iii) Percentage increase in share capital.

Illustration 23
NT Limited has an issued capital of 20000 equity shares of `10 each fully called up.
The following decisions are taken by the company:
To forfeit 100 shares on which `5 per share has been paid up and to be issue at `15 per
share as fully paid up. To issue right shares in the ratio of 1 fully paid up shares for

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every 4 existing shares held, at ` 15 per share. Assuming that the company has
sufficient to general reserve, the above through journal entries.

Illustration 24
Following items appear in the Trial Balance of M Ltd. as at 31st March, 2021:

Particula (`)
rs
60,000 Equity Shares of ` 10 each 6,00,000
Capital Redemption Reserve 45,000
Plant Revaluation Reserve 15,000
Securities Premium Account 52,500
General Reserve 1,50,000
Profit & Loss Account 75,000
Capital Reserve (including ` 37,500 being Profit on Sale of Machinery) 1,12,500
The company decided to issue bonus shares to its shareholders at the rate of one share for
every four shares
held.
Required: Pass the necessary journal entries. It is desired that there should be
minimum reduction in free reserves.

Illustration 25
Following is the extract of the Balance Sheet of YY Ltd. as at 31st March, 2021:

`
Authorised Capital
15,000 12% Preference shares of `10 each 1,50,000
1,50,000 Equity shares of `10 each 15,00,000
16,50,000
Issued and Subscribed Capital:

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 12,000 12% Preference Shares of `10 each fully paid 1,20,000
1,35,000 Equity shares of ` 10 each, ` 8 paid up 10,80,000
Reserves and Surplus:
Capital Redemption Reserve 30,000
General Reserve 1,80,000
Capital Reserve 1,12,500
Securities Premium 37,500
Profit and Loss Account 2,70,000
Secured Loans:
12% Partly Convertible Debentures @ `100 each 7,50,000

On 1st April, 2021 the Company has made final call @ 2 each on 1,35,000 equity shares.
The call money was received by 20th April, 2021. Thereafter the company decided to
capitalise its reserves by way of bonus at the rate of one share for every four shares held.
Securities premium of `37,500 includes a premium of `7,500 for shares issued to vendors
pursuant to a scheme of amalgamation. Capital reserves include `60,0000, being profit
on sales of plant and machinery. 20% of 12% Debentures are convertible into equity
shares of `10 each fully paid on 1st June 2021.
Required: Show necessary entries in the books of the company and prepare the extract
of the Balance Sheet immediately after bonus issue but before conversion of
debentures. Are the convertible debenture holders entitled to bonus shares?

Illustration 26
The following is the balance sheet of RR Company Ltd as on 31.12.2021

Liabilities: (`)
Issued and paid up capital:
225000 equity shares of `10 each fully called up 22,50,000
Less: Calls in arrear (25000 shares of `2 each) 50,000
100000 equity shares of `10 each, `4 paid up 4,00,000
P/L A/c 12,50,000
Dividend Equalization Reserve 1,00,000
General Reserve 1,50,000

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 Development Rebate reserve 2,50,000
Capital reserve 1,50,000
Securities premium 2,50,000
Capital redemption reserve 4,00,000
Current liability 10,00,000
Total 6,15,0000

Assets: (`)
Non current assets
Fixed assets 30,00,000
Current assets 10,00,000
Cash at bank 21,50,000
Total 61,50,000

The board of directors of the company took the following decisions.

a. To forfeit the shares on which final call of ` 2 each is due.
b. To issue fully paid bonus shares @ 1 fully paid up share for every 2 fully paid
shares held.
c. to pay bonus to the partly paid shares at an equivalent rate as in
(b)above without collecting any amount from the related shareholders.
d. to reissue the forfeited shares @ ` 12 each fully paid up.
e. To pay dividend equivalent to 10% on share capital including bonus shares.
f. To issue right shares in the ratio of 1 fully paid up share for every four existing
fully paid up shares held
at `15 per share.
g. To use minimum balance of profit and loss account.

Note:
1. All Capital Reserve are realised in cash.
2. One fifth of the development rebate reserve is free.
Pass necessary journal entries in the books of the company including cash transaction
after the above decisions are implemented.

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Illustration 27
MG Limited was registered on 1st January 2021 with an authorised capital of `3,00,000
divided into 30000 equity shares of `10 each. During the next 12 months to 31st
November 2021 following events occurred which related to the share capital of the
company.
On 1st January 2021 the company offered for subscription of 10,000 equity shares at a price of
rupees 19 each,to be paid as follows:
At the date of issue including premium `10

On allotment `4
On first and final call `5
On 30th June 2021 the company made right issue on 1 for 2 basis at ` 22.50 per share,
payable in full on 10th July 2021.
Only 80% of the issue was subscribed for by the shareholders with a payment being made on
the due date.
On 30th November 2021 Company decided to make a bonus issue of shares at par
by utilising the entire balance of securities premium account.
Prepare the equity share capital account and the securities premium account of the
company for the year ended 31st December 2021.
A share holder who had subscribed initially for 140 shares had subsequently taken up
80% of the right issue and then received the bonus shares to which he was entitled.
Calculate the ultimate number of shares owned by him and the total price paid by him for those
shares.

Illustration 28
Show the accounting entries for the following.
a. Tinku Ltd. allotted 500 sweat equity shares of `100 each to its directors at a
discount of 6%.
b. 800 sweat equity shares of `100 allotted to employees at par in consideration of
technical know-how.

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Illustration 29

ABC Ltd., a listed company, granted 2,000 options on 01.04.2019 at an exercise price of `50 per
share. The market price at that time was of `100 per option (face value of each share being `10).
The maximum exercise period and the vesting period are 1 year and 2 years respectively. On
01.04.2020, 600 unvested options were lapsed while 1,200 options were exercised on
30.06.2021. The remaining options were lapsed at the end of the exercise period. Show the
journal entries to record the above transactions.

Illustration 30
K Ltd. granted option for 16,000 equity shares on 01.10.16 at `80 when the market price
was `170. the vesting period is 4 ½ years. 8,000 unvested options lapsed on 01.12.2021.
6,000 options are exercised on 30.09.21 and 2,000 vested options lapsed at the end of the
exercise period. Pass journal entries to record the above transactions.

Illustration 31
Y Ltd issued 2,000 shares on 1st April, 2021 under ESPP at `50 when the market price was `150
(face value
being `10).
Pass necessary journal entries to record the above transactions.

Illustration 32
On 1st April, 2019, X Ltd. offered 200 shares to each of its 400 employees at `25 per share.
The employees are given a month to accept the shares. The shares issued under the plan
shall be subject to lock-in to transfer for three years from the grant date, i.e., 30th April,
2019. The market price of shares of the company on the grant date is `30 per share. Due
to post-vesting restrictions on transfer, the fair value of shares issued under the plan is
estimated at `28 per share.
Up to 30th April, 2019, 50% of employees accepted the offer and paid `25 per share purchased.
Nominal value

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of each share is `10. Record the issue of shares in the books of the company under the aforesaid
plan.

Illustration 33

X Co. Ltd. buys back its own 2,00,000 equity shares of ` 10 each at par. The company has sufficient
profits otherwise available for dividend besides general reserve. No fresh issue of shares is made
for this purpose. The shares are fully paid up.
Journalise the transactions.

Illustration 34:
(Where shares are partly paid up)
The BCG Co. Ltd. resolved by a special resolution to buy-back 2,00,000 of its equity
shares of the face value of `10 each on which `8 has been paid up. The general reserve
balance of the company stood at `50,00,000 and no fresh issue of shares was made.
Journalize the transactions.

Illustration 35:
(Where shares are bought-back at a premium)
The share capital of Beta Co. Ltd consists of 1,00,000 equity shares of `10 each, and
25,000 preference shares of `100 each, fully called up. Its securities premium account
shows a balance of `40,000 and general reserve of `7,00,000. The company decides to
buy-back 20,000 equity shares of `12 each.
Pass the necessary journal entries.

Illustration 36:
(Where shares are bought-back at a discount)
The PTC Co. Ltd. has a share capital of `15,00,000, comprising 1,00,000 equity shares of
`10 each and 50,000 8% preference shares of `10 each, both of which fully called up and

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paid up. The company has sufficient general reserve to its credit to enable it to comply
with the legal formalities connected with buy-back of shares. It decides to buy-back 20%
of its equity share capital at `9 per share. Record the transactions in the books of the
company.

Illustration 37:
(Fresh issue of shares for purposes of buy-back)
Alpha Co. Ltd. has a paid up equity share capital of `20,00,000 in 2,00,000 shares of `10
each. It resolved to buy-back 50,000 equity shares at `15 per share. For this purpose. it
issued 20,000 12% preference shares of
`10 each, at par, payable along with application. The company has to its credit `2,50,000
in securities premium account and `10,00,000 in the general reserve account. The
company utilized the general reserve. Pass the necessary journal entries.

Illustration 38
The following was the balance sheet of Diamond Ltd. as at 31st March, 2021.

Liabilitie ` in lakhs
s
10% Redeemable Preference Shares of `10 each, fully paid up 2,500
Equity Shares of `10 each fully paid up 8,000
Capital Redemption Reserve 1,000

Securities Premium 800

General Reserve 6,000
Profit and Loss Account 300
9% Debentures 5,000
Sundry creditors 2,300

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 Sundry Provisions 1,000
26,900
Assets
Fixed assets 14,000
Investments 3,000
Cash at Bank 1,650
Other Current assets 8,250
26,900
On 1st April, 2021 the company redeemed all of its preference shares at a premium of
10% and bought back 25% of its equity shares @ `15 per share. In order to make cash
available, the company sold all the investments for ` 3,150 lakh and raised a bank loan
amounting to `2,000 lakhs on the security of the company’s plant.
Pass journal entries for all the above mentioned transactions including cash transactions
and prepare the company’s balance sheet immediately thereafter.

Illustration 39:
XYZ Ltd. has the following capital structure on of 31st March 2021.

Particular ` in Crores
s
a. Equity Share capital (Shares of ` 10 each) 300
b. Reserves :
General reserve 270
Security Premium 100
Profit and Loss A/c 50
Export Reserve (Statutory reserve) 80
c. Loan Funds 800
The shareholders have on recommendation of Board of Directors approved vide special
resolution at their meeting on 10th April 2021 a proposal to buy back maximum
permissible equity shares considering the huge cash surplus following A/c of one of its
divisions.
The market price was hovering in the range of `25 and in order to induce existing
shareholders to offer their shares for buy back, it was decided to offer a price of 20%
above market.

20
Advice the company on maximum number of shares that can be bought back and record journal
entries for the
same assuming the buy back has been completed in full within the next 3 months.
If borrowed funds were `1200 crores, and 1500 crores respectively would your answer change?

Redemption of PreferenCe Shares,

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 Issue and Redemption of Debentures
Illustration 40:
T Ltd. furnishes you with the following Balance Sheet as at 31st March, 2021 : (` in Lakhs)

Equity shares of ` 10 each fully paid 400

12% redeemable preference shares of ` 100 each fully paid 200
Reserves and surplus:
- Capital reserve 15
- Share Premium 25
- Revenue reserves 260
300
Funds Employed in : 900
Fixed assets less depreciation 560
Current assets
540
Less : Current liabilities 200 340
900
The company redeemed preference shares on 1st April 2021 at a premium of 10%. You
are required to pass journal entries to record the above.

Illustration 41:
Find out in each case what amount shall be transferred to capital redemption reserve account:

Redeemable preference shares redeemed Fresh issue of share capital

a. ` 10,00,000 at par ` 10,00,000 at par
b. ` 10,00,000 at 5% premium ` 800,000 at par
c. ` 10,00,000 at par ` 800,000 at 10%
premium
d. ` 10,00,000 at 5% premium ` 800,000 at 10%

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 premium

Illustration 42:
The Balance Sheet of Pixel Ltd. as on 31.12.2021 is given below:

Liabilitie ` in Lakh Asset ` in Lakh

s s
Share Capital: Fixed Assets 140
10,00,000 Equity shares of `10 each 100 Investments 40
1,00,000 Redeemable Pref. shares of 100 Stock 46
`100 each
Less: Call-in-arrears on 20,000 shares (4) Debtors 30
Security premium account 15 Bank 30
Reserve 30
Profit and Loss account 15
Creditors 30
286 286
On 1st Jan 2022, fixed assets costing `40 Lakh were sold for `32 Lakh. It was decided that
on 1st Feb 2022, company issued sufficient number of equity shares at par so as to
finance redemption and to leaving a balance of `10 Lakh in the reserve. All the payments
were made except to a holder of 10,000 shares who could not be traced. The company
also made bonus issue to the existing equity shareholders in the ratio of 1: 10 as on
31.12.2021. You are required to pass the necessary journal entries.

Illustration 43:
The balance sheet of G Ltd as on 31.12.2018

Liabilities: (`)
Equity shares of `10 each 2,00,000
Less: Calls in arrear @ ` 2 10,000

23
 14% Preference Shares of `100 1,00,000
Securities Premium 10,000
Investment Allowance Reserve 40,000
Development Rebate Reserve 20,000
Workmen Compensation Fund 10,000
Dividend Equalization Reserve 12,000
Profit and Loss Account 38,000
Unsecured Loans 80,000
5,00,000
Assets
Non Current Assets 4,00,000
Current Assets(including Bank balance ` 10,000) 1,00,000
5,00,000
The board of directors decided to redeem the preference shares on 1st January 2019 on the
following conditions.
Issue 4000 equity shares and `50,000 10%
debentures. Redeem preference shares at
a premium of 10%.
Raise necessary bank loan to provide funds for redemption and to have `15,000 as balance.
Admit claim of `40,00 for workmen compensation.
Utilise `10,000 out of development rebate reserve for the purpose.
Necessary journal entries assuming that holders of 100 reference shares could not be traced by
the company.

Illustration 44:

Books of M Limited show the following balances on 31st December `

2020
15000 present equity shares of `10 each fully paid 1,50,000
2500 10% preference shares of `100 each fully paid 2,50,000
500 8% redeemable preference shares pop ups `108, what is `70 paid up `35,000
General Reserve 75,000

24
 Profit and Loss Account 1,60,000
Securities Premium 15,000
Investment 1,20,000
Cash at Bank 39,600
On 1st January 2021 the board of directors decided to redeem the preference shares at
a premium of 8%. In order to pay of preference shareholders the company also decided
to sell the Investments and use companies fund and to raise the balance by issue of
sufficient number of equity shares of `10 each at a premium of rupee 1 per share subject
to leaving a minimum bank balance of `9,000 after search Redemption.
Investments web sold at `1,08,000

Show the necessary journal entries (without narration) to record the transactions.

Illustration 45
P Ltd. issued 50,000, 8% Debentures of `100 each at a premium of `20 payable as follows:
`30 on application; `40 on allotment (including premium); and `50 on first and final call.
Applications were received for all the debentures along with the application money and
allotment was made
Call money was also received on due date. Pass necessary journal entries to record the issue of
debentures.
What will be the entries if the entire amount is received on application?

Illustration 46
Journalize the following transactions. Narration is not required:
Issue of 12% 1,00,000 debentures of `100 each
1. at par and redeemable at par.
2. at 10% discount and redeemable at par.
3. at 10% premium and redeemable at par.
4. at 10% premium and redeemable at a premium of 5%.
5. at par and redeemable at a premium of 5%.

25
 6. at 10% discount and redeemable at a premium of 5%.

Illustration 47
Z Ltd. took over the assets of `6,00,000 and liabilities of `80,000 of C Ltd. for an agreed purchase
consideration
of `5,40,000 to be satisfied by the issue of 10% Debentures of
`1,000 each. Required: Show the necessary journal entries in the
books of Z Ltd, assuming that— Case (a) Such Debentures are
issued at par;
Case (b) Such Debentures are issued at 20%
premium; and Case (c) Such Debentures are
issued at 10% discount;

Illustration 48
C Ltd. secured a loan of ` 8,00,000 from the Axis Bank by issuing 1,000, 12% Debentures of `
1000 each as
collateral security.
Required: How will you treat the issue of such debentures?

Illustration 49 (Redemption out of profits)

P Ltd. had issued `15,00,000, 10% Debentures which are due to be redeemed out of
profits on Nov. 1, 2020 at a premium of 5%. The company had a Debenture Redemption
Reserve of `6,21,000. It was decided to invest the required amount in Debenture
Redemption Investment on 15.4.2020. Pass necessary journal entries for recording the
transactions relating to redemption of debentures.

26
Illustration 50 (Redemption of debentures of capital)
A company issued 100,000 15% debentures of ` 100 each at par redeemable at a
premium of 15%. After 8 years the company served notice of redemption and redeemed
all debentures as per the terms of issue. You are required to make entries at the time of
issue and at the time of redemption.

Illustration 51 (Redemption partly out of profit and partly out of capital)

The Balance Sheet of AB Ltd. as on March 31, 2020 reflected 10,000, 12% Debentures of
`100 each outstanding. These debentures were due for redemption on July 31, 2021. The
company decided to transfer `5,00,000 to Debenture Redemption Reserve on March 31,
2021 and invest `1,50,000 in fixed deposits with Bank of India on April 8, 2021. The
investment was encashed as the debentures were redeemed on due date. Pass journal
entries to record the above transactions (Ignore transactions relating to interest on
debentures).

Illustration 52 (Issue and Redemption at premium, Redemption partly out of profit and
partly out of
capital)
K Ltd. issued `6,00,000,13% Debentures of `100 each on April 1, 2017 at a premium of
6% redeemable at a premium of 10% on March 31, 2021. The debentures were
redeemed on due date. Assume that the required minimum investment was made by
the company in 10% Government Securities on the last due date meant for the purpose
of this redemption. Pass journal entries to record the issue and redemption of
debentures. (Ignore transactions relating to interest on debentures and writing-off loss
on issue of debentures).

Illustration 53 (Redemption at lump-sum with Sinking Fund)

On 1st April 2017. H Ltd. issued 442, 10% Debentures of `1000 each at a discount of
10% redeemable at a premium of 5% after 4 years. It was decided to create a Sinking
Fund for the purposes of accumulating sufficient funds to redeem the Debentures and

27
to invest in some radily convertible securities yielding 10% interest p.a. Reference to the
table shows that `1.00 p.a. at 10% compound interest amounts to `4.641 in 4 years.
Investments are to be made in the Bonds of `1000 each available at par.
On 31st March 2021, the investments realised `3,40,000 and debentures were redeemed. The
bank balance as
on that date was `50,000.
Required: Prepare Debenture Redemption Fund Account and Debenture Redemption
Fund Investments Account for 4 years.

Illustration 54
X Ltd., a pharmaceutical company, has 20,000, 9% Debentures of `100 each outstanding. These
are due for
redemption in lots as follows:
On March 31, 2019 – 4,000 debentures; On March 31, 2020 – 6,000 debentures; On
March 31, 2021 – Balance debentures.
You are required to ascertain the amount of balance that is required to be maintained in DRR
A/c for each
redemption. Also state the balance required to be transferred from DRR to General Reserve after
each redemption.

Illustration 55
B Ltd. issued notice of its intention to redeem its outstanding `12,00,000, 8% Debentures at
102% and offered
the holders the following options to apply for the redemption moneys:
(i) 6% Cumulative Preference shares of `20 each at `22.50 per share; and
(ii) 10% Debentures of `100 each at `96.
The holders of `4,80,000 debentures accepted proposal (i), and `7,20,000 debenture-
holders accepted proposal (ii). Pass necessary journal entries to record the above-
mentioned transactions.

Illustration 56 (Purchase of own debentures and immediate cancellation)

28
A company purchased its own 12% Debentures in the open market for `25,00,000 (cum-
interest). The interest amount included in the purchase price is `75,000. The face value
of the debentures purchased is `26,00,000. The company immediately cancelled the
debentures so purchased. Pass journal entries to record the purchase and immediate
cancellation (ignoring transactions relating to Debenture Redemption Reserve and
Debenture Redemption Investment).

Illustration 57 (Purchase of own debentures and cancellation on a later date)

Draft journal entries in respect of the following since March 1, 2021:
In 2014 XY Ltd had issued 5,000, 7.5% Debentures of `100 each. On 1st March, 2018, the
company purchased 500 of its own 7.5% Debentures at ` 47,500 cum-interest.
The debentures were held as investment until 30th June, 2021 when it was decided to
cancel them. Interest is payable half yearly on 30th June and 31st December and the
books are closed on 30th June each year. Assume absence of sinking fund.

Illustration 58
On 01.01.2015 E Ltd. issued 500, 10% Debentures of `100 each, at a discount of 10% redeemable
at a premium
of 10%.
Required: Show the ‘Loss on Issue of Debentures A/c’, if (i) such debentures are
redeemable after 4 years, and (ii) such debentures are redeemable by equal annual
drawings in 4 years. E Ltd. follows calendar year as it accounting year.

29
Underwriting of SeCurities
U

Illustration 59 (Determination of underwriting commission)

XYZ Ltd. is issuing 20,00,000 shares of `10 each to the public. N Ltd. has been appointed as
the underwriter for 5% of the issue size. The commission payable to the underwriter is 5%

30
of the issue price. Calculate the amount of underwriting commission payable to N Ltd. if
the shares are issued at par. How will your answer change if the shares are issued at 20%
premium?

Illustration 60 (Single Underwriter – Full Underwriting)

A Ltd. issued 1,00,000 equity shares of `100 each at par to the public, underwritten only
by B & Co. The company received applications for 90,000 shares of which 80,000 shares
were marked. Determine the liability of the B & Co.

Illustration 61 (Full Underwriting, Multiple Underwriters, Without Firm Underwriting,

Alternative Treatment w.r.t Unmarked Applications)
A Ltd. issued 4,00,000 equity shares. The whole issue was underwritten as: X - 40%; Y - 30%; and
Z - 30%.
Applications for 3,20,000 shares were received in all, out of which applications for 80,000
shares had the stamp of X, those for 40,000 shares had that of Y and 80,000 shares had
that of Z. The remaining applications for 1,20,000 shares did not bear any stamp.
Calculate the liability of underwriters.
Find out the liability of the individual underwriters in each of the following situations:
(a) Unmarked applications are apportioned in the ratio of “Gross Liability”; and

(b) Unmarked applications are apportioned in the ratio of “Gross Liability Less.
Marked Applications”.

Illustration 62 (Full Underwriting, Multiple Underwriters, Without Firm Underwriting,

Alternative Treatment w.r.t Unmarked Applications, adjustment of surplus)
M Ltd., incorporated on April 1, 2021, issued a prospectus inviting applications for 5,00,000
equity shares of
`10 each. The issue was fully underwritten by A, B, C and
D as follows: A - 2,00,000; B - 1,50,000; C - 1,00,000; and
D - 50,000.
The applications were received for 4,50,000 shares of which marked

31
applications were as follows: A - 2,20,000; B- 90,000; C - 1,10,000; and D -
10,000.
Find out the liability of the individual underwriters in each of the following cases:
(i) Unmarked applications are apportioned in the ratio of “Gross Liability”; and
(ii) Unmarked applications are apportioned in the ratio of “Gross Liability (-)
Marked Applications”.

Illustration 63 (Full Underwriting, Multiple underwriters, Firm underwriting with Alternative

Treatment, Adjustment of Surplus)

The following underwriting took place for P Ltd. which invited applications for 10,000 shares of `
10 each:
X: 6,000 shares Y: 2,500 shares Z: 1,500 shares In addition, there were firm

underwriting as follows:

X: 800 shares Y: 300 shares Z: 1,000 shares

Total subscription including firm underwriting was 7,100 shares, and the forms included the
following marked
forms:
X: 1,000 shares Y: 2,000 shares Z: 500 shares
Show the allocation of liability of the underwriters, if –
(i) Firm underwriting is treated as unmarked applications.
(ii) Firm underwriting is treated as marked applications

Illustration 64 (Partial underwriting, Sole underwriter, Abatement allowed)

Mr. X underwrites 60% of an issue of 20,000 shares of `100 each of ABC Ltd. He has also
agreed for a firm underwriting for 1,600 shares. The company received applications for
13,600 shares out of which were 8,000 marked applications. Determine the number of
shares to be taken up by Mr. X:

32
 a) If the underwriting contract provides that no abatement would be allowed in
respect of shares taken up ‘firm’.
b) If the underwriting contract provides that abatement would be allowed in respect
of shares taken up ‘firm’.

Illustration 65 (Partial underwriting, Multiple underwriters, Without Firm underwriting)

C Ltd. offered for the issue of 3,00,000 equity shares of ` 10 each. The issue was partially
underwritten by M, N and O as follows: M - 40%; N - 30%; O - 20%. Applications were
received for 2,40,000 shares of which marked applications were as follows: M – 1,05,600
shares; N - 78,000 shares; O - 50,000 shares. There was no firm underwriting.
Required: (a) Compute the liability of the underwriters, (b) Determine how many share-remain
unissued.

Preparation of the Statement of Profit and Loss and Balance

Sheet

Introduction

33
financial statements are compilation of financial data, collected and classified in a systematic
manner according to the accounting principles, to assess the financial performance and
financial position of an enterprise. Financial statements provide information that is useful to a
wide range of users in making economic decisions.

Types of Financial Statement

The following are the major types of financial statements prepared by entities.
(a) Statement of Financial Performance or Income Statement
(b) Statement of Financial State of Affairs or Balance Sheet
(c) Statement of Changes in Financial Position
(d) Statement of Inflow and Outflow of Cash

Regulatory Framework Related to Preparation of Financial Statements

In India, preparation and presentation of financial statements is guided by –
(a) The Companies Act, 2013;
(b) The Companies (Accounts) Rules 2014;
(c) Accounting Standards (AS or Ind AS as applicable)
The relevant provisions under the above three regulatory sources are mentioned below.

Meaning of Financial Statements

According to Section 2(40) of Companies Act, 2013, financial statement in relation to a company,
includes—
(i) a balance sheet as at the end of the financial year;
(ii) a profit and loss account, or in case of a company carrying on any activity not
for profit, an income and
expenditure account for the financial year;
(iii) cash flow statement for the financial year; and

(iv) any explanatory note annexed to, or forming part of, any document
referred to in sub-clause (i) to sub- clause (iv).
However, the financial statement, with respect to one person company, small company and
dormant company (Section 455) may not include cash flow statement.

34
Meaning of Financial Year
According to Section 2(41), financial year, in relation to any company or body corporate, means
the periodending on the 31st day of march every year. Where a company has been incorporated
on or after 1st day ofJanuary of a year, the first financial year will end on 31st day of March of the
following year.

Frequency of Financial Statements

Financial statements are prepared as -
(i) Annual financial statements (i.e., once a financial year)
(ii) Quarterly financial statements which are prepared by listed
companies on quarterly basis as per SEBIrequirements.

Form and Content of Financial Statements

The form and content of Financial Statements have been specified in Schedule III of the
Companies Act, 2013. The objective of such specification is to improve the comparability
of financial information across entities.
Schedule III of the Companies Act, 2013 comprises of three divisions as follows:
• Division I: General Instructions for Preparation of Balance Sheet and Statement
of Profit and Loss of a company whose Financial Statements are required to
comply with the Companies (Accounting Standards)Rules, 2021.
• Division II: General Instructions for Preparation of Financial Statements of a
company whose Financial Statements are drawn up in compliance of the
Companies (Indian Accounting Standards) Rules, 2015.
• Division III: General Instructions for Preparation of Financial Statements for a
Non-Banking Financial Company (NBFC) whose financial statements are drawn
up in compliance of the Companies (Indian Accounting Standards) Rules, 2015.

Statement of Profit and Loss (as per Division I of

Schedule III)

The Statement of Profit and Loss of a company is the statement of financial performance
of the entity and is also known as the Income Statement. The objective of preparing this
statement is to determine the profit (or loss) of a company for a particular reporting

35
period.
Following is the pro-forma of the Statement of Profit and Loss suggested in Part II of
Division I of Schedule III.
Name of the Company:
…………………………………………………

Statement of Profit and Loss for the year ended:… (Amount in

`)

Not Figures Figures for

Particulars e forthe the Previous
No. Current Reporting
Reporting Period
Period
1 2 3 4
I Revenue from Operations XXX XXX
II Other Income XXX XXX
III Total Income (I+II) XXX XXX
IV Expenses:
Cost of Mat. Consumed XXX XXX
Purch. of Stock-In-Trade XXX XXX
Changes in Inventories of Finished Goods / Work- in- XXX XXX
progressand Stock-In-Trade
Employee Benefits Expense XXX XXX
Finance Costs XXX XXX
Depreciation and Amortization Expense XXX XXX
Other Expenses XXX XXX
Total Expenses XXX XXX
V Profit before Exceptional & Extraordinary Items XXX XXX
and Tax(III – IV)
VI Exceptional Items XXX XXX
VII Profit before Extraordinary Items and TAX (V-VI) XXX XXX
VIII Extraordinary Items XXX XXX
IX Profit before Tax (VII-VIII) XXX XXX
X Tax Expenses: XXX XXX
XI Profit /(Loss) for the period from Continuing XXX XXX
Operations (IX – X)

36
XII Profit /(Loss) from Discontinuing Operations XXX XXX
XIII Tax Expense of Discontinuing Operations XXX XXX
XIV Profit /(Loss) from Discontinuing Operations (After XXX XXX
Tax) (XII-XIII)
XV Profit / (Loss) for the period (XI + XIV) XXX XXX
XVI Earnings per Equity Share:
(1) Basic XXX XXX
(2) Diluted

Explanation of Statement of Profit & Loss

Revenue from Operation
• For Company other than a Finance Company: Revenue from Operations shall disclose
separatelyin the Notes, Revenue from –
(a) Sale of Products
(b) Sale of Services
(c) Grants or Donations received (relevant for Section 8 companies)
(d) Other Operating Revenues
Less: Excise Duty
• For Finance Company:
Revenue from Operations shall include Revenue from:
(a) Interest &
(b) Other Financial Services
Revenue under each of the above heads shall be disclosed separately by way of Notes to
Accounts to the extent applicable.

Other Income
Other Income shall be classified as –
(a) Interest Income (in case of a Company other than a Finance Company),
(b) Dividend Income,
(c) Net Gain/Loss on Sale of Investments,
(d) Other Non-Operating Income (Net of Expenses directly attributable to such income).
Note: Other operating revenues include Discount Received, Bad Debt Recovery etc.

37
Example 1:

Example 2:

Example 3:

38
Example 4:

Cost of material consumed

Cost of Materials Consumed is the first entry or line item in the 'Expenses' part of the
Statement of Profit & Loss. The term 'Materials' means raw materials and other materials used
in manufacturing of goods. 'Cost of Materials Consumed' means cost of raw materials and

39
other materials consumed in manufacturing the goods. Thus, it is, Opening Inventory (Stock) of
Materials + Purchases of Materials - Closing Inventory (Stock) of Materials.

Example 1:

Example 2:

40
Example 3:

Purchases of Stock-in-Trade
Purchase of Stock-in- Trade means goods purchased for reselling. If the company carries out
further processing on the goods purchased, they do not remain Stock-in- Trade but become
part of the Cost of Materials Consumed. For example, if a company purchases paper for resale,
it will be shown as 'Purchases of Stock-in-Trade'. But, if paper is purchased for (say)
manufacturing copies, it will be shown under 'Cost of Materials Consumed.'

Changes in Inventories of Finished Goods, Work-in-Progress

and Stock-in-Trade

41
Changes in Inventories of Finished Goods, Work-in-Progress and Stock-in-Trade means the
difterence between the Opening and Closing Inventories (Stock) of Finished Goods, Work-in-
Progress and Stock-in- Trade.
In the Note to Accounts on Changes in Inventories of Finished Goods, Work-in-Progress and
Stock-in-Trade each item of Inventory is shown separately. This item is positive when opening
inventory is more than the closing inventory and is negative when opening inventory is less
than the closing inventory. The balance under each Inventory is added to show one amount
against the entry in the Statement of Profit & Loss.

Example 1:

42
Employees Benefit Expenses
Employees Benefit Expenses mean payments made to and for the benetit of employees. For
example, wages, salaries, bonus, leave encashment, staff welfare expenses, etc., are shown in
the Note to Accounts on Employees Benefit Expenses and the total amount is shown on the
face of the Statement of Profit & Loss against Employees Benefit Expenses.
Expenses detailed in the Note to Accounts on Employees Benefit Expenses may be further
shown as direct expenses and indirect expenses. Following example (with imaginary data)
Example 1:

43
Example 2:

44
Finance Cost
Finance Costs mean costs incurred by the company on the borrowings, ve, loans taken by it. It,
therefore, includes interest paid on borrowings (such as term loans, bank overdraft and cash
credit limit) from banks and from others (such as public deposits, debentures, bonds, etc.).
Finance Costs also include expenses incurred for the borrowings such as loan processing fee,
discount on issue of debentures and premium payable on redemption ot debentures, etc., as
these expenses are incurred by the company for borrowings. However, Bank Charges are not
shown under Finance Costs but are shown under 'Other Expenses', they being an expense for
services availed from the bank.
Example 1:

45
Depreciation and Amortization Expenses
Depreciation is an expense written off to Statement of Profit & Loss, it being cost of tangible
fixed assets written off over their estimated useful life. Depreciation is the fall in value of fixed
asset due to its usage or efflux of time or obsolescence.
Amortization, like depreciation is also an expense written off to Statement of Profit & Loss,
being cost of intangible fixed assets written off over their estimated useful life.
In the Statement of Profit & Loss, total amount is shown against Depreciation and Amortization
Expenses and the details are given in the Note to Accounts on Depreciation and Amortization
Expenses.

Other Expenses
Expenses that are not shown under the above discussed six entries are shown under Other
Expenses. The detail of expenses shown under Other Expenses is given in the Note to Accounts.
It should be kept in mind that expenses shown as Other Expenses in the Note to Accounts on
Other Expenses may be shown as direct expenses and indirect expenses. For example, Carriage
Inwards and Carriage Outwards are shown as Other Expenses. Carriage Inwards is a direct
expense and Carriage Outwards is an indirect expense.

Balance Sheet (as per Division I of Schedule III)

The Balance Sheet of a company is the statement of financial affairs of the entity. The objective
of preparing this statement is to determine the financial position of a company for a particular
reporting period.
Following is the pro-forma of the Balance Sheet suggested in Part I of Division I of Schedule III.
Name of the Company:
……………………………………………….
Balance Sheet as at: …………………………………………………… (`
in……)
Particulars Not Figures as at the Figures as at the
e endof Current endof the
No. Reporting Previous
Period Reporting Period

46
 1 2 3 4
I. EQUITY AND LIABILITIES
(1) Shareholders’ Funds
(a) Share Capital
(b) Reserves & Surplus
(c) Money Received against Share Warrants
(2) Share Application money pending allotment
(3) Non-Current Liabilities
(a) Long Term Borrowings
(b) Deferred Tax Liabilities (Net)
(c) Other Long-Term Liabilities
(d) Long Term Provisions
(4) Current Liabilities
(a) Short Term Borrowings
(b) Trade Payables
(c) Other Current Liabilities
(d) Short Term Provisions
Total
II ASSETS
(1) Non-Current Assets
(a) PPE and Intangible Assets
(i) Property, Plant and Equipment
(ii) Intangible Assets
(iii) Capital WIP
(iv) Intangible Assets under Development
(b) Non-Current Investment
(c) Deferred Tax Assets (Net)
(d) Long Term Loans & Advances
(e) Other Non-Current Assets
(2) Current Assets
(a) Current Investments
(b) Inventories
(c) Trade Receivables
(d) Cash & Cash Equivalents
(e) Short Term Loans & Advances
Total

47
HEADS AND CONTENTS OF BALANCE SHEET
Balance Sheet is divided in two parts, i.e., I. Equity and Liabilities; and II. Assets.

I. EQUITY AND LIABILITIES

Equity is the liability towards the shareholders and is termed as Shareholders' Funds. It includes
Share Capital, Reserves and Surplus and Money Received against Share Warrants.
The term Liabilities means external liabilities of the company, i.e., liabilities towards outsiders.
It is further categorized and shown as Non-current Liabilities and Current Liabilities.
In between Shareholders' Funds and Non-current Liabilities, 'Share Application Money Pending
Allotment' is shown.

1. Shareholders' Funds
Shareholders' Funds include three items, i.e., (a) Share Capital; (b) Reserves and Surplus; and (c)
Money Received against Share Warrants. Let us discuss them in detail.
(a) Share Capital
Share Capital includes.
(i) Shares issued against amount to promoters as subscribers to Memorandum of
Association;
(ii) Shares issued by private placement.
(iii) Shares issued for subscription and subscribed.
(iv) Shares issued for consideration other than cash.
It includes both Equity Share Capital and Preference Share Capital.
The persons (individuals and companies) to whom shares are allotted are known as
shareholders.
Schedule III of the Companies Act, 2013 prescribes that the Balance Sheet disclose, i.e., show
authorized capital, issued capital, subscribed capital, amount called-up by the company and
paid-up by the shareholders. Details required by the schedule are given in the Note to Accounts
on Share Capital. The details prescribed to be given for share capital are:

(i) Authorized Capital or Nominal Capital or Registered Capital

It is the maximum amount of capital that a company can issue as Share Capital. It is stated in
the Memorandum of Association of the company under Capital Clause and is divided into
different classes of Share Capital such as Equity Share Capital and Preference Share Capital. It is
the maximum amount up to which a company can issue shares under each class of Share
Capital.
The amount of Authorized Capital is shown in the Note to Accounts on Share Capital for

48
information only. It is not added to the liability.
Definition of Authorised Capital [Section 2(8) of the Companies Act, 2013]
"Authorised Capital" or "Nominal Capital" or "Registered Capital" means such capital as is
authorised by the memorandum of a company to be the maximum amount of share capital of
the company.

(ii) Issued Capital

Issued Capital is that part of authorized capital which the company has issued to promoters (as
subscribers to the Memorandum of Association), by private placement and for subscription up
to the date of Balance Sheet. Shares issued under each class of Share Capital (Equity or
Preference) giving the number of shares issued and their nominal (face) value is shown in the
Note to Accounts on Share Capital.
It should be kept in mind that Issued Capital can be equal to or less than the Authorized Capital.
Also, it can be equal to or more than the Subscribed Capital.
Like Authorized Capital, the amount of Issued Capital is shown in the Note to Accounts on Share
Capital for information only. It is not added to the liability.

Definition of Issued Capital [Section 2(50) of the Companies Act, 2013]

"Issued Capital" means such capital as the company issues from time to time for subscription.

(iii) Subscribed Capital

Subscribed Capital is that part of the Issued Capital which has been subscribed. Amount
received by the company, whether in cash or kind, as Subscribed Capital is shown as Share
Capital on the face of the Balance Sheet.
Definition of Subscribed Capital [Section 2(86) of the Companies Act, 2013]
"Subscribed Capital" means such part of the capital which is for the time being subscribed by
the members of a company.
Subscribed Capital is classified, i.e., shown under the following two heads:
(a) Subscribed and fully paid-up; and
(b) Subscribed but not fully paid-up.

Subscribed and Fully Paid-up

Shares are shown as 'Subscribed and fully paid-up' when both the following conditions.
are met:
(i) the company has called the full nominal (face) value of the share; and
(ii) the company has received the amount called-up.

49
Subscribed but Not Fully Paid-up
Shares are shown as 'Subscribed but not fully paid-up' under the following two situations:
(i) When the Company has Called the full Nominal (Face) Value of the Share but has not
received the Amount Called-up.
(ii) When the Company has not Called the Full Nominal (Face) Value of the Share.

Definition of Called-up Capital [Section 2(15) of the Companies Act, 2013]

"Called-up Capital" means such part of the capital, which has been called for payment.

Definition of Paid-up Share Capital or Share Capital Paid-up [Section 2(64) of the Companies
Act, 2013]
"Paid-up Share Capital" or "Share Capital Paid-up" means such aggregate of money credited
as paid-up as is equivalent to the amount received as paid-up in respect of shares issued and
also includes any amount credited as paid-up in respect of shares of a company but does not
include any other amount received in respect of such shares, by whatever name called.

Besides the above, following information is given in the Note to Accounts on Share Capital:
1. Shares allotted for consideration other than cash (say for purchase of assets, services
taken and underwriting commission, etc.) and shares allotted as fully paid bonus shares.
This information is disclosed under Subscribed Capital.
2. Calls-in-Arrears are shown by way of deduction from the amount of Subscribed Capital
under the heading 'Subscribed but not fully paid-up. Calls-in-Arrears from directors and
officers are disclosed (given) separately.
3. Amount in Forfeited Shares Account, i.e., the amount received on forfeited shares and
not reissued is shown in the Notes to Accounts under the head 'Share Capital' as a
separate entry.

b) Reserves and Surplus

Reserve is the amount set aside, re., transferred out of profits.
(a) to meet the legal requirement such as Capital Reserve, Capital Redemption Reserve,
Debentures Redemption Reserve and Shares Options Outstanding Account.
(b) amount received being a capital receipt such as Securities Premium; or
(c) to meet any liability (say, Workmen Compensation Reserve) or to strengthen the financial
position of the company.

50
Schedule IlI of the Companies Act, 2013 prescribes the heads of Reserves and Surplus to be:
a) Capital Reserve.
b) Capital Redemption Reserve.
c) Securities Premium.
d) Debentures Redemption Reserve.
e) Revaluation Reserve.
f) Shares Options Outstanding Account.
g) Other Reserves (to specify the nature and purpose of each reserve); and
h) Surplus, i.e., Balance in Statement of Profit & Loss.

Capital Reserve
A reserve created out of the capital profit is known as Capital Reserve. It is created out of the
profit earned from transactions of capital nature and is not available for the distribution to the
shareholders as dividend.
The examples of capital profit from which Capital Reserve is created are:
• Gain (Proft) on sale of Property, Plant and Equipment;
• Gain (Profit) on sale of investment.
• Gain (Profit) on reissue of forfeited shares; and
• Gain (Profit) on purchase of an existing business.

Capital Redemption Reserve

Capital Redemption Reserve is a reserve created when a company purchases its own shares out
of free reserves or Securities Premium. Section 69(1) of the Companies Act, 2013, requires that
a sum equal to nominal (face) value of shares so purchased shall be transferred to Capital
Redemption Reserve. The reserve may be used by the company to issue fully-paid bonus
shares.
Section 55 of the Companies Act, 2013, requires that where preference shares are redeemed
out of profits which would be otherwise available for declaration of dividend a sum equal to
Nominal (Face) Value of the shares redeemed must be transferred to 'Capital Redemption
Reserve.

Securities Premium
Securities Premium is a reserve to which amount received in excess of the nominal (face) value
of securities (e.g., shares, debentures, etc.) is credited. It can be used by a company for the
purposes stated in Section 52(2) of the Companies Act, 2013.

Debentures Redemption Reserve (DRR)

51
Debentures Redemption Reserve is a reserve credited by the amount prescribed under Section
71(4) of the Companies Act, 2013 and Rule 18(7)(b) of the Companies (Share Capital and
Debentures) Rules, 2014 by a company before redemption of debentures.
It is discussed in the chapter Redemption of Debentures.

Revaluation Reserve
Revaluation Reserve is a reserve which is credited by the upward revision of the book value of
an asset. It is debited when the value of that asset is revised downward or the asset is sold or
discarded. The amount standing to the credit of Revaluation Reserve Account cannot be used
for payment of dividend or issuing bonus shares.

Shares Options Outstanding Account

Shares Options Outstanding Account is a reserve to which difference between the market value
and issue price of shares issued to employees is credited over the vesting period. For example,
the market price of the share is 75 and is to be issued to employees at 50. The difference
25 (i.e., < 75 - < 50) should be credited to this reserve.

(c) Money Received against Share Warrants

Share Warrants give the holder the right to get Equity Shares on a specified date and at a
specified value. Thus, Share Warrants will be converted into Equity Shares at a later date at a
predetermined price. Since these are to be converted into Equity Shares, these are classified or
shown as Shareholders' Funds.

2. Share Application Money Pending Allotment

The amount received by the company as shares application and against which the company will
certainly allot shares is shown against Share Application Money Pending Allotment.
This situation will arise only when the application money is received before the Balance Sheet
date and allotment is made after the Balance Sheet date, i.e., 3lst March of that year,

When is Share Application Money a Current Liability?

Share Application Money received by the company and which is refundable to the applicants,
ie, against which shares will not be allotted, is shown as 'Other Current Liabilities' under the
main head 'Current Liabilities' in the Equity and Liabilities part of the Balance Sheet.
Share Application Money becomes refundable in the following circumstances:
(d) When the Issue is Oversubscribed
The amount received as application money in excess of issued capital being refundable to the

52
applicants is classified or shown under the major head 'Current Liabilities' and sub-head Other
Current Liabilities' in the Equity and Liabilities part of the Balance Sheet.
(a) When the issue is Oversubscribed and the amount is Payable in Instalments
In this case, the amount in excess of amount retained by the company to be adjusted against
calls. It is shown as 'Other Current Liabilities' under Current Liabilities.
(in) In case the Company has not received Minimum Subscription
In such a situation, it is classified or shown under major head 'Current Liabilities', and sub-head
'Other Current Liabilities' in the Equity and Liabilities part of the Balance Sheet because the
share application money received is refundable to the applicants.

Liabilities
Liabilities are classified or shown as Non-current Liabilities and Current Liabilities in the Balance
Sheet. The two terms have been defined in Schedule Ill of the Companies Act, 2013.
The term 'Current Liabilities' is defined in Schedule III of the Companies Act, 2013 as follows:
Current Liability is that liability which Is:
(1) expected to be settled in company's normal operating cycle; or
(1) due to be settled within 12 months after the reporting date, i.e., Balance Sheet date; or (in)
held primarily for the purpose of being traded; or
(io) there is no unconditional right to defer settlement for at least 12 months after the
reporting date.
If a liability meets any of the above conditions, it is classified or shown as current liability.

The term Operating Cycle is defined in Schedule IlI of the Companies Act, 2013 as follows:
"Operating Cycle is the time between the acquisition of an asset for processing and its
realisation into Cash and Cash Equivalents.
Chart

53
Non-Current Liabilities
The term Non-current Liabilities is defined in Schedule III of the Companies Act, 2013 in a negative
manner, i.e., non-current liabilities are those liabilities which are not current liabilities.

Schedule III of the Companies Act, 2013 requires Non-current Liabilities to be classified into:

(a) Long-term Borrowings.

(b) Deferred Tax Liabilities (Net).

(c) Other Long-term Liabilities. and

(d) Long-term Provisions.

Let us now discuss each line item under non-current liabilities in detail.

(a) Long-term Borrowings

54
Borrowings mean the amount taken as loan by the company. It may be by issue of debentures, loan
from banks or private lenders, public deposits or of any other nature.

Borrowings are classified or shown as 'Long-term Borrowings' when the loan is repayable by the
company after 12 months or after the period of operating cycle from the date of Balance Sheet.
Whether a borrowing is Long-term Borrowing or Short-term Borrowing, it is determined on the date of
borrowing. Long-term Borrowings are shown under the following heads in the Note to Accounts on
Long-term Borrowings:

1. Debentures;
2. Bonds;
3. Term Loans: (a) from Banks; and (b) Other Parties; (iv) Public Deposits; and
4. Other Loans and Advances (nature to be specified).

(b) Deferred Tax Liabilities (Net)

Every year Accounting Income is compared with Taxable Income and if the difference between the two
exists which is temporary in nature, income tax on the difference amount is termed as deferred tax.

In case Accounting Income is more than the Taxable Income, it results in Deferred Tax Liability.

In case Accounting Income is less than the Taxable Income, it results in Deferred Tax Asset. The amount
of Deferred Tax Liability or Asset is adjusted to the existing balance in Deferred Tax Liabilities (Net) or
Deferred Tax Assets (Net) as the case may be.

(c) Other Long-term Liabilities

Long-term Liabilities other than Long-term Borrowings are classified or shown as Other

Long-term Liabilities under Non-current Liabilities. They are classified into:

1. Trade Payables
The term Trade Payables is defined in Schedule IlI of the Companies Act, 2013 as follows:
"Trade Payables are the amounts payable for goods purchased and services taken in the normal
course of business."
Trade payables include both sundry creditors and bills payable.
2. Others

(d) Long-term Provisions

55
Provision is the amount set aside to meet future liability, the amount of which cannot be determined
with accuracy but is estimated. Liability, on the other hand, means a liability the amount of which is
determined, i.e., the amount payable to meet the liability is known. Provision, like liability, can be long-
term (non-current) provision and short-term (current) provision.

Current Liabilities
Current Liability as defined in Schedule Ill of the Companies Act, 2013

Schedule III of the Companies Act, 2013 prescribes that Current Liabilities shall be classified into:

(a) Short-term Borrowings;

(b) Trade Payables;

(c) Other Current Liabilities; and

(d) Short-term Provisions.

Short-term borrowings
Short-term borrowings are borrowings of the company which are due for payment within 12 months or
within the period of Operating Cycle from the date of Balance Sheet. Whether a borrowing is Short-term
Borrowing is determined on the date of borrowing. Accordingly, loans that are repavable on demand or
within 12 months or within the period of Operating Cycle from the date of Balance Sheet are classified
or shown as Short-term Borrowings.

Each Short-term Borrowing is disclosed or shown in the Note to Accounts on Short-term

Borrowings. The items included are:

1. Loans repayable on demand;

2. Bank Overdraft or Cash Credit from banks;
3. Current Maturities of Long-term Debts;
4. Loans from other parties repayable within 12 months from the date of loan;
5. Deposits; and
6. Other Loans and Advances (Nature to be specified).

56
(b) Trade Payables
The term 'Trade Payables' is defined in Schedule III of the Companies Act, 2013 as the amount payable
against purchase of goods or services taken in the normal course of business and includes both sundry
creditors and bills payable. Thus, a liability on account of a transaction which is not the normal business
of the company is not shown as Trade Payables. For example, a trading company sells its fixed asset
through an agent. The agent is to be paid § 10,000 as fee. © 10,000 will be shown as Other Current
Liabilities and not as 'Trade Payables

(c) Other Current Liabilities

All current liabilities that are not short-term borrowings or trade payables are classified or shown as
Other Current Liabilities. These include:

(i) Interest Accrued but not Due on Borrowings

Interest accrued but not due means interest is provided in the books of account but it has not become
due for payment. For example, interest is payable half-yearly in June and December. If the company
closes its books on 31st March, it will provide interest for the quarter Januarv to March following the
Accrual Concept of accounting. But the interest will become due for payment on 30th June along with
the interest for the quarter April to June. The interest for the quarter January to March will be classified
as 'Interest accrued but not dué' (it) Interest Accrued and Due on Borrowings

Interest accrued and due means interest is provided in the books of account and is due for payment. In
the above example, interest for half-year June to December is provided in the books of account but has
not been paid. It is 'Interest accrued and due' and shown as Other Current Liabilities. (ini) Income
Received in Advance

Income received in advance means advance received by the company against which sale is yet to be
made and/or services are yet to be rendered. Since the income has not been earned, i.e., sales made or
services rendered, it is shown as 'Other Current Liabilities' and when it is earned it is transferred to
income. (iv) Unpaid Dividends

Unpaid dividends are dividends declared but they remain unclaimed by the shareholders.

(U) Excess application money refundable and interest accrued thereon.

(vi) Unpaid matured deposits and interest accrued thereon.

(wit) Unpaid matured debentures and interest accrued thereon. (viii Calls-in-Advance.

(ix) Other Payables (Nature to be Specified)

57
Other payables include any other liability that is due for payment within 12 months or within the period
of Operating Cycle from the date of Balance Sheet. Examples are:

Outstanding Expenses, Provident Fund Payable, ESI Payable, etc.

(d) Short-term Provisions

Short-term Provisions are the provisions for liabilities which are likely to be paid within 12 months or
within the period of Operating Cycle from the date of Balance Sheet. Each item of short-term provision
is disclosed or shown separately in the Note to Accounts on Short-term Provisions, which are totalled
and a single amount is shown against Short-term Provisions in the Balance Sheet.

Short-term Provisions are classified into:

1. Provision for Employees Benefits;

2. Provision for Expenses;
3. Provision for Tax; and
4. Other Provisions.

Liability and Provision

The two terms 'Liability' and 'Provision' differ from each other as follows:

Liability: The term 'Liability' is used where the amount of the liability is known. For example, salary for
March, 2023 of 1,00,000 is payable. It is classified or shown as Outstanding Salary (Liability) because the
liability and the amount is known Liability.

Provision: The term Provision' is used where the liability is known to exist, but the amount is not known.
It is estimated with substantial accuracy. Provision, if for providing as expense, is a charge against profit
and is transferred to the debit of Statement of Profit & Loss.

Examples of Provision: Provision for Doubtful Debts, Provision for Discount on Debtors, Provision for
Depreciation, Provision for Warranties, Provision for Repairs, Provision for Expenses (say Electricity),
Provision for Tax, etc.

58
 II. ASSETS
Assets, like liabilities, are also divided into non-current assets and current assets.

Non-current assets is defined in Schedule III of the Companies Act, 2013 as "Non-current assets are
those assets which are not current assets."

Since non-current assets are defined in a negative manner, it is important to understand the meaning of
current assets.

Current Assets are defined in Schedule III of the Companies Act, 2013 as follows:

Current Assets are those assets which are:

1. expected to be realized in or intended for sale or consumption in the company's normal

operating cycle; or
2. held primarily for the purpose of trading; or
3. expected to be realized within 12 months from the reporting date, i.e., Balance Sheet date; or
4. Cash and Cash Equivalents unless they are restricted from being exchanged or used to settle a
liability for at least 12 months after the reporting date, i.e., Balance Sheet date.

Operating Cycle

Operating Cycle is defined in Schedule III of the Companies Act, 2013 as follows:

Operating Cycle is the time between the acquisition of assets for processing and their realisation in
Cash or Cash Equivalents. If operating cycle cannot be identified, it is assumed to be of 12 months."

Non-Current Assets
Non-current Assets are classified into following five major heads:

(a) Property, Plant and Equipment and Intangible Assets.

(b) Non-current Investments.

(c) Deferred Tax Assets (Net).

(d) Long-term Loans and Advances; and

(e) Other Non-Current Assets.

Let us discuss them in detail.

59
Property, Plant and Equipment and Intangible Assets
Propertv, Plant and Equipment and Intangible Assets are those assets which are held by a company not
for the purpose of sale but for the purpose to increase earnings of the business. They are used for a long
time to earn profit. These assets are categorised into:

1. Property, Plant and Equipment.

2. Intangible Assets.
3. Capital Work-in-Progress; and
4. Intangible Assets under Development.

1. Property, Plant and Equipment are the assets which have physical existence, i.e., they can be
seen and touched. Examples are: Land, Building, Machinery, Furniture and Fixtures, Computers,
Vehicles, Office Equipment, etc.
2. Intangible Assets are the assets which do not have physical existence and, thus, cannot be seen
and touched. Examples of Intangible Assets are:Goodwill, Brands/Trademarks, Computer
Software,Mastheads and Publishing Titles, Mining Rights, Copyrights, Patents, Licences and
Franchise, etc.
3. Capital Work-in-Progress means (fixed) tangible assets under construction. (iv) Intangible Assets
under Development means (fixed) intangible assets like patents, intellectual property rights,
etc., under development.

Non-Current Investments
Non-current Investments are investments which are held not with the purpose to resell but to retain
them. Non-current Investments are further classified into "Trade Investments" and "Other Investments"
Trade Investments are investments made by a company in shares or debentures of another company to
promote its own trade and business. Other Investments are those investments which are not trade
investments.

Investments are classified or shown under the following heads:

1. Investments in Property.
2. Investments in Equity Instruments.
3. Investments in Preference Shares.
4. Investments in Government or Trust Securities.
5. Investments in Debentures or Bonds.
6. Investments in Mutual Funds.

60
 7. Investments in Partnership Firms; and\
8. Other Non-current Investments (Nature to be specified).

Deferred Tax Assets (Net) and Deferred Tax Liabilities (Net)

Deferred Tax Liabilities (Net) appears under Non-current Liabilities in the Equitv and Liabilities part of
the Balance Sheet and Deferred Tax Assets (Net) appears under Non-current Assets in the Assets part of
the Balance Sheet. The two terms are interrelated as balance in Deferred Tax Liabilities (Net) in one year
may get converted into Deferred Tax Assets (Net) in the next year and vice versa.

Long-term Loans and Advances

Long-term loans and advances are those loans and advances that are expected to be received back in
cash or kind, ie., in the form of an asset after 12 months or after the period of Operating Cycle from the
date of Balance Sheet. These are classified into:

(i) Capital Advances

Advances given for acquiring property, plant and equipment and intangible assets are known as Capital
Advances. Normally, such advances are not received back in cash but are received in the form of an
asset. It means capital advances get converted into asset of the company.

(ii) Other Loans and Advances (Nature to be specified)

Long-term loans and advances, other than those classified or shown under Capital Advances are
classified or shown as Other Loans and Advances. Other loans and advances are shown according to its
nature. Examples of such loans and advances are long-term loans to employees and long-term advances
to suppliers, etc.

Other Non-Current Assets

All other non-current assets that do not fall into any of the above classifications (categories) are
classified or shown as Other Non current Assets. They are classified into:

• Security Deposits
Security deposits that are given for a long period, i.e., for a period of more than 12 months or
after the period of Operating Cycle from the date of Balance Sheet of the business are classified
or shown as other non-current asset. Example is security deposit for electricity.
• Long-term Trade Receivables
If the amount of trade receivable is receivable after 12 months from the date of Balance Sheet
or after the period of Operating Cycle, whichever is later, it is classified i.e., shown as Long-term

61
 Trade Receivable.
• Others
Besides trade receivables there may be other assets such as unamortised expenses/losses,
insurance claim receivable or amount due for asset sold, etc. Such assets are classified or shown
under Other Non-current Assets.
• Insurance Claim Receivable

Current Assets
Current Assets are classified or shown under following six heads:

(a) Current Investments.

(b) Inventories.

(c) Trade Receivables.

(d) Cash and Cash Equivalents.

(e) Short-term Loans and Advances; and

(f) Other Current Assets.

Let us discuss them in detail.

a) Current Investments
It refer to those investments which are held to be converted into cash within a short period, ie.,
within 12 months from the date of purchase of investment.
These are to be classified into:
1. Investments in Equity Instruments
2. Investments in Preference Shares.
3. Investments in Government or Trust Securities
4. Investments in Debentures or Bonds.
5. Investments in Mutual Funds; and
6. Investments in Partnership Firms, etc.

b) Inventories (stock)

62
 Inventories held for the purpose of trade in the ordinary course of business, i.e., for
manufacturing or trading of goods are classified or shown as current assets because they are
held with the purpose to convert them into Cash and Cash Equivalents within a short period. It
includes Raw Materials; Work-in-Progress; Finished Goods; Stock-in-Trade (for goods purchased
for trading); Stores and Spares and Loose Tools, etc.

c)Trade Receivables
Trade Receivables means amounts receivable against sale of goods or services rendered by the
company in the normal course of business. They are classified or shown as current assets if they
are receivable within a period of 12 months or within the period of operating cycle from the
date of Balance Sheet. Trade Receivables includes both Debtors and Bills Receivable, Provision
for Doubtful Debts:

(d) Cash and Cash Equivalents

Schedule IlI requires that Cash and Cash Equivalents be classified or shown as follows:

1. Balances with banks

2. Cheques, drafts on hand
3. Cash in Hand
4. Others.
5. Earmarked balances with banks (for example, Unpaid Dividend).
6. Balance with banks held as Margin Money; and
7. Bank Deposits with more than 12 months maturity.

(e) Short-term Loans and Advances

Short-term Loans and Advances are those loans and advances which are expected to be realised within
12 months or within the period of operating cycle from the date of Balance Sheet, if operating cycle is
more.

(f) Other Current Assets

All other current assets that do not fall in any of the above classifications or categories under Current
Assets are classified or shown as Other Current Assets. Examples of Other Current Assets are prepaid
expenses, accrued income, dividend receivable, advance taxes, etc.

63
Study Material Question
Illustration 1
(Reporting Authorised, Issued, Subscribed, Called up and Paid up Capital including
Forfeited Shares) Authorised Capital:
Equity Share 1,00,000 Shares @ `100 each = ` 1,00,00,000. Preference Share Capital: 15%
Redeemable Preference Shares, 50,000 Shares @ `100 each = `50,00,000. 18%,
Convertible Preference Shares, 30,000 shares @ `100 each = `30,00,000.
Issued Capital: Equity Share 30,000 Shares @ `100 each, fully paid up = `30,00,000; 19,800
Equity Shares of
`100 each, `80 called up and paid up = `15,84,000. Amount received on 200 shares
forfeited for non-payment of allotment and first call of `30 and `40 each, final call was
not made on those shares. Amount payable on application
`10 per share.
Preference Share Capital: 15% Redeemable Preference Shares, 10,000 Shares @ `100 each =
`10,00,000. 18%, Convertible Preference Shares, 20,000 shares @ `100 each = `20,00,000
How will this be shown in the Workings/Schedules, assuming first year of operation?

Illustration 2
While preparing the Balance Sheet as on 31.03.2021, the Accountant of ABC Ltd. is
confused regarding classification of following Trade Payables into current and non-
current.
Sl. Amount due (`) Due from To be settled on
No.
1 3,10,000 01.04.20 18.05.2021
20
2 1,80,000 01.06.20 15.09.2022

64
 20
3 40,000 01.08.20 15.07.2022
20
4 15,000 01.01.20 30.04.2022
21
5 2,30,000 06.03.20 05.07.2022
21
6 1,08,000 15.03.20 31.12.2021
21
The normal operating cycle of the company is 15 months. Advice the Accountant on classification
with reason.

Illustration 3
X Ltd., a manufacturer-cum trader, provides you the following details for the financial
year ended on 31.03.2021.
Item of Balance on 01.04.2020 Balance on Purchases during the
Inventory (`) 31.03.2021 (`) year (`)
Raw Materials 2,00,000 2,50,000 5,00,000
WIP 1,20,400 1,50,200 --
Finished 5,10,000 3,50,000 --
Goods
Stock-in-trade 59,000 1,25,000 --
You are required to draft an extract of the Statement of Profit and Loss and also show
the relevant Notes to Accounts.

Illustration 4
The following are the extracts from the Trial Balance of Y Ltd. on March 31, 2021: (figures in `)

Provision for current tax 4,00,000 Tax deducted at source (2020- 20,000
(2019-20) 21)
Advance tax paid (2019-20) 3,60,000 Advance tax paid (2020-21) 2,00,000
The assessment for the year 2019-20 was finalized during the year 2020-21. The total tax

65
liability for that year was fixed at `4,40,000 and the net amount payable for the year
2019-20 has not yet been paid. The net profit before tax for the year 2020-21 amounted
to `8,00,000. Balance of Profit & Loss A/c at the end of 2019-20 was `4,00,000. Assume
corporate income tax @ 35% (inclusive of surcharge and education cess) You are
required to draft:
(a) Extract of Statement of Profit and Loss for the year ended March 31,2019 along
with the relevant Notes;
and
(b) Extract of Balance Sheet as on March 31, 2019 along with the relevant Notes.

Illustration 5

The following information has been extracted from the books of account of Hero Ltd. as at 31st
March, 2021:

Particula Dr. (` ’000) Cr. (` ’000)

rs
Administration Expenses 480
Cash at Bank and on Hand 228
Cash Received on Sale of Fittings 10
Long Term Loan 70
Investments 200
Depreciation on Fixtures, Fittings, Tools and Equipment (1st 260
April, 2020)
Distribution Costs 102
Factory Closure Costs 60
Fixtures, Fittings, Tools and Equipment at Cost 680
Profit & Loss Balance (at 1st April, 2020) 80
Purchase of Equipment 120
Purchases of Goods for Resale 1710
Sales (net of Excise Duty) 3,000
Share Capital (1,00,000 shares of `10 each fully paid) 1,000
Stock (at 1st April, 2020) 140

66
 Trade Creditors 80
Trade Debtors 780
4,500 4,500

Additional Information:
1. The stock at 31st March, 2021 (valued at the lower of cost or net realizable
value) was estimated to be
worth `
2,00,000.
2. Fixtures, fittings, tools and equipment all related to administration.
Depreciation is charged at a rate of 20% per annum on cost. A full year’s
depreciation is charged in the year of acquisition, but no depreciation is
charged in the year of disposal.
3. During the year to 31st March, 2021, the Company purchased
equipment of `1,20,000. It also sold some fittings (which had originally
cost ` 60,000) for `10,000 and for which depreciation of `30,000 had been
set aside.
4. The average Income tax for the Company is 50%. Factory closure cost is
to be presumed as an allowable expenditure for Income tax purpose.
5. The company proposes to pay a dividend of 20% per Equity Share. Profits
transferred to reserves `30,000.
Prepare Hero Ltd.’s Statement of Profit and Loss for the year to 31st March, 2021 and
balance Sheet as at that date in accordance with the Companies Act, 2013 as per Division
I of schedule III along with the Notes on Accounts containing only the significant
accounting policies.

Illustration 6
The following balances are extracted from the books of Supreme Ltd., a real estate company, on
31st March, 2021:
(` ’000)

Particula Dr. Cr.

67
 rs
Sales 13,800
Purchases of materials 6,090
Share capital fully paid 500
Land purchased in the year as stock 365
Leasehold premises 210
Creditors 2,315
Debtors 3,675
Directors’ salaries 195
Wages 555
Work in progress on 01.04.2020 1,050
Sub-contractors’ cost 4,470
Equipment, Fixtures and Fittings at cost on 01.04.2020 1,320
Stock on 01.04.2020 295
Profit and Loss Account, Credit Balance on 01.04.2020 640
Secured Loan 560
Bank Overdraft 525

Interest on Loan and Overdraft 110

Depreciation on Equipment on 01.04.2020 820
Administration Expenses 735
Office Salaries 90
19,160 19,160
You also obtain the following information:
a. On 31st March, 2021, stock on hand including the land acquired during the
year, is valued at `7,10,000. Work- in-progress at that date is valued at
`7,00,000.
b. On 1st October, 2021 the company moved to new premises. The premises
are on a 12 years lease and the lease premium paid amounted to `2,10,000.
The company used sub-contract labour of `2,00,000 and materials at cost of
`1,90,000 in the refurbishment of the premises. These are to be considered
as part of the cost of leasehold premises.
c. A review of the debtors reveals specific doubtful debts of `1,75,000 and the

68
 directors wish to provide for these together with a general provision based
on 2% of the balance.
d. Depreciation on equipment, fixtures and fittings is provided at 15% on the written
down value.
e. Supreme Ltd. sued Shallow Ltd. for supplying defective materials which has
been written off as valueless. The Directors are confident that Shallow Ltd.
will agree for a settlement of `2,50,000.
f. The directors propose a dividend of 25%.
g. `1,00,000 is to be provided as audit fee.
h. The company will provide 10% of the pre-tax profit as bonus to employees
in the accounts before charging the bonus.
i. Income tax to be
provided at 50% of the
profits. You are required:
a. to prepare the company’s financial statements for the year ended 31st
March, 2021 as near as possible to proper form of company final accounts;
and
b. to prepare a set of Notes to accounts including significant accounting policies.
Notes: Workings should form part of
your answer. Previous year figures can
be ignored.
Figures are to be rounded off to nearest thousands.

Illustration 7
PQR Ltd. was registered with a nominal capital of `20,00,000 divided into shares of `100
each. The following Trial Balance is extracted from the books on 31st March, 2021:

Particulars ` Particulars `
Buildings 11,60,000 Sales 20,80,000
Machinery 4,00,000 Outstanding Expenses 8,000
Closing Stock 3,60,000 Provision for Doubtful Debts (1-4-2020) 12,000

69
Loose Tools 92,000 Equity Share Capital 8,00,000
Purchases (Adjusted) 8,40,000 General Reserve 1,60,000
Salaries 2,40,000 Profit and Loss A/c (31.03.2020) 1,00,000
Directors' Fees 40,000 Creditors 3,68,000
Rent 1,04,000 Provision for depreciation:
Depreciation 80,000 On Building 2,00,000
Bad Debts 24,000 On Machinery 2,20,000
Investment 4,80,000 14% Debentures 8,00,000
Interest accrued on 8,000 Interest on Debentures accrued but not 56,000
investment due
Debenture Interest 1,12,000 Interest on Investments 48,000
Advance Tax 2,40,000 Unclaimed dividend 20,000
Sundry expenses 72,000

70
 Debtors 5,00,000
Bank 1,20,000
48,72,000 48,72,00
0
You are required to prepare Statement of Profit and Loss for the year ending 31st March, 2021 and
Balance sheet as at that date after taking into consideration the following information:
(i) Closing stock is more than opening stock by `3,20,000.
(ii) Provide to doubtful debts @ 4% on Debtors.
(iii) Make a provision for income tax @30%.
(iv) Depreciation expense included depreciation of `32,000 on Building and that of `48,000 on
Machinery.
(v) Transfer to General Reserve @ 10%.
(vi) The directors proposed a dividend @ 25%.
(vii)Bills Discounted but not yet matured ` 40,000.

Illustration 8
XYZ Pharmaceuticals is a pharma start-up established in 2017. The company has registered significant
growth over the last two years. To further expand its business, the company wants to mop up additional
capital. Motivated by the recent success of a number of IPOs, the BOD has decided to go for a public issue
rather than accessing institutional loan.
In order to apply for the IPO to SEBI, the company requires to submit, along with all other documents, its
restated financial statements in prescribed format. The company, therefore, has hired you as an expert to
assist its accountant in preparing the financial statements so that the statements conform, in all respect, to
the relevant legislation and can be used to prepare restated financial statements for the purpose of filing
for an IPO.
You have been given the following information for the financial year 2020-2021.
Particulars Dr. (`) Cr. (`)
Stock on 1st April, 2020 1,60,000 -
Purchases & Sales 5,00,000 8,00,000
Purchase returns - 10,000
Carriage inward 2,100 -
Wages 50,000 -
Salaries 20,000 -
Discount Received - 8,000
Furniture & Fittings 40,000 -
Rent 10,000 -
Sundry expenses 16,500 -
Balance of Profit & Loss (1.4.2020) - 50,000
Share Capital (Subscribed & Paid-up; `10 each) - 2,00,000
Interim Dividend 16,000 -
Debtors & Creditors 52,400 31,000

71
 Plant & Machinery 2,46,000 -
General Reserve - 20,000
Cash at bank 8,000 -
Bills Receivable & Bills Payable 6,000 8,000
Total 11,27,000 11,27,000
Additional information:
(i) Stock on March 31, 2021 was valued at ` 98,000
(ii) Depreciate: Plant & Machinery @ 15%, Furniture & Fitting @ 10%.
(iii) On 31st March, 2021 outstanding rent amounted to ` 800 while outstanding salaries totalled ` 1,200.

(iv) Make a provision for doubtful debts @ 5%.

(v) Provision for tax is to be made @ 30%.

(vi) The directors proposed a dividend @ 10% for the year ended March 31, 2021 excluding interim dividend
and
decided to transfer ` 10,000 to General Reserve.
a. You are required to prepare the Notes to Accounts to support preparation of the Statement of Profit
and Loss for the year ended on 31.03.2021.
b. You are required to prepare the Statement of Profit and Loss for the year ended on 31.03.2021.
c. You are required to prepare the Notes to Accounts to support preparation of the Balance Sheet as on
31.03.2021.
d. You are required to prepare the Balance Sheet as on 31.03.2021.

Comprehensive Numerical Problems

1. Elixir Ltd. provides the following Trial Balance as on 31st March 2021:

Particulars Dr. Cr.

Balanc Balan
es (`) ces (`)
Equity Share Capital: 300000 shares of ` 10 each fully paid 30,00,000
12% Bank Loan 2,00,000
Furniture 2,25,000
Machinery 7,50,000
Building 12,50,000
Non-current Investment 2,00,000
Sales 48,00,000
Sales Return 4,00,000
Interest Received on Investment 20,000
Interest on Bank Loan 20,000
Purchase 33,20,000

72
 Purchase Returns 4,20,000
Opening Stock 2,00,000
Discount 6,250
Carriage on Goods Sold 1,39,000
Rent and Taxes 60,000
Trade Receivables 12,00,000
Trade Payables 80,000
Advertisement 1,20,000
Bad Debt 10,000
Salaries 4,00,750
Audit fees 27,000
Contribution to P. F 60,000
Cash at Bank and in hand 1,32,000
Total 85,20,000 85,20,000
Additional Information:
(i) Closing Stock as on 31st March 2021 was ` 2,12,500
(ii) Depreciation Rates: Furniture 10%; Machinery 20% and Building 10%
(iii) Outstanding salaries as on 31st march 2021 was ` 62250

(iv) Trade receivables include a sum of `25,000 due from Mr. B. Reddy and trade payables include
`15,000 due to him.
(v) Create a provision for doubtful debt @ 5% on trade receivables.
(vi) Provide for income tax ` 80,000

Prepare a Statement of Profit and Loss for the year ended on 31st March 2021 and a Balance Sheet
as on that date as per the format provided in Division I of Schedule III.
[Answer: Balance Sheet Total ` 35,97,750]
2. ABC Ltd provides the following Trial Balance as on 31st March 2021.

Particulars Dr. Cr.

Balanc Balance
es (`) s (`)
Equity Share Capital: 350000 shares of `10 each fully paid 35,00,000
10% Debentures 3,00,000
Motor Van 4,00,000
Machinery 20,00,000
Land and Building 12,00,000
12% Long Term Govt. Securities 2,00,000
Sales 60,00,000
Sales Return 3,00,000
Interest on Debenture 22,500
Purchase 36,00,000
Purchase Returns 4,00,000

73
 Opening Stock 3,00,000
Discount 7,500
Carriage Outward 1,50,000
Rent and Rates 50,000
Income from Govt. Securities 24,000
Trade Receivables 10,00,000
Trade Payables 2,00,000
Advertisement 1,50,000
Bad Debt 20,000
Salaries 6,72,000
Misc. Expenditure 30,000
Contribution to P.F and Gratuity Funds 1,00,000
Cash at Bank and in hand 2,22,000
Total 1,04,24,000 1,04,24,000
Additional Information:
(i) Closing Stock as on 31st March 2021 was `3,50,000
(ii) Depreciation Rates: Motor Vehicle 10%, Machinery 20% and Land & Building 5%
(iii) Misc. expenditure includes `20,000 as audit fees.

(iv) Interest on debenture is payable quarterly and the last quarter’s interest is yet to be paid.

(v) Trade receivables include a sum of `25,000 due from Mr. X who has become insolvent and only
25 paisa in a rupee is expected to be recoverable from him.
(vi) Create a provision for doubtful debt @ 2% on trade receivables.

(vii)Provide for income tax `1,50,000

Prepare a Statement of Profit and Loss for the year ended on 31st March 2021 and a Balance Sheet
as on that date as per the format provided in Division I of Schedule III.
[Answer: Balance Sheet Total `48,04,500]
3. PQR Ltd. was registered with a nominal capital of `20,00,000 divided into shares of `100 each. The
following Trial Balance is extracted from the books on 31st March, 2021:

Particulars ` Particulars `
Buildings 11,60,000 Sales 20,80,000
Machinery 4,00,000 Outstanding Expenses 8,000
Closing Stock 3,60,000 Provision for Doubtful Debts (1-4- 12,000
2020)
Loose Tools 92,000 Equity Share Capital 8,00,000
Purchases (Adjusted) 8,40,000 General Reserve 1,60,000
Salaries 2,40,000 Profit and Loss A/c (1-4-2020) 1,00,000
Directors' Fees 40,000 Creditors 3,68,000
Rent 1,04,000 Provision for depreciation:
Depreciation 80,000 On Building 2,00,000

74
 Bad Debts 24,000 On Machinery 2,20,000
Investment 4,80,000 14% Debentures 8,00,000
Interest accrued on 8,000 Interest on Debentures accrued but 56,000
investment not due
Debenture Interest 1,12,000 Interest on Investments 48,000
Advance Tax 2,40,000 Unclaimed dividend 20,000
Sundry expenses 72,000
Debtors 5,00,000
Bank 1,20,000
48,72,000 48,72,000
You are required to prepare statement of Profit and Loss for the year ending 31st March, 2017 and
Balance sheet as at that date after taking into consideration the following information:
(i) Closing stock is more than opening stock by `3,20,000.
(ii) Provide to doubtful debts @ 4% on Debtors.
(iii) Make a provision for income tax @30%.
(iv) Depreciation expense included depreciation of `32,000 on Building and that of `48,000 on Machinery.
(v) The directors declared a dividend @ 25% and transfer to General Reserve @ 10%.
(vi) Bills Discounted but not yet matured `40,000.
[Answer: Balance Sheet total ` 29,20,000]

4. The following is the trial balance of Alpha Ltd. as on 31.03.2021:

Particulars ` Particulars `
Stock in trade on 01.04.17 1,50,000 Purchase returns 20,000
Purchases 4,90,000 Sales 6,80,000
Salaries 60,000 Discount received 6,000
Freight, carriage etc. 1,900 Balance of Profit and Loss (Cr.) 30,000
Furniture 34,000 Share capital (`10) 2,00,000
Contribution to P.F 10,000 Trade payables 49,000
Rent and Rates 8,000 General reserve 31,000
Stationary 3,800
Repairs 4,000
Insurance 6,000
Misc. expenses 300
Interim dividend paid 18,000
Staff welfare expenses 5,000
Plant and machinery 58,000
Cash at bank 92,400
Patents 9,600
Trade receivables 65,000
10,16,000 10,16,000
You are required to prepare statement of Profit and Loss for the year ending 31st March, 2021 and

75
 Balance Sheet as at that date after taking into consideration the following information:
(i) Closing stock as at 31.03.2021 is `1,76,000.
(ii) Make a provision for income tax @ 40%.
(iii) Depreciate plant and machinery @ 15%, furniture @ 10% and patents @ 5%.

(iv) Outstanding rent `1,600 and outstanding salaries `1,800.

(v) The directors recommended a dividend @ 15% after transfer to General Reserve `4,000.
(vi) Provide `1,020 for doubtful debts.

The authorized capital of the company is `4,00,000 divided into 40,000 equity shares of `10 each of
which
20000 shares have been issued and fully paid up.
[Answer: Balance Sheet Total `4,21,400]

🖸 Unsolved Cases
1. As per the present regulations in India, financial statements of companies must strictly adhere to the
format prescribed in the relevant legislation for being acceptable to regulators as well as to various
stakeholders.
PQR Ltd. registered as a company on 30.06.2018 and commenced operation with effect from
01.04.2019. The authorized capital of the company is 10,00,000 equity shares of `10 each. The paid-
up capital of the company is, however, 6,00,000 equity shares of `10 each.
On 10.04.2021, the BOD has decided to undertake an expansion programme for which the capital
expenditure is estimated at `15,00,000. The BOD has decided to apply for an institutional loan to
arrange the funds. The lender however, requires the financial statements of the company to be
submitted in prescribed format along with the loan application.
The directors, being novice in this respect, have asked your help as an expert in drafting the financial
statements of the company for the financial year 2020-21.
In this respect, the following information is available.

Particulars Dr. Balances Cr. Balances

(`) (`)
Equity Share Capital: 6,00,000 shares of `10 each fully 60,00,000
paid
12% Bank Loan 4,00,000
Furniture 4,50,000
Machinery 15,00,000
Building 25,00,000
Non-current Investment 4,00,000
Sales 96,00,000
Sales Return 8,00,000
Interest Received on Investment 40,000
Interest on Bank Loan 40,000
Purchase 66,40,000

76
 Purchase Returns 8,40,000
Opening Stock 4,00,000
Discount 12,500
Carriage on Goods Sold 2,78,000
Rent and Taxes 1,20,000
Trade Receivables 24,00,000
Trade Payables 1,60,000
Advertisement 2,40,000
Bad Debt 20,000
Salaries 8,01,500
Audit fees 54,000
Contribution to P.F. 1,20,000
Cash at Bank and in hand 2,64,000
Total 1,70,40,000 1,70,40,000
Additional Information:
(i) Closing Stock as on 31st March 2021 was `4,25,000
(ii) Depreciation Rates: Furniture 10%, Machinery 20% and Building 10%
(iii) Outstanding salaries as on 31st march 2021 was `1,24,500

(iv) Trade receivables include a sum of `50,000 due from Mr. B. Reddy and trade payables include ` 30,000
due to him.
(v) Create a provision for doubtful debt @ 5% on trade receivables.
(vi) Provide for income tax `1,60,000

a. You are required to prepare the Notes to Accounts (Employee Benefit Expenses, Finance Cost,
Other Expenses and Depreciation) to support preparation of the Statement of Profit and Loss for
the year ended on 31.03.2021.
b. You are required to prepare the Statement of Profit and Loss for the year ended on 31.03.2021.
c. You are required to prepare the Notes to Accounts (Fixed Assets and Trade Receivable) to support
preparation of the Balance Sheet as on 31.03.2021.
d. You are required to prepare the Balance Sheet as on 31.03.2021.
[Answer: Balance Sheet Total `71,95,500]

77
Chapter = Cash Flow Statement

Introduction
1. Cash Flow Statement is a statement that shows the cash flows, ie., inflow and outflow of Cash and
Cash Equivalents during the accounting period (usually between two Balance Sheet dates) from
operating, investing and financing activities.
2. In other words, Cash Flow Statement is a statement that gives information of change in Cash and Cash
Equivalents of an enterprise during the accounting period under Operating, Investing and Financing
Activities.
3. Transactions that increase Cash and Cash Equivalents are inflows of Cash and Cash Equivalents and
transactions that decrease it are outflows of Cash and Cash Equivalents.
4. Cash and Cash Equivalents includes Cash on hand, Bank Balance, Demand Deposits with Banks,
Marketable Securities, etc. Current Investments are taken as Marketable Securities, unless stated to
be Non-Marketable Securities. Hence, are included in Cash and Cash Equivalents.
5. Cash Flow Statement is prepared as per Accounting Standard-3 (Revised) [AS-3 (Revised)], Cash Flow
Statement. The accounting standard prescribes that Cash Flow Statement be prepared either by:
(i) Direct Method ; or
(ii) Indirect Method;
Showing cash flow under three heads, namely:
1. Cash Flow from Operating Activities;
2. Cash Flow from Investing Activities; and
3. Cash Flow from Financing Activities.
Cash Flow Statement by Indirect Method is prepared from the financial statements, i.e., Balance Sheet
and Statement of Profit & Loss of two years and additional information

Objective of Cash Flow Statement

The objectives or purposes for which Cash Flow Statement is prepared are:
1. To determine the sources (receipts) of Cash and Cash Equivalents under Operating, Investing and
Financing Activities of the enterprise.
2. To determine applications (payments) of Cash and Cash Equivalents under Operating, Investing and
Financing Activities of the enterprise.
3. To determine net change in Cash and Cash Equivalents. It is the difference between sources (receipts)
and applications (payments) under Operating, Investing and Financing Activities between the dates of
two Balance Sheets.

Classification of Cash Flow Statement

78
Accounting Standard-3 (Revised) prescribes that the changes resulting in inflows and Outflows of Cash and
Cash Equivalents be classified (shown) under three activities, ie, Operating, Investing and Financing. These are
discussed below:

1. Operating Activities
Operating Activities are the principal revenue producing activities of the enterprise and other activities that
are not Investing or Financing Activities.
Cash Flow from Operating Activities being the principal revenue producing activity of the enterprise, generally
results from the business transactions and events that determine net profit or loss for the year.
It is therefore, important to identify the business activities, i.e., Operating Activities of the enterprise and
activities that are not Investing & Financing Activities to determine Cash Flow from Operating Activities.
Examples of Cash Flow from Operating Activities are:

For Non-financial Companies

(a) Cash receipts from sale of goods and/or rendering services;
(b) Cash receipts from royalties, fees and commission, etc.;
(c) Cash receipts from Trade Receivables (i.e., Debtors and Bills Receivable);
(d) Cash payment for purchase of goods and/or availing services;
(e) Cash payment to Trade Payables (i.e., Creditors and Bills Payable);
(f) Cash payment of wages, salaries and other payments to employees;
(8) Cash receipts of premium and payment of claims (for an Insurance Company); and
(h) Cash payment of and refund of income tax unless these are identified with Investing Of Financing
Activities.

For Financial Companies

a) Payment for purchase of securities for sale;
b) Payment of interest on loans;
c) Receipts from sale of securities held for sale;
d) Dividend received on securities held for sale;
e) Interest received on loans given:
f) Payment of salaries, bonus, etc. to employees; and
g) Payment of and refund of income tax unless these are identified with Investing or Financing Activities.
Expenses/payments that are not directly Operating Activities but are shown as Operating Activities because
they are neither Investing nor Financing Activities:
h) Preliminary Expenses.
i) Profit/Loss on Sale of Marketable Securities.
Net effect of Cash Flow from Operating Activities is shown in Cash Flow Statement as Cash Flow from (or Used
in) Operating Activities.

79
Illustration 1.
Identify which of the following transactions are classified or shown as Operating Activity by non-financial
companies:
1. Cash received from sale of goods.
2. Cash paid for purchase of goods.
3. Payment of salaries and wages.
4. Payment of interest on loan.
5. Repayment of loan.
6. Purchase of machinery against payment.
7. Dividend paid.
8. Sale of car in cash.
9. Commission received.
10. Amount (Cash/Cheques) received from trade receivables.
Illustration 2.
Identify which of the following transactions are classified or shown as Operating Activis by a financial
company:
1. Payment of salaries and wages;
2. Payment of interest on loans taken;
3. Receipt of interest on loans given;
4. Purchase of shares for trading;
5. Purchase of shares as investment;
6. Purchase of shares on behalf of customers;
7. Sale of shares on behalf of customers;
8. Issue of Debentures.

Illustration 3.
State a transaction that is classified or shown as an Operating Activity by both non-financing companies and
financing companies.

2. Investing Activities
Investing Activities are the acquisition and disposal of the Long-term Assets and Other Investments, not
included in cash equivalents.
These activities include transactions involving purchase and sale of the Long-term Assets, which are not held
for sale such as plant and machinery, land and building, investments, etc.
Investments include investments other than current investments, they being marketable securities. It includes
investment made in long-term investments.

IMPORTANT NOTE

80
In the question, if the term used is 'Investment under Current Assets, it is to be included in Cash Equivalent.

Examples of Cash Flow from Investing Activities are:

1. Payments for purchase of Property, Plant and Equipment (fixed assets and intangible assets).
2. Receipts from sale (disposal) of Property, Plant and Equipment (fixed assets and intangible assets).
3. Payments for purchase (acquisition) of securities, i.e., shares, warrants, debentures, bonds or debt
instruments of other enterprises as investment.
4. Receipts from sale (disposal) of securities, i.e., shares, warrants, debentures, bonds or debt
instruments of other enterprises held as investments.
5. Advances and loans to parties (other than advances and loans by a financial enterprise).
6. Receipts from repayments of advances and loans to parties (other than advances and loans by
financial enterprise).
Illustration 4.
Identify out of the following transactions that are classified or shown as Investing Activity by (a) Non-finance
companies; and (b) Finance companies:
(i) Proceeds from sale of fixed asset.
(ii) Payment for purchase of Stock-in-Trade.
(iii) Repayment of loan taken.
(iv) Debentures purchased as investment.
(v) Loan advanced.
(vi) Purchase of Patents.

3. Financing Activities
Financing Activities are the activities which result in change in size and composition of owner's capital
(including Preference Share Capital in the case of a company) and borrowings of the enterprise from other
sources.
Thus, increase in share capital (both equity and preference), redemption of preference shares, issue of
debentures, increase in borrowings (short-term and long-term), repayment of borrowings (short-term and
long-term) and redemption of debentures, etc, are Financing Activity.
Examples of Cash Flow from Financing Activities are:
(a) Proceeds from the issue of shares.
(b) Proceeds from the Issue of Debentures, Loans, Bonds and other Short-term Borrowings.
(c) Payment for Buy-back of Equity Shares.
(d) Repayments of the amounts borrowed including redemption of debentures.
(e) Payments of dividends both on Equity and Preference Shares.
(f) Payments of Interest on Debentures and Loans (Short-term and Long-term).
(g) Increase or decrease in Bank Overdraft and Cash Credit.

Illustration 5.
Identify out of the following transactions that are shown as Financing Activity:

81
 (1) Repayment of Loan taken.
(2) Proceeds from Issue of Shares.
(3) Debentures subscribed by the company.
(4) Redemption of Preference Shares.
(5) Interest paid on Borrowings.
(6) Dividend paid.
(7) Increase in Bank Overdraft or Cash Credit.
(8) Issue of bonus shares

Non-cash Transactions
Non-cash Transactions are those transactions which do not involve cash and, therefore, flow (inflow or
outflow) of Cash and Cash Equivalent does not take place. For example, Depreciation, Issue of Equity Shares
or Debentures for consideration other than cash, etc.

Illustration 6.
Identify the following transactions with (1) Operating Activities, (2) Investing Activities, (3) Financing Activities,
and (4) Cash and Cash Equivalents:
1. Cash Sales;
2. Cash Purchase;
3. Rent Paid;
4. Cash-in-Hand;
5. Income Tax Paid;
6. Office Expenses;
7. Balance at Bank;
8. Sale of Machines by a dealer of Machines;
9. Issue of Debentures;
10. Dividend Paid;
11. Cash Paid against Trade Payables;
12. Purchase of Machines;
13. Income Tax Refund Received;
14. Issue of Share Capital;
15. Sale of Patents;
16. Purchase of Marketable Securities;
17. Purchase of Goodwill;
18. Short-term Deposits in Banks;
19. Purchase of Securities (as Investment);
20. Cash Received from Debtors.

Illustration 7.

82
Identify which of the following transactions are (1) Operating Activities, (2) Investing Activities, (3) Financing
Activities, and (4) Cash and Cash Equivalents:
1. Marketing Expenses;
2. Purchase of Investments;
3. Cash Received from Trade Receivables;
4. Buy-back of Equity Shares;
5. Repayment of a long-term Loan;
6. Commission Received;
7. Redemption of Debentures;
8. Selling and Distribution Expenses;
9. Bank Overdraft/Cash Credit.
10. Sale of Marketable Securities;

Illustration 8.
Identify which of the following transactions are (1) Operating Activities, (2) Investing Activities, (3) Financing
Activities, and (4) Cash and Cash Equivalents:
1. Sale of Investments;
2. Dividend received on Shares;
3. Interest received on Investments;
4. Rent received by a Real Estate Company;
5. Rent received by a Manufacturing Company;
6. Interest paid on Debentures or Long-term Loans;
7. Marketable Securities.
8. Proceeds from Shares issued; and
9. Interest paid on Bank Overdraft.

Illustration 9.
Identify Financing Activities out of the following transactions:
1. Purchase of securities of a company;
2. Brokerage paid for the above purchases;
3. Sale of securities of a company;
4. Dividend and interest received on securities;
5. Dividend paid to the shareholders;
6. Interest paid on borrowings;
7. Loans and advances made; and
8. Receipt of loans and advances made.

Illustration 10.
Classify the following transactions as Operating Activities for: (1) Finance Enterprise, and (2) Non-finance
Enterprise:

83
 (a) Purchase of securities of a company for resale;
(b) Brokerage paid for the above purchases;
(c) Sale of securities of a company;
(d) Dividend and interest received on securities;
(e) Dividend paid to shareholders;
(f) Interest paid on borrowings;
(g) Loans and advances made; and
(h) Receipt of loans and advances made.

Illustration 11.
State which of the following would result in inflow/ outflow /no flow of Cash and Cash Equivalent
(1) Sale of fixed assets Book value 50,000) at a loss of 75,000;
(2) Purchase of Inventory for cash;
(3) Purchase of fixed assets against issue of shares;
(4) Cash received from debtors 10,000;
(5) Issue of fully paid bonus shares;
(6) Sale of marketable securities for cash at par;
(7) Declaration of final dividend § 25,000;
(8) Writing off bad debts against the provision for doubtful debts;
(9) Declaration of Interim Dividend;
(10) Sale of Current Investments;
(11) Increase in Bank Overdraft;
(12) Decrease in Cash Credit; and
(13) Charging Depreciation on Machinery

Extraordinary Items
Extraordinary items are incomes and expenses that arise from events or transactions that are clearly distinct
from the ordinary business activities of the enterprise and, therefore, are not expected to recur frequently or
regularly. Examples of Extraordinary items are:
Operating Activities - Preliminary expenses, Compensation paid to employees under Voluntary Retirement
Scheme.
Investing Activities - Claim received against damage of fixed assets say because of earthquake.
Financing Activities - Payment for buy-back of Shares.

PREPARATION OF CASH FLOW STATEMENT

Steps involved in the preparation of Cash Flow Statement are as follows:
Step 1: Calculate Cash Flow from Operating Activities, as is discussed earlier in the chapter.
Step 2: Calculate Cash Flow from Investing Activities, as is discussed earlier in the chapter.

84
Step 3: Calculate Cash Flow from Financing Activities, as is discussed earlier in the chapter.
Step 4: Calculate Net Increase or Decrease in Cash and Cash Equivalents
(Step 4 = Step 1 + Step 2 + Step 3).
Step 5: Calculate Cash and Cash Equivalents in the beginning of the Year.
Step 6: Resulting amount (Step 6 = Step 4 + Step 5) should be the balance of Cash and Cash Equivalents at the
end of the year matching with the balance as per Balance Sheet.

Format of Cash Flow Statement

Particulars Amount
I. Cash Flow from Operating Activities
A. Net Profit before Tax and Extraordinary Items (as per Working Note) Adjustment for
Non-cash and Non-operating Items
B. Add: Items to be Added
• Depreciation
• Goodwill, Patents and Trademarks Amortized
• Interest on Bank Overdraft/Cash Credit
• Interest on Borrowings (Short-term and Long-term) and Debentures
• Underwriting Commission/Share Issue Expenses/ Discount on Issue of
Debentures Written off
• Loss on Sale of Fixed Assets
• Premium on Redemption of Preference Shares/Debentures Written off
• Increase in Provision for Doubtful Debts*
C. Less: Items to be Deducted
• Interest Income
• Dividend Income
• Rental Income
• Gain (Profit) on Sale of Fixed Assets
• Decrease in Provision for Doubtful Debts*
D. Operating Profit before Working Capital Changes (A + B - C)
E. Add: Decrease in Current Assets and Increase in Current Liabilities
• Decrease in Inventories (Stock)
• Decrease in Trade Receivables (Debtors and Bills Receivable)
• Decrease in Accrued Incomes
• Decrease in Prepaid Expenses
• Increase in Trade Payables (Creditors and Bills Payable)
• Increase in Outstanding Expenses
• Increase in Advance Incomes
F. Less: Increase in Current Assets and Decrease in Current Liabilities
• Increase in Inventories (Stock)
• Increase in Trade Receivables (Debtors and Bills Receivable)
• Increase in Accrued Incomes Increase in Prepaid Expenses
• Decrease in Trade Payables (Creditors and Bills Payable)
• Decrease in Outstanding Expenses
• Decrease in Advance Incomes

85
 G. Cash Generated from Operations (D + E - F)
Less: Income Tax Paid (Net of Tax Refund)
H. Cash Flow before Extraordinary Items
• Extraordinary Items (+/-)
Cash Flow from (or Used in) Operating Activities

Cash Flow from Investing Activities

• Proceeds from Sale of Fixed Assets
• Proceeds from Sale of Investments (Other than Current Investments (to be
included in Cash and Cash Equivalents) and Marketable Securities)
• Proceeds from Sale of Intangible Assets
• Interest and Dividend received (For Non-financial Companies only)
• Rent Received
• Payment for Purchase of Fixed Assets
• Payment for Purchase of Investments (Other than Marketable Securities)
• Payment for Purchase of Intangible Assets like Goodwill
• Extraordinary Items (e.g., Insurance Claim on Machinery against Fire) (+/-)
Cash Flow from (or Used in) Investing Activities

Cash Flow from Financing Activities

• Proceeds from Issue of Shares and Debentures Proceeds from Other Long-
term Borrowings
• Increase/Decrease in Bank Overdraft and Cash Credit
• Payment of Final Dividend (on both Equity and Preference Share Capital)
• Payment of Interim Dividend
• Payment of Interest on Debentures and Loans (Short-term and Long-term)
• Repayment of Loans
• Redemption of Debentures/Preference Shares
• Payment of Share Issue Expenses or Underwriting Commission
• Payment for Buy-back of Shares as Extraordinary Activity
Cash Flow from (or Used in) Financing Activities

Net Increase/Decrease in Cash and Cash Equivalents (I + II + III)

Add: Cash and Cash Equivalents in the beginning of the year
• Cash on Hand
• Cash at Bank
• Short-term Deposits
• Current Investments
Marketable Securities

Cash and Cash Equivalents in the end of the year

86
COMPUTATION OF CASH FLOW FROM DIFFERENT ACTIVITIES
Cash Flow Statement is prepared to show inflow and outflow of Cash and Cash Equivalents under the
following activities:
1. Cash Flow from Operating Activities;
2. Cash Flow from Investing Activities; and
3. Cash Flow from Financing Activities.

87
CASH FLOW FROM OPERATING ACTIVITIES
Operating Activities are
1. The principal revenue producing activities of the enterprise, and
2. Other activities that are not investing or financing activities.
Thus, Cash Flow from Operating Activities arises from principal revenue producing activities of the enterprise
that determine the net profit or loss; and from those activities that are not investing and financing activities.
Examples of Cash Flow from Operating Activities are: cash receipts from sale of goods and services, cash
purchase of goods and services and Employees Benefits Expenses, Gain (Profit) on sale of Marketable
Securities, Preliminary Expenses, etc.
Cash Flow from Operating Activities may be calculated by either:
1. Direct Method; or
2. Indirect Method.
Indirect Method of Calculating Cash Flow from Operating Activity
Under Indirect Method, Cash Flow from Operating Activity is calculated from the financial Statements, i.e.,
Statement of Profit & Loss and Balance Sheet as follows:

Step 1: Determine Net Profit before Tax and Extraordinary Items.

Determining Net Profit before Tax and Extraordinary Items is the starting point for calculating Cash Flow from
Operating Activities. It may be taken from the Statement of Profit & Loss or may be calculated from the
balances of Surplus, i.e., Balance in Statement of Profit & Loss.

(a) If the starting point is Profit as per the Statement of Profit & Loss:

(b) If the Starting point is Surplus, i.e., Balance in Statement of Profit & Loss:

88
Note: Working of Net Profit before Tax and Extraordinary Items (Activities) may be given by way of Working
Note (as is given in the format) or in Cash Flow Statement itself.

Concept of Dividend
Dividend of two types,
a. Interim Dividend and
b. Proposed or Final Dividend.

Interim Dividend
1. It is declared (approved) by the Board of Directors of the company. Stating it differently, Interim
Dividend is not declared by the Shareholders.
2. Also it is not paid on the Preference Shares since rate of dividend on preference shares is decided at
the time of its issue.

Proposed or Final Dividend

1. Final Dividend is proposed by the company at the end of the year and is approved by the shareholders.
It is termed as Proposed or Final Dividend.
2. Proposed or Final Dividend on both Equity Shares and Preference Shares ore paid after it is declared
(approved) by the Shareholders in their Annual General Meeting (AGM). AGM for the year is held after
the end of the financial year, i.e., in the next financial year.

89
 3. AS 4 (Revised), Contingencies and Events Occurring After the Balance Sheet Date prescribes that
Proposed or Final Dividend is not to be accounted in the books of accounts unless it is declared
(approved) by the Shareholders. It is to be shown as Contingent Liability in the Notes to Accounts of
the year to which it relates.
4. Dividend is an appropriation of profit and is deducted from balance in Surplus, ie., Balance in
Statement of Profit & Loss in the year it is declared (approved) by the shareholders.

Dividend on Preference Shares

Dividend is paid on the paid-up Share Capital. It is paid on the Preference Shares if dividend (Interim or Final)
is paid on the Equity Shares.

Payment of Declared Dividend

The amount of Proposed or Final Dividend, as have been declared (approved) by the shareholders is
transferred to a special or separate bank account within 5 Days of declaration and is paid within 30 Days of
being declared.

Reasons for Adding or Deducting Above Items

(1) Dividend Paid:
(a) Interim Dividend
Interim Dividend is declared (approved) by the Board. It is added to determine Net Profit before Tax and
Extraordinary Items because it is a Financing Activity and payment thereof is shown as outflow of cash under
Financing Activity. In brief,
a. Add Interim Dividend to the current year's profit under Cash Flow from Operating Activities; and
b. Show it as Cash Used (Outflow) in Cash Flow from Financing Activities of the current year.
(b) Proposed or Final Dividend
In the current year, Proposed (Final) Dividend of previous year will be declared (approved) by the
shareholders in their Annual General Meeting because the meeting will be held after the end of the financial
year. For example, the company has proposed final dividend of 10,00,000 for the year ended 31st March,
2022. Annual General Meeting to approve the final dividend will be held in the year ending 31st March, 2023
after which it will be accounted in the books of Account. Thus Proposed Dividend for the year ended
31stMarch , 2022 will be approved by the shareholder and also accounted in the year 31 st March, 2023
Illustration 12.
Following is the extract from the balance sheet of KBC ltd.

Equity and Liabilities 31st March 202331st March

2022
Surplus i.e., Balance in Statement of Profit & Loss 8,00,000 5,00,000
Dividend Payable 30,000 -
Dividend Proposed (Final) for the years ended 31st March, 2022 and 2023 were 3,00,000 and 73,50,000
respectively.
Prepare the Note to show Net Profit before Tax and Extraordinary Items for the year ended 31st March, 2023.

90
Illustration 13.
Following is the extract from the balance sheet of KBC ltd.

Equity and Liabilities 31st March 2023 31st March

2022
Equity Share Capital 5,00,000 5,00,000
10% Redeemable Preference Capital 5,00,000 5,00,000
Surplus i.e., Balance in Statement of Profit & Loss 4,50,000 2,50,000
Dividend Payable 20,000 -

Additional Information:
1. Proposed (Final) Dividend on Equity Share for the year ended 31 st March 2022 and 2023 were 150,000
& 100,000 respectively.
2. An Interim Dividend of 50,000 on Equity share was paid on 31st December 2022.

Illustration 14.
Following is the extract from the balance sheet of KBC ltd.

Equity and Liabilities 31st March 2023 31st March

2022
Equity Share Capital 5,00,000 5,00,000
9% Preference Share Capital 10,00,000 10,00,000
Surplus i.e., Balance in Statement of Profit & Loss 25,00,000 7,00,000

Additional Information:
1. An Interim Dividend of 100,000 on was paid on 1st Januray 2023 on equity share,

Illustration 15.
From the following information for the year ended 31st March, 2023, calculate Net Profit before Tax and
Extraordinary Items:
a) Surplus, i.e., Balance in Statement of Profit & Loss (Opening) = (2,00,000)
b) Surplus, i.e., Balance in Statement of Profit & Loss (Closing) = 5,40,000
c) Proposed Dividend for the year ended 31st March, 2023 = 3,15,000
d) Proposed Dividend for the year ended 31st March, 2022 = 2,10,000
e) Transfer to Workmen Compensation Reserve = 1,50,000
f) Provision for Tax made during the Current Year = 2,30,000

Illustration 16.

91
From the following information for the year ended 31st March, 2023, calculate Net Profit before Tax and
Extraordinary Items:
a) Surplus, i.e., Balance in Statement of Profit & Loss (Opening) = 200,000
b) Surplus, i.e., Balance in Statement of Profit & Loss (Closing) = 672,000
c) Proposed Dividend for the year ended 31st March, 2023 = 144,000
d) Proposed Dividend for the year ended 31st March, 2022 = 180,000
e) Transfer to Workmen Compensation Reserve = 200,000
f) Provision for Tax made during the Current Year = 200,000
g) Income tax Paid = 216,000
Illustration 17.
From the following information, calculate Net Profit before Tax and Extraordinary Items:

Particulars Amount
a) Surplus, i.e., Balance in Statement of Profit & Loss (Opening) 50,000
b) Surplus, i.e., Balance in Statement of Profit & Loss (Closing) 1,18,000
c) Dividend paid (Proposed dividend for the previous year) 36,000
d) Interim Dividend paid during the year 45,000
e) Transfer to Reserve 50,000
f) Provision for Tax made during the current year 75,000
g) Refund of Tax 1,500
h) Loss of Inventory due to Fire 1,00,000
i) Insurance Claim Received for above Loss 50,000

Illustration 18.
From the following information, calculate Net Profit before Tax and Extraordinary Items:

Particulars Amount
a) Surplus, i.e., Balance in Statement of Profit & Loss 4,36,000
b) Proposed dividend for the year 90,000
c) Interim Dividend paid during the year 1,62,000
d) Transfer to Reserve 50,000
e) Provision for Tax made during the current year 1,550,000
f) Loss of Inventory due to Fire 2,00,000
g) Insurance Claim Received for above Loss 1,00,000

Step-2 Determine Operating Profit before working capital changes.

Illustration 19.
From the following information, calculate Operating Profit before Working Capital Changes:

Particulars Amount
a) Net Profit before Tax and Extraordinary Items 2,23,500
b) Depreciation 42,000
c) Interest on Borrowings 8,400

92
 d) Goodwill Amortized 9,300
e) Loss on Sale of Machinery 9,000
f) Premium on Redemption of Debentures 3,000
g) Interest and Dividend Received on Investments 13,800
h) Profit on Sale of Investments 6,000

Step-3 Calculate Cash Generated from Operating Activities.

Step-4 Calculate Cash flow from operating Activity before Extraordinary items.

Step-5 Calculate Cash flow from operating Activity.

Illustration 19.
From the following information, calculate Operating Profit before Working Capital Changes:

Particulars 31st March 31st March 2022

2023
a) Surplus, i.e., Balance in Statement of Profit & Loss 3,00,000 2,00,000
b) Bills Receivable 1,80,000 1,40,000
c) Accumulated Depreciation 3,20,000 3,00,000
d) Outstanding Rent 40,000 16,000
e) Prepaid Insurance 12,000 14,000
f) Goodwill 1,60,000 2,00,000
g) Inventories (Stock 1,80,000 1,40,000

Illustration 20.
From the following information, calculate Operating Profit before Working Capital Changes:

Particulars 31st March 31st March 2022

2023
a) Surplus, i.e., Balance in Statement of Profit & Loss 1,00,000 1,20,000
b) Trade Receivable 50,000 62,000
c) Outstanding Rent 24,000 42,000
d) Goodwill 80,000 76,000
e) Prepaid Insurance 8,000 4,000
f) Trade Payable 26,000 38,000

Illustration 20.

93
From the following information, calculate Operating Profit before Working Capital Changes:

Particulars 31st March 31st March 2022

2023
a) General Reserve 1,50,000 1,00,000
b) Surplus, i.e., Balance in Statement of Profit & Loss 70,000 (60,000)
c) 10% Debentures 3,10,000 2,10,000
d) Trade Payables 11,75,000 75,000
e) Cash and Cash Equivalents 1,30,000 90,000
f) Goodwill 80.000 1,00,000
g) Machinery 4,60,000 5,00,000
h) 10% Non-current Investments 1,60,000 60,000
i) Inventories 2,45,000 60,000
j) Provision for Doubtful Debts 1,50,000 1,00,000
k) Trade Receivables 21,00,000 10,00,000

CASH FLOW FROM INVESTING ACTIVITIES

Thus, cash inflow and outflow relating to the fixed assets, shares and debt instruments of
other enterprises, advances and loans to third parties and also their repayments are classified
or shown under Investing Activities in the Cash Flow Statement.
Cash Flow from Investing Activities is shown separately because it shows the extent to which
investments have been made of resources for generating revenue and cash flows in future.
Cash Flow from Investing Activities is ascertained by analysing the changes in Fixed Assets
(Property, Plant and Equipment and Intangible Assets) and Long-term Investments (i.e., Non-
current Assets) in the beginning and at the end of the year.
In case, amount say of purchase or sale of fixed asset and depreciation are not given, the
required amounts may be determined by preparing Fixed Asset Account with available
information.
CALCULATION OF CASH FLOW FROM INVESTING ACTIVITIES
Particulars Amount
(A) Cash Flow from Investing Activities
• Proceeds from Sale of Tangible or Intangible Fixed Assets xxxxx
• Proceeds from Sale of Investment (Other than Marketable Securities) xxxxx
• Loans and Advances (Short-term or Long-term) repayment received xxxxx
• Receipt of Income from Investments (Non-Current and Current Investments other xxxxx
than Marketable Securities) xxxxx
• Rent received from Property held as Investment xxxxx
• Dividend Received on Shares xxxxx
• Interest Received on Debentures xxxxx

(B) Cash Used in Investing Activities xxxxx

94
 • Payment for Purchase of Tangible or Intangible Fixed Asset xxxxx
• Payment for Purchase of Investment (Non-Current and Current xxxxx
• Investments other than Marketable Securities) xxxxx
• Loans and Advances (Given)
(C) Cash Flow from (if 'A' is more than 'B') or Used in (if 'B' is more than 'A) Investing
Activities

Case 1: When Fixed Asset is shown at Written Down Value, i.e., cost less depreciation.
Asset Account is credited with the amount of depreciation for the year, sale proceeds of the asset and loss, if
any. On the other hand, gain (profit) is debited to it. Balance is the written down online of the asset, which is
also called the book value.
Illustration 21.
Global Ltd. has Machinery written down value of which on 1st April, 2022 was © 8,60,000 and on 31st March,
2023 was * 9,50,000. Depreciation for the year was © 40,000. In the beginning of the year, an item of
machinery was sold for § 25,000 which had a written down value of © 20,000. Calculate Cash Flow from
Investing Activities.

Case 2: When Fixed Assets are shown at Original Cost and Accumulated Depreciation Account (Provision for
Depreciation Account) is maintained.
In this case, (in contrast to the above case), depreciation is not credited to the Asset Account. Depreciation for
the period is debited to the Depreciation Account (transferred to the Statement of Profit & Loss) and credited
to Accumulated Depreciation Account or Provision for Depreciation Account. In the Balance Sheet, asset is
shown at its original cost less accumulated depreciation. In such cases, accounts for fixed asset and
accumulated depreciation or provision for depreciation are prepared. Depreciation for the year can be
determined from Accumulated Depreciation Account/Provision for Depreciation Account.
Illustration 22.
From the following information, calculate Cash Flow from Investing Activities:

Particulars Closing Bal. Opening Bal.

Machinery (At cost) 4,20,000 4,00,000
Accumulated Depreciation 1,10,000 1,00,000
Patents 1,60,000 2,80,000
Additional Information:
(1) During the year, a machine costing 7 40,000 with its accumulated depreciation of 24,000 was sold for
20,000.
(2) Patents written off were 7 40.000 and some patents were sold at a profit of 7 20,000.

Illustration 23.
From the following information, calculate Cash Flow from Investing Activities:

95
 Particulars Closing Bal. Opening Bal.
10% Investment 5,00,000 2,50,000
Fixed Assets 11,90,000 8,75,000
Additional Information:
1. Half of the investments held in the beginning of the year were sold at 10% gain (profit).
2. Depreciation on Fixed Assets was 1,00,000 for the year.
3. Interest received on investments 35,000.
4. Dividend received on investments 25,000.
Illustration 24.
From the following information, calculate Cash Flow from Investing Activities:

Particulars Purchase Sale

Investment 1,80,000 1,00,000
Goodwill 2,00,000 -
Machinery 4,40,000 1,50,000
Patents - 1,00,000

Interest received on Debentures held as an investment § 16,000.

Dividend received on Shares held as an investment § 20,000.
A plot of land was purchased out of surplus funds for investment purposes and was let out for commercial
use. Rent received was 80,000.

CASH FLOW FROM FINANCING ACTIVITIES

1. Financing Activities of an enterprise are those activities which result in change in size and composition
of owners' capital (including equity and preference share capital in case of Company) and Borrowings
of the enterprise.

2. Cash Flow from Financing Activities is separately shown because it is useful in estimating claims on
cash flows by lenders of funds in future.

3. Cash Flow from Financing Activities is determined by analysing the change in Equity and Preference
Share Capital, Debentures and other borrowings (Both short-term and long-term borrowings).

4. Dividend paid (in all enterprises) and interest paid (in the case of non-financing enterprises) are also
included in Financing Activities.

5. It is important to note that an increase in share capital due to bonus issue of shares is not shown in
Cash Flow Statement, because the company does not receive cash in this case, but it is the
capitalization of reserves. Similarly, conversion of debentures into new debentures or shares is not
shown in Cash Flow Statement.

96
 6. When shares or debentures are issued at a premium, Cash Flow Statement shows total cash received
from the issue (i.e., Nominal (Face) Value of Shares + Securities Premium).

7. Increase in underwriting commission means payment of underwriting commission in raising Share

Capital/Debentures. It is Cash Outflow in Financing Activities.

CALCULATION OF CASH FLOW FROM FINANCING ACTIVITIES

Particulars Amount
(A) Cash Flow from Investing Activities
• Proceeds from Issue of Shares (including premium) xxxxx
• Proceeds from Issue of Debentures (including Premium but excluding Discount) xxxxx
• Loans Received [Short-term (Bank Overdraft and Cash Credit) and Long-term] xxxxx
xxxxx
xxxxx
(B) Cash Used in Investing Activities
xxxxx
• Payment for Redemption of Preference Shares xxxxx
• Payment for Redemption of Debentures xxxxx
• Payment for buy-back of Equity Shares (Including Premium)
• Repayment of Loans [Short-term (Bank Overdraft and Cash Credit) and Long-
term] xxxxx
• Interim Dividend paid during the year xxxxx
• Final Dividend paid during the year xxxxx
• Interest paid on Debentures xxxxx
• Interest on Loans (Short-term and Long-term)
(C) Cash Flow from (if 'A' is more than 'B') or Used in (if 'B' is more than 'A) Financing
Activities

Illustration 25.
From the following information, calculate Cash Flow from Investing Activities:

Particulars Purchase Sale

Equity share capital 5,00,000 4,00,000
Long term Borrowing-10% Debenture 1,00,000 1,00,000
Short term Borrowing-10% Debenture - 50,000
Securities Premium 50,000 40,000
Bank Overdraft 2,00,000 1,50,000

Additional Information:
1. Interest Paid on debenture 10,000
2. Interest on Bank Overdraft 15,000 and previous year 10,000

Illustration 25.
From the following information, calculate Cash Flow from Investing Activities:

97
 Particulars Purchase Sale
Equity share capital 9,00,000 7,00,000
12% Preference capital 3,00,000 5,00,000
Securities Premium 1,40,000 1,00,000
12% Debenture 4,00,000 3,00,000

Additional Information:
1. Interim dividend on Equity Shares at the end of current year was paid © 15%.
2. Dividend on Preference Shares was paid.
3. Preference Shares were redeemed at a premium of 5% on 31st March, 2023.
4. New shares and debentures were issued on the last date of current year.
Determine Cash Flow from Financing Activities.

Share Issue Expenses and Underwriting Commission Paid

Share Issue Expenses

Share Issue Expenses are shown as outflow under Financing Activity, it being an expense on issue of Share
Capital.
Underwriting Commission
Underwriting is an agreement whereby the underwriters undertake to subscribe unsubscribed shares and/or
debentures offered to the public for subscription. The underwriters are paid commission for undertaking to
subscribe the unsubscribed shares and/or debentures. The underwriters charge commission which is
calculated on the issue price of shares and debentures. Payment of underwriting commission is shown as an
Outflow of Cash under Financing Activities.
It is to be noted that Share Issue Expenses and Underwriting Commission are written of in the Financial
Statements from Securities Premium, Capital Reserve or from Statement of Profit & Loss in that order.
Illustration 26.
From the following information, calculate Cash Flow from Investing Activities:

Particulars Purchase Sale

Equity share capital 20,00,000 15,00,000
12% Preference capital - 5,00,000
14% Debenture 2,50,000 -

Additional Information:
1. Equity Shares were issued at a premium of 20%.
2. 12% Preference Shares were redeemed at par.
3. 14% Debentures were issued at a discount of 10%.
4. Interim dividend paid on Equity Shares © 1,50,000.
5. Interest paid on 14% Debentures ™ 35,000.

98
 6. Underwriting Commission on Equity Shares © 20,000 was paid and was written off from Securities
Premium.
7. Dividend paid on Preference Shares £ 60,000.

Study Material Question

Illustration 1
M Ltd. had a cash balance of `1,50,000 as on 30.09.2021. On 15.10.2021, M Ltd. used the cash balance
to purchase a short-term bank deposit with a maturity of three months. How should this be shown in
the statement of cash flow to be prepared for the quarter ended 31.12.2021?

Illustration 2
Classify the following cash receipts and payments of a furniture company into cash from operating, investing
and
financing activities:
a. Receipt from sale of furniture
b. Purchases of furniture from various suppliers
c. Wages paid
d. Advertisement expenses paid
e. Credit sales of furniture
f. Misc. charges received from customers for repairs of furniture
g. Warranty claims received from the suppliers
h. Loss due to decrease in market value of the closing stock of furniture
i. Payment to suppliers of furniture
j. Depreciation on furniture of sales showrooms
k. Interest paid on bank loan
l. Profit on sale of equipment, in exchange of new equipment
m. Advance received from customers
n. GST paid
o. Equity dividend paid for the current financial year

Illustration 3
Classify the following transactions into cash flow from operating, investing and financing activities in respect of
a
pharmaceutical company:

99
 a. Issued equity shares
b. Bonus shares issued
c. Right shares issued
d. Purchased 90% shares of subsidiary company
e. Dividend received from subsidiaries
f. Dividend received from investment in other companies
g. Payment of license fees
h. Royalty received from the goods patented
i. Rent received from the letting out of free space
j. Interest received on loans to Y Ltd.
k. Preference Dividend paid
l. Interest paid on security deposits
m. Acquired the assets of a company through issue of equity shares
n. Purchased goodwill
o. Interim dividends paid
p. Sale of investment in subsidiary

Illustration 4
On 01.01.2022, P Ltd., an Indian company, bought goods from USA for $1000 to be sold within India. The
exchange rate on that date was `76 = 1$. On 31.03.2022, the exchange rate moved to `78 = 1 $. How
will you report the above in the Cash Flow Statement?

Illustration 5
X Ltd. provides you the following information of its cash inflow and outflow for the financial year 2021-22:
a. Dividend paid to equity and preference shareholders `50,000
b. Interest paid `10,000
c. Interest received on loan ` 20,000
d. Dividend received from Y Ltd. `15,000
How will you classify the above in the Cash Flow Statement of X Ltd. if –
(i) X Ltd. is a financial institution and
(ii) X Ltd. is a manufacturing concern.

Illustration 6
B Ltd., a manufacturing concern, invested `3,00,000 in a five-year bond with an effective interest rate
of 10% for 4 years. It received `4,40,000 on maturity. During the four years it recognised the interest
income based on the effective interest rate in its income statement. How will you treat the transactions

100
over four years and on maturity?
Illustration 7
A Ltd. paid an advance tax amounting to `3,65,000 out of which `15,000 is relating to a short-term
capital gain on sale of securities. How will A Ltd. report the payment of advance tax in its Cash Flow
Statement?

Illustration 9:
Name of the Company: MZ Ltd.
Statement of Profit and Loss for the year ended 31st March, 2021

Not As at 31st As at 31st

Particula
e March, March,
rs
No. 2021 2020
IREVENUE FROM OPERATION 10,000
II
OTHER INCOME 1,200
III
TOTAL INCOME (I+II) 11,200
IVEXPENSES:
(a) Cost of material consumed 5,500
(b) Purchase of products for sale
(c) changes in inventories of finished goods, work-in- (1,000)
progress and
products for sale
(d) Employees cost/ benefits expenses 2,500
(e) Finance cost 800
(f) Depreciation and amortization expenses 500
(g) Product development expenses/Engineering -
expenses
(h) Other expenses 2,000
TOTAL EXPENSES 10,300
V PROFIT BEFORE EXCEPTIONAL AND EXTRAORDINARY 900
ITEMS AND TAX ( III-IV)
VI EXCEPTIONAL ITEMS --

VII PROFIT BEFORE EXTRAORDINARY ITEMS AND TAX (V-VI) 900

VIII EXTRAORDINARY ITEMS --

IX PROFIT BEFORE TAX from Continuing Operations (VII – 900

VIII)
X Tax expenses:

(1) Current Tax 100

(2) deferred tax -

101
 XI PROFIT FOR THE YEAR FROM CONTINUING OPERATION 800
(IX -X)
XII Profit (loss) from discontinued operations -

XIII Tax expenses from discontinued operations -

XIV Profit(loss) from discontinued operations (XII-XIII) -

XV PROFIT (LOSS) FOR THE PERIOD (XI + XIV) 800

Balance brought forward from previous year 550

Profit available for appropriation 1350

Appropriation:

Dividend paid 450

Transfer to General Reserve 250

Distribution Tax -

Total 700

Balance carried forward 650

XVI Earning per equity share:

(1) Basic

(2) Diluted

Name of the Company: MZ Ltd.

Balance Sheet as at 31st March, 2021
Ref Particula Note As at 31st March, As at 31st March,
No. rs No. 2020 2021
I EQUITY AND LIABILITIES
1 Shareholders’ Fund
(a) Equity Share capital 3,000 4,000
(b) Reserve and Surplus 1300 1,650
2 Liabilities
Non-current liabilities
(a) Long-term borrowings 4,000 6,000
Current Liabilities
(a) Trade payables 4,650 4,200
(b) Short-term provisions 300 250
Total 13,250 16,100
II ASSETS
1 Non-current assets

102
 (a) Property, Plant and 5,000 6,500
Equipment
(b) Non-current investments 1,000 1,500
(c) Long-term loans and 150 100
advances
2 Current assets
(a) Inventories 5,000 5,500
(b) Trade receivables 1,500 2,000
(c) Cash and cash equivalents 600 500
Total 13,250 16,100
Note: Relevant items of Assets/ Liabilities are reflected in Balance Sheet and Schedule III. Hence sub-
item not having any value for the given illustration is not shown/ represented in Balance Sheet.
Notes on Accounts (` in lakhs)

1. Revenue from operation As at 31st As at 31st

March,2020 March,2021
Sales (net of Excise Duty) 10,000
Tota 10,000
l

2. Other Income As at 31st As at 31st

March,2020 March,2021
Income from Investments 1,200
Tota 1,200
l

3. Raw Material Consumed As at 31st As at 31st

March,2020 March,2021
Opening Stock of Raw Material 2,000
Add: Purchase of Raw Material 5,000
7,000
Less: Closing Stock of Raw Material 1,500
Tota 5,500
l

4. Changes in stock of Finished Goods As at 31st As at 31st

March,2020 March,2021
Closing stock 4,000
Less: Opening Stock 3,000
Tota 1,000
l

103
 5. Employees Benefits As at 31st As at 31st
March,2020 March,2021
Salaries and Contribution to Retirement Benefit 2,500
Schemes
Tota 2,500
l

6. Other Equity (Reserve & Surplus) As at 31st March,2020 As at 31st

March,2021
General Reserve 750 1,000
Profit & Loss A/c 550 650
Tota 1300 1650
l

7. Long Term Borrowings As at 31st As at 31st

March,2020 March,2021
Secured Loan 4,000 6,000
Tota 4,000 6,000
l

8. PPE As at 31st As at 31st

March,2020 March,2021
Gross Block 6,000 8,000
Less: Accumulated Depreciation 1,000 1,500
5,000 6,500

9. Long Term Loans and Advances As at 31st As at 31st

March,2020 March,2021
Advance tax 150 100
150 100

10. Short Term Provisions As at 31st As at 31st

March,2020 March,2021
Tax Provision 150 100
Other Provisions 150 150
300 250

Consider the above Profit and Loss account and Balance Sheet and derive Cash flows from operating
activities
using direct and indirect method.
Illustration 10 (a):

104
Taking the data given in Illustration 9, and using the following additional information derive cash flow
from
investment activities:
Take 10% of the investments given in the Balance Sheets as risk-free and readily encashable and remaining of
the investments as long-term investments.
Cash flow from Investment Activities

Particular ` In lakhs
s
Purchase of fixed assets
Increase in gross block (2,000)
Purchase of long-term investments
31-03-2020 31-03-2021
1,000 1,500
Less: cash equivalents 100 150
900 1,350 (450)
(2,450)
Income from Investments 1,200
(1,250)

Thus, there were net cash outflows for investing activities.

Illustration 10 (b):
Take the information given in Illustration 9 & 10 (a) and derive cash flow from financing activities:

Cash flows from financial ` In lakhs

activities
Issue of share 1,000
Loans raised 2,000
Interest (800)
Dividend paid (450)
1,750

Illustration 10 (c):

Use the data given in Illustration 9 & 10(a) and find out change in cash and cash equivalents:

Particular 31-03- 31-03-2021 Increase /

105
 s 2020 (Decrease)
Cash and bank Balances 600 500 (100)
Risk-free and readily encashable
Investments 100 150 50
700 650 (50)

There was a decrease in cash and cash equivalents by `50 lakh.

Illustration 10 (d):
Now using data given in Illustration 9-10 (c), prepare a cash flow statements:

Cash Flow ` in lakh

Statement
Cash flows from operating activities (550)
Cash flows from investment activities (1,250)
Cash flows from financing activities 1,750
Decrease in cash and cash equivalents: (50)

Illustration 11:
The following is the income statement XYZ Company for the year 2020 – 21.
(`)
Sale 1,62,700
Add: Equity in ABC company’s earning 6,000
1,68,700
Expenses
Cost of goods sold 89,300
Salaries 34,400
Depreciation 7,450
Insurance 500
Research and development 1,250
Patent amortization 900
Interest 10,650
Bad debts 2,050
Income tax:
Current 6,600
Deferred 1,550
Total expenses 8,150 1,54,650
Net income 14,050

106
Additional information is:
1. 70% of gross revenue from sales were on credit.
2. Merchandise purchases amounting to ` 92,000 were on credit.
3. Salaries payable totalled ` 1,600 at the end of the year.
4. Amortisation of premium on bonds payable was `1,350.
5. No dividends were received from the other company.
6. XYZ Company declared cash dividend of ` 4,000.
7. Changes in Current Assets and Current Liabilities were as follows:

Increase (Decrease) `
Cash 500
Marketable securities 1,600
Accounts receivable (7,150)
Allowance for bad debt (1,900)
Inventory 2,700
Prepaid insurance 700
Accounts payable (for merchandise) 5,650
Salaries payable (2,050)
Dividends payable (3,000)

Prepare a statement showing the amount of cash flow from operations.

Illustration 12
From the information contained in Income Statement and Balance Sheet of ‘A’ Ltd., prepare Cash Flow
Statement:
Income statement for the year ended March 31,2021

`
Net Sales (A) 2,52,00,000
Less:
Cash Cost of Sales 1,98,00,000
Depreciation 6,00,000
Salaries and Wages 24,00,000
Operating Expenses 8,00,000
Provision for Taxation 8,80,000
(B) 2,44,80,000
Net Operating Profit (A – B) 7,20,000
Non-recurring Income – Profits on sale of equipment 1,20,000

107
 8,40,000
Retained earnings and profits brought forward 15,18,000
23,58,000
Dividends declared and paid during the year 7,20,000
Profit and Loss Account balance as on March 31, 2021 16,38,000

Name of the company: A Ltd. Balance

Sheet as at: 31.03.2021 (`)

Ref Particular Note As at As at

No. s No. 31.03.21 31.03.20
I EQUITY AND LIABILITIES
1 Shareholders’ Fund
(a) Share capital 44,40,000 36,00,000
(b) Reserve & Surplus 16,38,000 15,18,000
2 Liability
Non-current liabilities NIL NIL
Current Liabilities
(a) Trade payables 23,40,000 24,00,000
(b) Other current liabilities 4,80,000 2,40,000
(c) Short-term provisions 1,32,000 1,20,000
Total 90,30,000 78,78,000
II ASSETS
1 Non-current assets
(a) Property, Plant and Equipment 54,00,000 28,80,000
2 Current assets

(a) Inventories 9,60,000 26,40,000

(b) Trade receivables 18,60,000 16,80,000
(c) Cash and cash equivalents 7,20,000 6,00,000
(d) Short-term loans and advances 90,000 78,000
Total 90,30,000 78,78,000
Note - Relevant items of Assets/ Liabilities are reflected in Balance Sheet and Schedule III. Hence sub-
item not having any value for the given illustration is not shown/ represented in Balance Sheet.
Note on Accounts

1. PPE 31.03.2 31.03.2

1 0
Land 9,60,000 4,80,000
Building and Equipment 57,60,000 36,00,000
Less: Depreciation 13,20,000 44,40,000 12,00,000 24,00,000

108
 Total 54,00,000 28,80,000

2.Short Term Provisions 31.03.2 31.03.2

1 0
Income Tax Payable 1,32,000 1,20,000
Total 1,32,000 1,20,000

3. Other Current Liabilities 31.03.2 31.03.2

1 0
Outstanding Expenses 4,80,000 2,40,000
Total 4,80,000 2,40,000

4. Short Term Loans and Advances 31.03.2 31.03.2

1 0
Advances 90,000 78,000
Total 90,000 78,000
The original cost of equipment sold during the year 2020-21 was `7,20,000.

Illustration 13:
Name of the Company:
Balance Sheet as at 31-12-2020 and 31- 12- 2021
(` in thousands)

Ref No. Particula Note 31.12.20 31.12.202

rs No. 21 0
I EQUITY AND LIABILITIES
1 Equity
(a) Equity Share capital 1,500 1,250
(b) Reserve & Surplus 3,410 1,380
2 Liability NIL
Non-current liabilities NIL
(a) Long-term borrowings 1,110 1,040
Current Liabilities
(a) Trade payables 150 1,890
(b) Other current liabilities 230 100
(c) Short-term provisions 400 1,000
Total 6,800 6,660
II ASSETS
1 Non-current assets
(a) PPE 730 850
(b) Non-current investments 2,500 2,500

109
 2 Current assets
(a) Current investments 670 135
(b) Inventories 900 1,950
(c) Trade receivables 1,700 1,200
(d) Cash and cash equivalents 200 25
Total 6,800 6,660

Note - Relevant items of Assets/ Liabilities are reflected in Balance Sheet and Schedule III. Hence sub-
item not having any value for the given illustration is not shown/ represented in Balance Sheet.

Notes on Accounts (` in thousands)

1. Other Current Liabilities 31.12.2021 31.12.2020

Interest Payable 230 100
Total 230 100

2. Short Term Provision 31.12.2021 31.12.2020

Income Tax Payable 400 1,000
Total 400 1,000

3. PPE 31.12.2021 31.12.2020

Fixed Assets at cost 2,180 1,910
Less: Accumulated Depreciation 1,450 1,060
Total 730 850

4. Other Current Assets 31.12.2021 31.12.2020

Interest Receivable 100 -
Total 100 -

Statement of profit and Loss for the year ended 31 – 12 – 2021

(` in thousands)
Sales 30,650
Cost of sales (26,000)
Gross profit 4,650
Depreciation (450)
Administration and selling expenses (910)
Interest expenses (400)
Interest income 300
Dividend income 200
Foreign exchange loss (40)

110
 Net profit before taxation and extraordinary item 3,350
Extraordinary item - Insurance proceeds from earthquake disaster 180
settlement
Net profit after extraordinary item 3,530
Income-tax (300)
Net profit 3,230

Additional information (` in thousands):

a. An amount of ` 250 was raised from the issue of share capital and a further ` 250 was raised from
long-term
borrowings.
b. Interest expense was ` 400 of which ` 170 was paid during the period. `100 relating to interest
expenses of the
prior period was also paid during the period.
c. Dividends paid were `1,200.
d. Tax deducted at source on dividends received (included in the tax expenses of `300 for the year)
amounted to
`40
e. During the period, the enterprise acquired fixed assets for `350. The payment was made in cash.
f. Plant with original cost of `80 and accumulated depreciation of `60 was sold for `20.
g. Foreign exchange loss of `40 represents reduction in the carrying amount of a short-term
investment in foreign currency designated bonds arising out of a change in exchange rate
between the date of acquisition of the investments and the balance sheet date.
h. Sundry debtors and sundry creditors include amounts relating to credit sales and credit purchases
only.

Illustration 14
Sumangal Ltd. finds on 31st December, 2020 that it is short of funds with which to implement its branch
expansion programme. On 1st January, 2020, it had a bank balance of `1,80,000 in its current account.
From the following information, prepare a statement of Cash Flow to show how the overdraft of
`58,750 at 31st December, 2021 has arisen:

Sumangal Ltd.
Figures as per Balance
Sheet (as on 31st
December)

2019 (`) 2020 (`)

PPE 7,50,000 11,00,000
Stock and stores 1,90,000 3,00,000
Debtors 3,80,000 3,65,000

111
 Bank Balance/(Overdraft) 1,70,000 (58,750)
Trade Creditors 2,70,000 3,50,000
Share Capital (in shares of `10 each) 2,50,000 3,00,000
Bills Receivable 87,500 95,000

The profit for the year ended 31st December, 2020 before charging depreciation and taxation amounted
to `2,50,000. The 5,000 shares were issued on 1st January, 2020 at a premium of `5 per share. `1,37,500
was paid in March 2020 by way of income tax including tax on distribution of dividend. Dividend was
paid as follows: for 2020 (final) on the capital on 31-12-2019 @ 10% less tax 25%. For 2020 (interim)
5% on capital on 31st March, 2020 free of tax.

Illustration 15
From the following figures of LK Ltd. prepare a Cash Flow Statement:

Particulars 31.03.2020 31.03.2021

Equity and Liabilities (`) (`)
Equity Share Capital 12,00,000 16,00,000
10% Preference Share Capital 4,00,000 2,80,000
Capital Reserve 40,000
General Reserve 6,80,000 8,00,000
Profit and Loss Account 2,80,000 4,04,000
9% Debentures 4,00,000 2,80,000
Current Liabilities 4,80,000 5,36,000
Provision for Tax 3,60,000 3,40,000
38,00,000 42,80,000
Fixed Assets 32,00,000 38,00,000
Less Depreciation 9,20,000 11,60,000
22,80,000 26,40,000
Investments 4,00,000 3,20,000
Cash 10,000 10,000
Other Current Assets 11,10,000 13,10,000
38,00,000 42,80,000

Additional information:
1. The company sold one fixed asset for `1,00,000 the cost of which was ` 2,00,000 and the
depreciation provided on it was ` 80,000.
2. The company also decided to right off another fixed asset costing ` 56,000 on which
depreciation amounting to ` 40,000 has been provided.
3. Depreciation on fixed assets provided `3,60,000.
4. Company sold some investment at a profit of ` 40,000, which was credited to Capital Reserve.
5. Debentures and preference share capital where redeemed at 5% premium.

112
 6. Company decided to value stock at cost, whereas previously, the practice was to Value
stock at cost less 10%. The stock according to book on 31st March 2020 was ` 2,16,000. The
stock as on 31st March 2021 was correctly valued at ` 3,00,000.
Illustration 16
Given below is the Statement of Profit and Loss Account of ABC Ltd. and relevant Balance Sheet information:
Statement of Profit and Loss for the year ended 31st March, 2021 (` in lakhs)

Particulars Not As at As at
e 31st 31st
No. March, March,
2021 2020
I Revenue from Operation 4,150
II Other Income 100
III TOTAL INCOME (I+II) 4,250
IV EXPENSES:
(a) Cost of material consumed
(b) Purchase of products for sale 2,400
(c) changes in inventories of finished goods, work-in- (20)
progress and
products for sale
(d) Employees cost/ benefits expenses 800
(e) Finance cost 60
(f) Depreciation and amortization expenses 100
(h) Other expenses 200
TOTAL EXPENSES 3,540
V PROFIT BEFORE EXCEPTIONAL ITEMS AND TAX (III-IV) 710
VI EXCEPTIONAL ITEMS -
VII PROFIT BEFORE TAX FROM CONTINUING OPERATIONS 710
(V-VI)
VIII Tax expenses:
(1) Current Tax 200
(2) deferred tax -
IX PROFIT FOR THE YEAR FROM CONTINUING 510
OPERATION (VII – VIII)
X Profit (loss) from discontinued operations
XI Tax expenses from discontinued operations
XII Profit(loss) from discontinued operations (after tax)
(XII-XIII)
XIII PROFIT (LOSS) FOR THE PERIOD (XI+XIV)
XIV Other Comprehensive Income --
XV Total Comprehensive Income (XIII + XIV) 510
XVI Earning per equity share:
(1) Basic

113
 (2) Diluted
Balance brought forward from previous year 50
Profit available for appropriation 560
Appropriation:
Dividend 300
Transfer to General Reserve 200
Total 500
Balance carried forward 60
Notes on Accounts
(` in lakhs)

1. Revenue from operation As at 31st As at 31st

March,2021 March,2020
Sales (net of Excise Duty) 4,150
Total 4,150
2. Other Income As at 31st As at 31st
March,2021 March,2020
Interest and Dividend 100
Total 100

3. Employees Cost/ Benefits Expenses As at 31st As at 31st

March,2021 March,2020
Wages and Salaries 800
Total 800

4. Finance Expenses As at 31st As at 31st

March,2021 March,2020
Interest 60
Total 60

Relevant Balance Sheet information 31-03-2021 (` in 31-03-2020 (` in

lakhs) lakhs)
Debtors 400 250
Inventories 200 180
Creditors 250 230
Outstanding wages 50 40
Outstanding expenses 20 10
Advance tax 195 180
Tax provision 200 180
Assessed tax liability 180
Prepare the Cash Flow from Operating Activities of the company under (a) Direct Method and (b) Indirect
Method.

114
 Comprehensive Numerical Problems
1. From the following information provided, prepare a Cash Flow Statement of XYZ Ltd. as per Ind AS-7.
Balance Sheet of XYZ Ltd.

Particulars Note As on As on
No. 31.03. 31.03.
21 20
I Assets
1. Non-current Assets
(a) PPE 2 704000 648000
(b) Non-current Investment 296000 440000
2. Current Assets
(a) Inventories 424000 328000
(b)Trade Receivables 172000 268000
(c)Cash and Cash Equivalent 360000 360000
(d)Short term loan and advances (Prepaid Expenses) 8000 4000
1964000 204800
0
II Equity and Liabilities
1. Equity
(a) Share Capital 920000 920000
(b) Other Equity 1 332000 304000
2. Liability Nil Nil
Non-Current Liability
(a) Long Term Borrowings (10% debentures) 280000 360000
Current Liabilities
(a) Trade Payables 384000 412000
(b) Short term Provisions (Provision for Tax) 48000 52000
Total 1964000 204800
0
Notes to Accounts:

1. Reserve & Surplus As on 31.03.21 As on 31.03.20

Balance of Profit 92000 64000
General Reserve 240000 240000
332000 304000
2. PPE
(a) Land 600000 600000
Machinery (Gross Block) 280000 208000
Provision for depreciation 176000 160000
(b) Machinery (Net Block) 104000 48000
(a)+(b) 704000 648000

115
 Additional information:
(i) 10% dividend was paid during the year.
(ii) Machinery for ` 12,000 was purchased and old machinery costing ` 48,000 (accumulated
depreciation `
24,000) was sold for ` 16,000.
(iii) ` 80,000, 8% debentures were redeemed by purchase from open market at `96 for a Debenture of
`100.
(iv) Investments worth `1,44,000 were sold at a loss of `4,000.

(v) Actual income tax liability for the year amounted to `40,000.
[Answer: C/F from Operating activities `1,68,800; Investing
activities ` 36,000; Financing activities ` (2,04,800)]
2. The following are the summarized Balance Sheets of ABC Limited as on 31st March 2020 and 2021:

Liabilities 31.3.20 (`) 31.3.21 (`) Assets 31.3.20 (`) 31.3.21 (`)
Share Capital 4,60,000 4,60,000 Land & Building 3,00,000 3,00,000
Profit & Loss 32,000 46,000 Machinery 1,04,000 1,40,000
Balance
Reserve 1,20,000 1,20,000 Investments 2,20,000 1,48,000
8% Debentures 1,80,000 1,40,000 Stock 1,64,000 2,12,000
Depreciation Fund 80,000 88,000 Debtors 1,34,000 86,000
Creditors 2,06,000 1,92,000 Cash 1,80,000 1,80,000
Outstanding 26,000 24,000 Prepaid expenses 2,000 4,000
expenses
11,04,000 10,70,000 11,04,000 10,70,000
Additional Information:
(1) 10% Dividend was paid during the year.
(2) Old Machinery costing `24,000 (accumulated depreciation ` 12,000) was sold for ` 8,000.
(3) 40,000 8% Debenture were redeemed by purchase from open market at ` 96 for a debenture of `
100 on 31.03.2017.
(4) Investments worth ` 72,000 were sold at book value.
(5) Bad debt written off during the year ` 10,000.
Prepare a Statement of Cash flow for the year ended 31.03.21.
[Answer: C/F from Operating activities `78,800; Investing
activities `20,000; Financing activities ` (98,800)]
3. On the basis of the following information provided by X Ltd. prepare a Cash Flow Statement for the year
ended on 31st March 2021.
(i) X Ltd. sold all the goods for cash only and purchased the goods in credit only.
(ii) The company earned a Gross Profit of `4,00,000 with a Gross Profit Ratio of 25%.

116
 (iii) The closing inventory was higher than the opening inventory by `20,000.

(iv) The company paid `4,50,000 as wages and `90,000 as office expenses during the year.

(v) Balance of Suppliers accounts on 31.03.2020 were higher than the balance on 31.03.2021 by `30,000.
(vi) Tax paid by the company amounts to `80,000 while provision for taxation was `70,000.

(vii) The company repaid bank loan of `1,75,000 which included interest of `15,000.

(viii)Dividend paid during the year `50,000 (including dividend distribution tax).
(ix) X Ltd. sold investments of `6,00,000 at a profit of `40,000.
(x) Depreciation charged on fixed assets `1,20,000.
(xi) Furniture purchased during the year `2,00,000.
(xii) Cash and Cash Equivalents as on 31.03.2020 was `1,00,000.

(xiii) Cash and Cash Equivalents as on 31.03.2021 was `4,95,000.

[Answer: C/F from Operating activities `1,80,000; Investing

activities `4,40,000; Financing activities ` (2,25,000)]
4. Following are the summarized Balance Sheets of Beta Ltd.

Liabilities 31.03.2 31.03.2 Assets 31.03.202 31.03.202

0 1 0 1
Equity Share Capital (` 4,00,000 5,00,00 Land and Building 4,00,000 3,80,000
10) 0
General Reserve 1,00,000 1,20,00 Plant and Machinery 3,00,000 3,38,000
0
Profit and Loss (Cr.) 61,000 61,200 Inventory 2,00,000 1,48,000
Bank Loan 1,40,000 ------ Trade Receivable 1,60,000 1,28,400
Trade Payable 3,00,000 2,70,40 Cash in hand 1,000 1,200
0
Provision for Taxation 60,000 70,000 Cash at Bank ---- 16,000
Goodwill ----- 10,000
10,61,00 10,21,60 10,61,000 10,21,600
0 0
Additional Information:
(i) Dividend paid during the year `46,000.
(ii) Net profit for the year `1,32,200.
(iii) Depreciation written off on building `20,000 and on machinery `28,000.

(iv) Income tax paid during the year `56,000.

(v) The following assets of another company were purchased for a consideration of `1,00,000 and paid
in shares. Assets were: Inventory `40,000 and Machinery `50,000.
(vi) Further machinery was purchased for `50,000 during the year.

117
 You are required to prepare a Cash Flow Statement as per Ind AS 7.

[Answer: C/F from Operating activities `2,18,200; Investing

activities `(16,000); Financing activities ` (1,86,000)]
5. The following figures have been extracted from the books of M Limited for the year ended on 31.3.2021.
You.
are required to prepare a Cash Flow Statement.
(i) Net profit, before adjusting income tax but after taking into account the following items, was `10
lakhs.
• Depreciation on Assets `2,50,000.
• Discount on issue of Debentures written off `15,000.
• Interest on Debentures paid `1,75,000.
• Book value of investments `1,50,000 (Sold for `1,60,000).
• Interest received on investments `30,000.
(ii) Income tax paid during the year `4,80,000.
(iii) 7,500 10% preference shares of `100 each were redeemed on 31.3.2021 at a premium of 5%. Further
the company issued 25,000 equity shares of `10 each at a premium of 20% on 2.4.2020. Dividend on
preference shares were paid at the time of redemption.
(iv) Dividends paid for the year 2019-20 `2,50,000 and interim dividend paid ` 1,50,000 for the year 2020-
21.
(v) Land was purchased on 2.4.2018 for ` 1,20,000 for which the company issued 10,000 equity shares of
`10 each at a premium of 20% to the land owner as consideration.
(vi) Current assets and liabilities were as follows:

Particulars 31.03.2020 (`) 31.03.2021 (`)

Stock 6,00,000 6,59,000
Sundry Debtors 1,04,000 1,06,550
Cash in hand 98,150 17,650
Bills Receivable 25,000 20,000
Bills Payable 22,500 20,000
Sundry Creditors 83,000 85,650
Outstanding expenses 37,500 40,900
[Answer: C/F from Operating activities `8,67,000; Investing
activities `1,90,000; Financing activities ` (11,37,500)]
 Unsolved Case
1. Balance Sheet of Y Ltd. as on 31.03.2021 and 31.03.2020 [Figures in ` ’000]

(` in ‘000)

118
 Particulars Notes 31.03.20 31.03.202
No. 21 0
I. ASSETS
1. Non-Current Assets
(a) Property, Plant and Equipment 4 5,100 5,200
2. Current Assets
(a) Inventory 1,400 1,550
(b) Trade Receivables 800 650
(c) Cash and Cash Equivalent 400 600
(d) Other Current Assets 5 65 80
TOTAL 7,765 8,080
II. EQUITY AND LIABILITIES
1. Equity
(a) Equity Share Capital (`10 each fully paid) 4,300 4,000
(b) Other Equity 1 640 980
2. Liabilities
Non-Current Liabilities
(a) Long-term Borrowing 2 2,050 2,200
Current Liabilities
(a) Trade Payables 650 800
(b) Short-term Provision 3 125 100
TOTAL 7,765 8,080
Notes to the Financial Statements (`’000)

Particulars 31.03.202 31.03.2020

1
1. Reserve & Surplus
(a) Profit and Loss 640 980
2. Long-term Borrowings
(a) 10% Debentures 2,050 2,200
3. Short-term Provision
(a) Provision for Taxation 125 100
4. Property, Plant and Equipment
(a) Building 1,900 2,000
(b) Machinery 1,700 1,400
(c) Land 1,500 1,800
5,100 5,200
5. Other Current Asset
(a) Prepaid Expenses 65 80
The accountant of Y Ltd. has finalized the accounts and prepared its Balance Sheet with supporting
Notes
given above. In addition, he has the following information.

119
1. Dividend paid during the year `4,50,000.
2. Land was sold for cash at a profit of `50,000.
3. Machinery costing `2,00,000 (W.D.V. `40,000) was sold for `30,000. Also costing `6,00,000 was
purchased.
4. Amount transferred to provision for taxation during the year `1,60,000.
5. Depreciation Funds as on 31.3.2020 and 31.3.2021 on Building were `5,00,000 and `6,00,000 and
on Machinery were `2,00,000 and `3,00,000.
Assist him in preparing a Cash Flow Statement for the year ended 31.03.2021 as per Ind AS 7.
[Answer: C/F from Operating activities `5,40,000; Investing
activities `(2,20,000); Financing activities `(5,20,000)]

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 ACCounts of Banking Companies
Illustration 1
When closing the books of a bank on 31.03.2021 you find in the loan ledger an unsecured balance of
`2,00,000 in the account of a merchant whose financial condition is reported to you as bad and doubtful.
Interest on the same account amounted to `20,000 during the year.
How would you deal with this item of interest in 2020-21 account?
During the year 2021-22, the bank accepts 75 paise in the rupee on account of the total debt due up to
31.03.2021.
Show the entries and the necessary accounts showing the ultimate effect of the transactions in 2021-
22 books of account under Interest Suspense Method.

Illustration 2
From the following details prepare “Acceptances, Endorsements and other Obligation A/c” as would appear
in the General Ledger.
On 1.4.21 Acceptances not yet satisfied stood at ` 33,45,000. Out of which ` 30 lacs were subsequently paid
off by clients and bank had to honour the rest. A scrutiny of the Acceptance Register revealed the following:

Clien Acceptances/ Guarantees Remarks

t (`)
P 15,00,000 Bank honoured on 10.6.21
Q 18,00,000 Party paid off on 30.9.21
R 7,50,000 Party failed to pay and bank had to honour
on 30.11.21
S 12,00,000 Not satisfied up to 31.3.22
T 7,50,000 -do-
X 4,05,000 -do-
Total 64,05,000
Clien Acceptances/ Guarantees (`) Remarks
t
P 15,00,000 Bank honoured on 10.6.21
Q 18,00,000 Party paid off on 30.9.21
R 7,50,000 Party failed to pay and bank had to honour on
30.11.21
S 12,00,000 Not satisfied up to 31.3.22
T 7,50,000 -do-
X 4,05,000 -do-
Total 64,05,000

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Illustration 3
Calculate Rebate on Bills discounted as on 31 December, 2021 from the following data and show journal
entries for adjustment.

Date of Bill ` Period Rate of

Discount
(i) 15.10.2021 50,000 5 8%
months
(ii) 10.11.2021 30,000 4 7%
months
(iii) 25.11.2021 40,000 4 7%
months
(iv) 20.12.2021 60,000 3 9%
months

Illustration 4
On 31 March, 2021 Victory Bank Ltd. had a balance of `18 crores in Rebate on Bill Discounted A/c.
During the year ended 31st March, 2022, Victory Bank Ltd. discounted bills of exchange of `8,000 crores
charging interest at 18% p.a., the average period of discount being for 73 days. Of these, bills of
exchange of `1,200 crores were due for realization from the acceptor/customers after 31st March,
2022, the average period outstanding after 31st March, 2022 being 36.5 days.
Victory Bank Ltd. asks you to pass journal entries and show the ledger accounts pertaining to:
a. Discounting of Bills of Exchange; and
b. Rebate on bill Discounted.

Illustration 5

The books of a bank include a loan of `5,00,000 advanced on 31.12.2020, interest changeable @ 16%
p.a. compounded quarterly. The security for the loan being 7,000 shares of `100 each in a public limited
company valued @ `90 each. There is no repayment till 31.03.2022. On 31.03.2022, the value of shares
declined to `80 per share.

How would you classify the loan as secured or unsecured in the Balance Sheet?

122
Illustration 6
Given below are details of interest on advance of a Commercial Bank as on 31.03.2021:
(` in Crore)

Particular Interest Earned (`) Interest Received

s (`)
Performing Assets
Term Loan 240 160
Cash Credit and Overdraft 1,500 1,240
Bills Purchased and Discounted 300 300
Non-Performing Assets
Term Loan 150 10
Cash Credit and Overdraft 300 24
Bills Purchased and Discounted 200 40
Find out the income to be recognized for the year ended 31st March 2021.

Illustration 7
From the following information of details of advances of X Bank Limited calculate the amount of
provisions to be made in Profit and Loss Account for the year ended 31.3.2021:

Asset classification ` in lakhs

Standard 6,000
Sub-standard 4,400
Doubtful:
For one year 1,800
For two years 1,200
For three years 800
For more than three years 600
Loss assets 1,600

Illustration 8
From the particulars given below, ascertain the amount of provision to be made against the advances
of SBI, Kolkata. (` in’00,000)

Particula (`)
rs
Total amount of Loans & Advances 120
Advance fully secured 70

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 Advance overdue for 15 months 20
Advance overdue for more than 2½ year but less than 3 years 10
(Secured by mortgage of land & building valued ` 5 lakhs) —
Unsecured Advance not recoverable 20
Illustration 9 (Provisions covered by Guarantee of DICG/ ECGC in case of advance)
Rajatapeeta Bank Ltd. had extended the following credit lines to a Small-Scale Industry, which had
not paid any Interest since March, 2015:

Term Loan Export Loan

Balance Outstanding on 31.03.2021 ` 35 lakhs ` 30 lakhs
DICGC/ECGC cover 40% 50%
Securities held ` 15 lakhs ` 10 lakhs
Realisable value of Securities ` 10 lakhs ` 08 lakhs
Compute necessary provisions to be made for the year ended 31st March, 2021.

Illustration 10
From the following information find out the amount of provisions required to be made in the Profit &
Loss Account of a commercial bank for the year ended 31st March, 2021:

a. Packing credit outstanding from Food Processors ` 90 lacs against which the
bank holds securities worth ` 22.50 lacs. 50% of the above advance is
covered by ECGC. The above advance has remained doubtful for more than
3 years.

b. Other Advances:

Assets classification ` in lacs

Standard 4,500
Sub-standard 3,300
Doubtful:
For one year 1,350
For two years 900
For three years 600
For more than 3 years 450
Loss assets 900

Illustration 11
The following are the figures extracted from the books of Y Bank Ltd. [Scheduled Commercial Bank] as

124
on 31.3.2021.

Other information: (Amount in `)

Interest and Discount received 20,30,00 Directors’ fees and allowance 12,000
0
Interest paid on Deposits 12,02,00 Rent and taxes paid 54,000
0
Issued and Subscribed Capital 5,00,000 Stationery and printing 12,000
Reserve under Section 17 3,50,000 Postage and Telegram 25,000
Commission, Exchange and 90,000 Other expenses 12,000
Brokerage
Rent received 30,000 Audit fees 4,000
Profit on sale of investment 95,000 Depreciation on Bank’s 12,500
properties
Salaries and Allowances 1,05,000

a. Provision for bad and doubtful debts necessary ` 2,00,000.

b. Rebate on bills discounted as on 31.3.2021 ` 7,500.

c. Provide `3,50,000 for income tax.

d. The directors desire to declare 10% dividend.

Make the necessary assumption and prepare the Profit and Loss Account in accordance with the law.

Illustration 12

From the following trial balance and the additional information, prepare a Balance Sheet of Lakshmi
Bank Ltd. a Scheduled Commercial Bank as at 31st March, 2021:

Debit balance ` (in Lakhs)

Cash Credits 1,218.15
Cash in hand 240.23
Cash with Reserve Bank of India 67.82
Cash with other Banks 132.81
Money at c all and short notice 315.18
Gold 82.84
Government securities 365.25
Current Accounts 42.00
Premises 133.55
Furniture 95.18

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 Term Loan 1,189.32
3,882.33
Credit balance ` (in Lakhs)
Share Capital (29,70,000 equity shares of `10 each fully paid up) 297.00
Statutory Reserve 346.50
Net Profit for the year (before appropriation) 225.00
Profit & Loss Account (Opening balance) 618.00
Fixed deposit Accounts 775.50
Savings Deposit Accounts 675.00
Current Accounts 780.18
Bills Payable 0.15
Borrowings from other Banks 165.00
3,882.33
Additional Information:
a. Bills for collection: ` 18,10,000
b. Acceptance and endorsements: ` 14,12,000
c. Claims against the bank not acknowledged as debts: ` 55,000
d. Depreciation charged on premises: ` 1,10,000 and Furniture: ` 78,000

126
 ACCounts of EleCtriCity Companies
Illustration 13
Consider the following information provided by ABC Power Supply Company Ltd.
Security deposit received from a customer on 01.10.2020 for `2,00,000. Interest rate applicable was
8% for 2020-21 and 9% for 2021-22. The accrued interest for the year is adjusted against the bill for
the immediate next quarter. Journalize the above transaction for 2020-21 and 2021-22.

Illustration 14

From the following calculate Weighted Average Rate of Depreciation considering the rates as per
Appendix-I.

Asset Closing Balance at Cost

s (`)
1. Land under full ownership 14,30,000
2. Land under Lease 4,30,000
3. (a) Building & Civil Engineering Works other than 33,00,000
Kutcha Roads
(b) Railways Sidings 40,00,000
(c) Temporary Erections such as Wooden Structures 10,00,000
4. IT Equipment 20,00,000
5. Self-Propelled Vehicles 30,00,000
6. Portable Air Conditioning Plants 25,00,000
7. (a) Apparatus other than Motors let on hire 15,00,000
(b) Motors let on hire 2,00,000
8. Communication Equipment 5,00,000
9. Office Furniture, Furnishing, Equipment, Fittings & 5,00,000
Apparatus
10. Plants & Machinery in generating stations 2,52,00,000

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 11. Cooling Towers & Circulating Water Systems 10,00,000
12. Hydraulic Works Forming part of the Hydro-dams, 20,00,000
etc.
13. Transformers & Switchgear 2,05,00,000
14. Lighting Arrestor, Batteries, Overhead lines 42,00,000
including c able support
15. Meters 20,00,000
16. Static Air Conditioning Plants 1,00,00,000
17. Street Light Fittings 47,85,000
18. Vehicles other than Self Propelled Vehicles 2,15,000

Illustration 15
Consider the following information provided by XYZ Power Supply Company Ltd. (` in lakhs):
Gross opening equity `3,000 as on 01.04.2019.
Adjustment in opening equity – Nil Adjustment during
the year – Nil
Increase in equity due to addition during the year (over 5 years): `500 Decrease
due to reversal and de-capitalization (over 5 years): Nil Increase due to
discharges during the year: Nil
Rate of ROE: 18%
Calculate total ROE for the next five years.

Illustration 16
From the following information Calculate Return on Equity:
1. Date of Commercial Operation of COD = 1st April 2019
2. Approved Opening Capital Cost as on 1st April 2019 = `15,00,000
3. Details of allowed Additional Capital Expenditure:
1st year 2nd 3rd year 4th year
year
Additional Capital Expenditure (Allowed) 30,000 20,000 10,000
1,00,000
Rate of ROE: 15.5%

Illustration 17
Consider the following estimated information provided by XYZ Power Supply Company Ltd. (` in
lakhs) for the next 5 years:

128
Cost of coal: `2,000 per year
Cost of secondary fuel oil: `200 per year for first 2 years and `300 per year for 3-5 years O
and M expenses: `250 per year for first 2 years and `350 per year for 3-5 years Maintenance
spares: `100 per years
Receivables: `1,800 per year
Rate of interest: 12%
Calculate the interest on working capital.

Illustration 18

Consider the following estimated information provided by XYZ Power Supply Company Ltd. (` in
lakhs) for the next 5 years:
Normative O & M expenses: `2500 for Year 1 and this will increase @10% per year. Water

Charges: `500 for year 1 and 2 and it will increase @20% per year thereafter. Security

expenses: `750 per year up to year 4 and `800 for 5th year.
Calculate total O & M expenses for five years.

Illustration 19
The trial balance of MM Electric Supply Ltd. For the year ended 31st March, 2021 is as below:
Particular Dr. Balances Cr. Balances
s Amount (` in Amount (` in
‘000) ‘000)
Share Capital:
Equity Shares of `10 each 50,000
14% Preference Shares of `100 each 15,000
Patents and trade mark 2,504
15% Debentures 24,700
16% term loan 15,300
Land (additions during the year 20,50) 12,450
Building (additions during the year 50,80) 35,134
Plant & Machinery 57,058
Mains 4,524
Meters 3,150
Electric al Instruments 1,530
Office Furniture 2,450
Capital Reserve 4,020
Contingency Reserves 12,030
General Reserve 1,000

129
 Transformers 16,440
Opening Balance of Profit & Loss Account 350
Profit for the year 2012-13 subject to 17,100
adjustments
Stock in hand 12,050
Sundry Debtors 6,246
Contingency Reserve Investments:
SBI Bonds-2020 10,010
Other Investments 2,000
Cash & Bank 3,254
Public lamps 3,040
Depreciation Fund 25,816
Sundry Creditors 6,524

During 2020-21, 1,00,000, 14% Preference Shares were redeemed at a premium of 10% out of
proceeds of fresh issue of equity shares of necessary amounts at a premium of 10%.

Adjustments:
a. Transfer to Contingency Reserve ` 1,70,000 & to General Reserve ` 2,00,000
b. Loss on Contingency Reserve Investment ` 10,000
c. Make a Provision for debts considered doubtful of `1,014,000.
You are required to prepare the balance sheet as on 31st March, 2013 as per the schedule III.

130
 ACCounts of InsuranCe Companies
Illustration 20
The Revenue Account of a life insurance company shows the life assurance fund on 31st March, 2021 at
` 62,21,310 before taking into account the following items:
(i) Claims covered under re-insurance ` 12,000.
(ii) Bonus utilized in reduction of life insurance premium ` 4,500.
(iii) Interest accrued on securities ` 8,260.
(iv) Outstanding premium ` 5,410.
(v) Claims intimated but not admitted ` 26,500.
What is the life assurance fund after taking into account the above omissions?

Illustration 21
The life insurance fund of Prakash Life Insurance Co. Ltd. was ` 34,00,000 on 31st March, 2021. Its actuarial
valuation on 31st March, 2021 disclosed a net liability of ` 28,80,000. An interim bonus of ` 40,000 was paid to
the policyholders during the previous two years. It is now proposed to carry forward ` 1,10,000 and to divide
the balance between the policyholders and the shareholders. Show (a) the Valuation Balance Sheet, (b) the net
profit for the two-year period, and (c) the distribution of the profits.

Illustration 22
From the following figures of Well Life assurance Co. Ltd. prepare a Valuation Balance Sheet and Profit
Distribution Statement for the year ended 31st March 2014. Also pass necessary journal entries to
record the above transactions with narrations:

Particula ` (in lakhs)

rs
Balance of Life Assurance Fund as on 1.4.2021 167.15
Interim bonus paid in the valuation period 25.00
Balance of Revenue Account for the year ended 31.3.2022 240.00
Net Liability as per valuer’s Certificates as on 31.3.2022 165.00
The company declares a reversionary bonus of `185 per `1,000 and gave the policyholders an option to
take bonus in cash `105 per `1,000. Total business conducted by the company was `600 lakhs. The
company issued profit policy only. 3/5th of the policyholders in value opted for cash bonus.

131
Illustration 23
The following balances appeared in the books of Happy Mutual Life Assurance Society Ltd. as on 31 March
2014:

(` in lakh)
Dr. Cr.

Particular ` Particular `
s s
Claims less reassurance paid Life Assurance Fund at the
during the year beginning of the year 1,00,000
By death 4,400 Premium less Re-assurances 30,000
By 3,000 Claims less reassurances outstanding
maturity 12 At the
500 beginning of the year: 1,800
Annuities
By death 1,200
Furniture and Office Equipment at
154 By 120
cost (including `80 lakh bought
2,700 maturity
during the year) 4
60 Credit balances pending
Printing and Stationery 3,600
80
Cash with Bank in current adjustments Consideration for
500 4
account Cash and stamp in annuities granted Interest, 200
6,200
hand Surrenders less dividends and rents Registration 600
2
Reassurances Commission and other Fees 2,300
Expenses of Management 100 Sundry Deposits 700
Sundry Deposits with 100 Taxation Provision 300
Electricity Companies 200 Premium Deposits 80
Advance Payment of Tax 900 Sundry Creditors 600
Sundry Debtors 1,000 Contingency Reserve
Agents Balances Furniture and Office Equipment
Depreciation Account
Income Tax
Income Tax on Interest, Dividend Building Depreciation Account
and
Rents

Loans and Mortgages 300

Loans on Policies 6,500
Investments 1,04,00
0
(`500 lakh deposited with Reserve

132
 Bank
of India)
House Property at Cost (including ` 10,800
170
lakh added during the year)
1,41,50 1,41,50
8 8

From the foregoing balances and the following information, prepare the Balance Sheet of Happy
Mutual Life Assurance Society Ltd. as on 31st March 2014 and its Revenue Account for the year
ended on that date:
(i) Claims less reassurance outstanding at the end of the year: By death ` 1,200 lakh, By maturity `
800 lakh.
(ii) Expenses outstanding ` 120 lakh and prepaid ` 30 lakh.
(iii) Provide ` 90 lakh for depreciation on buildings, `30 lakh for depreciation on furniture and office
equipment
and ` 220 lakh for taxation.
(iv) Premiums outstanding `4,056 lakh, commission thereon ` 130 lakhs.
Interests, dividends and rents outstanding (net) ` 60 lakh and interests and rents accrued (net) ` 700 lakh.

Illustration 24
From the following, you are required to calculate the loss on account of claim to be shown in the revenue
account for the year ending 31st December, 2012:
Claims:

Intimated Admitted Paid `

in in in
2020 2020 2021 15,000
2021 2021 2022 10,000
2019 2020 2020 5,000
2019 2020 2021 12,000
2021 2022 2022 8,000
2021 2021 2021 1,02,000

Claim on account of re-insurance was `25,000

Particula `
rs
Total claim paid in 2021: ` (1,02,000 + 12,000 + 15,000) 1,29,000

133
 Less: Outstanding in the beginning i. e., intimated in 2020 or earlier
whether accepted in 27,000
2020 & accepted in 2021 (`15,000 + `12,000)
1,02,000
Add: Outstanding at the end i.e., intimated in 2021 whether accepted in
2021 or in 2022 18,000
`(10,000 + 8,000)
1,20,000
Less: re-insurance claim 25,000
Claims to be shown in revenue account 95,000

Notes:
1. It may be seen that the column for ‘admitted in’ is useless for calculating loss on account of
claim. This
is a mere information.
2. No. 3 item ‘intimated in 2019, admitted in 2020, paid in 2020 `5,000 is useless as the
amount paid in
2020 is not included in the amount paid in 2021.

Illustration 25
Khush Raho Insurance Co. Ltd. furnishes you the following information:
(i) On 31.3.2013 it had reserve for unexpired risks to the tune of `100 crore. It comprised of
` 37.5 crore in respect of machine insurance business; `50 crore in respect of fire
insurance business and `12.5 crore in respect of miscellaneous insurance business.
(ii)It is the practice of Khush Raho Insurance Co. Ltd. to create reserve at 100% of net
premium income in respect of marine insurance policies and at 50% of net premium in
respect of fire and miscellaneous insurance business.
During the year 31st March, 2014 the following business was conducted

Marine Fire Miscellaneo

Particular
(` (` us
s
crores) crores) (` crores)
Premia collected from :
45 107.5 30
(a) Insured (other than insurance companies) in respect of
policies issued
(b) Other insurance companies in respect of risks 17.5 12.5 10
undertaken
Premia paid/payable to other insurance companies on 16.75 10.75 17.5
business ceded

Khush Raho Insurance Co. Ltd. asks you to :

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 (i) Pass journal entries relating to “unexpired risks reserve”
(ii) Show in columnar form Unexpired Risks Reserve Account for the year ended 31st March, 2014.

Illustration 26
From the following figures appearing in the books of Fire Insurance division of a General Insurance
Company, show the amount of claim as it would appear in the Revenue Account for the year ended
31st March, 2014 :

Particular Direct Re-Insurance

s Business
` `
Claim paid during the year 46,70,000 7,00,000
Claim Payable — 1st April, 2013 7,63,000 87,000
31st March, 2014 8,12,000 53,000
Claims received – 2,30,000
Claims Receivable — 1st April, 2013 – 66,000
31st March, 2014 – 1,13,000
Expenses of Management 2,30,000 –
(includes ` 35,000 Surveyor’s fee and ` 45,000
Legal expenses for settlement of claims)

Illustration 27
Prepare the Fire Insurance Revenue A/c as per IRDA regulations for the year ended 31st March, 2014
from the following details:

Particular `
s
Claims paid 4,90,000
Legal expenses regarding claims 10,000
Premiums received 13,00,000
Re-insurance premium paid 1,00,000
Commission 3,00,000
Expenses of management 2,00,000
Provision against unexpired risk on 1st April, 2013 5,50,000
Claims unpaid on 1st April, 2013 50,000
Claims unpaid on 31st March, 2014 80,000
Create Reserve for Unexpired Risk @ 50%.

135
 ACCOUNTING STANDARD NOTES
TOTAL AS IN OUR SYLLABUS

IND AS-1 Presentation of Financial Statements

IND AS-2 Inventories

IND AS-10 Events after the Reporting Period

IND AS-19 Employee Benefits

IND AS-33 Earnings Per Share

IND AS-37 Provisions, Contingent Liabilities and

Contingent Assets

CONCEPTUAL FRAMEWORK (Theory Part)

136
 IND AS-1 Presentation of Financial Statements

Introduction
1. Financial statements are the end products of accounting. Thus, they must reflect a
true and fair view ofthe financial performance and financial position of the
organisation in order to facilitate appropriate decisions by the users of accounting
information.
2. Accordingly, the financial statements must possesscertain characteristics and be
prepared based on certain well-defined principles.
3. Ind AS 1, Presentation of Financial Statements, prescribes the principles for
preparation of General Purpose Financial Statements, their structures and
minimum content requirements as well as
guidelines for specific disclosure in India.

Applicability
1. This Standard applies to all profit-oriented business undertakings including
public sector business entities. Non-profit entities may also apply the
provisions of this Standard with suitable modification in terminology used.
2. It is also equally applicable to all entities which prepare Consolidated Financial
Statements and Separate Financial Statements as defined in Ind AS 27,
Consolidated and Separate Financial Statements.
3. However, thestandard does not apply to condensed/summarized financial
statements covered by Ind AS-34, Interim Financial Reporting.

Meaning of General Purpose Financial Statements

General purpose financial statements (referred to as ‘financial statements’) are those
intended to meet the needs of users who are not in a position to require an entity to
prepare reports tailored to their particular informationneeds. Hence, their use is
‘General’ and not specific.

Objectives of Financial Statements

1. Financial statements are a structured representation of the financial position

137
 and financial performance ofan entity.

2. The objective of financial statements is to provide information about the

financial position (assets, liabilities and equity), financial performance
(income/expenses, gains and losses) and cash flows (movement of cash and
cash equivalent) of an entity that is useful to a wide range of users in making
economic decisions.
3. Financial statements also show the results of the management’s stewardship
of the resources entrusted to it.

Complete Set of Financial Statements

A complete set of financial statements comprises:
a. a balance sheet as at the end of the period;
b. a statement of profit and loss for the period in a single statement of profit and loss,
with profit or loss andother comprehensive income presented in two sections. The
sections shall be presented
together, with theprofit or loss section presented first followed directly by the other
comprehensive income section.;
c. Statement of changes in equity for the period;
d. a statement of cash flows for the period;
e. notes, comprising a summary of significant accounting policies and other
explanatory information; and comparative information in respect of the preceding
period.
f. a balance sheet as at the beginning of the preceding period when an entity applies
an accounting policy retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial statements.

General Features of Financial Statements

The above financial statements must possess the following features or characteristics in
order to be relevant and reliable:
a. True and fair presentation and compliance with Ind ASs.
b. Adherence to Going Concern assumption.
c. Accrual basis of accounting
d. Materiality and aggregation
e. Offsetting

138
 f. Frequency of reporting (financial statements are to be prepared at least
annually)
g. Comparative information (information for the previous period should be
disclosed unless exempted by Ind
AS)
h. Consistency of presentation (similar accounting policies should be continued;
changes if any for appropriate presentation or as required by Ind AS will be
allowed).

These features are discussed below

True and fair presentation and compliance with Ind ASs.

1. Financial statements shall present a true and fair view of the financial position,
financial performance andcash flows of an entity.
2. Such presentation requires the faithful representation of the effects of
transactions,other events and conditions in accordance with the definitions
and recognition criteria for assets, liabilities, income and expenses set out in the
Framework.
3. The application of Ind ASs, with additional disclosure, when necessary, is
presumed to result in financial statements that present a true and fair view.
Going Concern
Financial statement should be prepared assuming that the entity will continue its
business in foreseeable future unless management intends to liquidate the entity or
cease trading or has no realistic option but to close.

Accrual basis of accounting

An entity shall prepare its financial statements, except for cash flow information,
using the accrual basis of accounting. Thus, asset and liabilities will be recognized
when they are receivable and payable rather thanwhen actually received or paid.

Materiality and aggregation

Each material class of similar items shall be presented separately in the financial
statement, Items which are not material need not to be disclosed except if it is
required by law.

139
Offsetting
An entity shall not offset assets and liabilities or income and expenses, unless required
or permitted by Ind AS.

Frequency of reporting
An entity shall present a complete set of financial statements (including comparative
information) at least annually. When an entity changes the end of its reporting period
and presents financial statements for a period longer or shorter than one year, an
entity shall disclose the following, in addition to the period covered bythe financial
statements:

1. the reason for using a longer or shorter period, and

2. the fact that amounts presented in the financial statements are not entirely comparable.

Comparative information
1. Minimum comparative information
Except when Ind ASs permit or require otherwise, an entity shall present comparative
information in respectof the preceding period for all amounts reported in the current
period’s financial statements. An entity shallpresent, as a minimum, two balance
sheets, two statements of profit and loss, two statements of cash flowsand two
statements of changes in equity, and related notes.
2. Additional comparative information
An entity may present comparative information in addition to the minimum comparative
financial statements required by Ind ASs, as long as that information is prepared in
accordance with Ind ASs.
Note: When there is change in accounting policy and such change is retrospectively
applied or there is retrospective restatement of item in the financial statement then
the entity shall present a minimum of three balance sheet, two profit or loss
statement and two cash flow.
When it is impracticable to re-classify comparative amounts, an entity must disclose the reason
thereof.

Consistency of presentation
Entities should retain their presentation and classification of items from one period to
the next. Change may be allowed only when

140
 • the change result in a more appropriate presentation
• it is required by an Ind AS.

Structure and Content

Students are advised to follow Module 2 of this Study Material for detail discussion
on structure and contentof financial statement.

141
Accounting Standard Question
IND AS-2 INVENTORY
Illustration 1
How do you deal with the following?
On 31.3.2021, the closing stock of Gourav Ltd. includes 10,000 units costing @ ` 10 i.e., `1,00,000. But
the current market price as on that date was @ ` 9 i.e., ` 90,000.

Illustration 2
From the following information presented by P Ltd. ascertain the value of stock to be included in
Balance Sheet: Cost Price of certain stock amounted to `60,000; being obsolete, it can be used for
production purposes after incurring `10,000 for modification. The same could be used as a raw material
for an existing product, the purchase price for the same amounts to `40,000.

Illustration 3
How will you deal with the following situation?
“A company deals in purchase and sale of timber and has included notional interest charges calculated
(on the paid-up share capital and free reserves) in the value of stock of timber as at the Balance Sheet
date as part of cost of holding the timber”.

Illustration 4
The company deals in three products A, B and C which are neither similar nor interchangeable. At the
time of closing of its account for the year 2020-21, the historical cost and net realisable value of the
items of closing stock are determined as:

Item Historical Cost (` in Net Realizable Value (` in

s lakhs) lakhs)
A 40 28
B 32 32
C 16 24
What will be the value of closing inventories?

Illustration 5
Z Co. Ltd. purchased goods at the cost of ` 40 lakhs in October 2020. Till March 2021, 75% of the stocks
were sold. The company wants to disclose closing stock at `10 lakhs. The expected sales value is `11
lakhs and a commission at 10% on sale is payable to the agent. What is the correct closing stock to be

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disclosed as at 31.3.2021?

Illustration 6
How would you deal with the following in the annual accounts of a company for the year ended 31.3.2021?
“The company has to pay delayed cotton clearing charges over and above the negotiated price for asking delayed
delivery of cotton from the supplier’s godown. Up to 2019-20, the company has regularly included such charges
in the valuation of closing stock. This being in the nature of interest the company has decided to
exclude it from closing stock valuation for the year 2020-21. This would result into decrease in profit
by `7.60 lakhs.”

Illustration 7
Sonar Bhandar deals in old colour TVs. It has 4 TVs the particulars of which are given below:
You are asked to compute the value of inventory to be included, in Balance Sheet for the year ended 31st
March 2021.

TVs Onid Philip EC Son Tot

a s (`) (`) y al
(`) (`) (`)
Cost Price 10,000 20,000 35,000 50,000 1,15,00
0
Expenses incurred to bring into salable 3,000 2,000 5,000 - 10,00
conditions 0
Net Realizable Value 18,000 30,000 36,000 55,000 1,39,00
0

Illustration 8
The following particulars are presented by M Ltd. (deals in clothing) as on 31.3.2021:
Compute the value of stock as per Ind AS 2.
Stock held by M Ltd.:
Cost Price `10,550
Net Realisable Value
`11,50
0 The details of such stocks were:
Particulars Cost Price Net Realizable Value
(`) (`)

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 Cotton 5,600 4,960
Woolen 3,450 4,540
Synthetic 1,500 2,000
Total 10,550 11,500

Illustration 9
The total stock of A Ltd. as on 31.3.2021 was `5,00,000 of which stock amounting to `31,000 were not
ascertained as per Ind AS 2.
Compute the value of the said stocks as per Ind AS 2 for inclusion in financial statements as on that date.

Type Cost of Production Selling and Estimated

of Materials Expenses Distribution Selling Price (`)
Produ (`) incurred (`) expense to be incurred
ct (`)
P 10,000 2,000 1,000 15,000
S 5,000 --- 500 4,500
T 12,000 3,000 2,000 18,000
27,000 5,000 3,500 37,500

Illustration 10
X Ltd. presented the following particulars as on 31.3.2021 on the total cost of product:

Particula Cost per unit

rs (`)
Cost of materials (`12 each) 50
Manufacturing inputs 30
Total Cost 80
Profit 20
Selling Price 100
On 31.3.2021, selling price has gone down suddenly from ` 100 to `70. Price of raw material has also
gone down to `8 each. X Ltd. had in its stock 6,000, units of materials which was bought as per the
above rate on the same date. Compute the value of stock as on 31.03.2021.

Illustration 11
State with reference to accounting standards how will you value the inventories in the following cases:

144
 (i) Raw materials were purchased at `100 per kg. Prices of raw materials are on the decline.
The finished goods in which the raw materials is incorporated is expected to be sold at
below cost. 10,000 Kgs. of raw materials is on stock at the year end. Replacement cost
is `80 per kg.
(ii) In a production process, normal waste is 5% of input. 5,000 MT of input were put in
process resulting in a wastage of 300 MT. Cost per MT of input is `1,000. The entire
quantity of waste is on stock at the year-end.
(iii) Per kg of finished goods consisted of:

`
Material Cost 100
Direct Labour 20
Direct Variable Production Overhead 10
Fixed production charges for the year on normal capacity of one lakh kg is `10 lakhs. 2,000 kg of
finished goods are on stock at the year end.

IND AS-10 EVENT AFTER REPORTING PERIOD

Illustration 1
X Ltd. finalized its accounts on 31.03.2021. However, the financial statements were approved by the
Board on 20.05.2021. An accident occurred in the premises of X Ltd. on 30.05.2021 and properties worth
`50 lakh has been lost. Will it be considered as an event after the reporting period as per the scope of
Ind AS 10?

Illustration 3
A Ltd. closed its accounting year on 31/03/2021 and the accounts for that period were considered and
approved by the board of directors on 20th May, 2021. The company was engaged in boring tunnels
for metro railway. While doing the boring work on 01/06/2021 it hit an aquifer and as a result 18
building were damaged. It was estimated that there would be extra cost to the tune of `15 crores. You
are required to state with reasons, how it would be dealt with in the financial statements for the year
ended 31.03.2021.

Illustration 4
While preparing its final accounts for the year ended 31st March, 2021, a company made a provision for
doubtful debts @ 5% of its total debtors. In the last week of February 2021, a debtor for `20 lakh suffered
heavy loss and subsequently became insolvent in April, 2021. Can the company provide the full loss out of the
insolvency of the debtor in the final accounts for the year ended on 31.03.2021?

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Illustration 5
B Ltd. supplies parts to a car manufacturer in respect of a particular model of car. On the reporting date,
B Ltd. has a high level of inventory of parts due to low order levels. After the reporting date but before
the date of approval of the financial statements, the car manufacturer announces that the specific
model will no longer be produced. There is no alternative market for the inventory. Should B Ltd. write-
down of inventory to net realizable value and adjust the inventory reported on the reporting date?

Illustration 6
Prior to the approval of the financial statements but subsequent to the balance sheet date, C Ltd. in trading
difficulties obtained a valuation of its properties for the purpose of providing additional security to its
bankers. C Ltd. is also considering selling certain properties to generate additional cash. The amount
estimated by the valuer is materially lower than the carrying amount attributed to the properties at the
balance sheet date based on the last impairment review carried out three years ago. How should this
be reflected in the financial statements?

Illustration 7
The exchange differences arising on the translation of the bank overdraft since the balance sheet date
exceed the profit for the period under review due to an adverse movement on the foreign exchange
rate after year end. How should this be reflected in the financial statements?

Illustration 8
AIR Aviation Co. Ltd. announced a restructuring programme in 2018 which was implemented in full in
2019. The workforce was adequately downsized and a number of non-profitable routes were
suspended. However, in view of the still -difficult market environment, the high cost of aviation fuel
and continuing declines in yields, the Board of Directors approved a further package of measures on
January 31, 2020 under which the regional aircraft fleet will be reduced by at least 15 aircraft. This
action is intended to reduce net annual cost by recurring `200 lakh. The
actions will be taken over the next 15 months. The company is expecting a break-even in 2021. Should the company
prepare its financial statements on a going concern basis?

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IND AS-19 Accounting for Employee benefit.

Illustration 1
A Ltd. has 100 employees. Each employee is entitled to 10 days sick leave each year. Unused sick leave
is carried forward for one year. An employee avails the carried forward leave only if the current year’s
entitlement falls short of the leave he or she requires.
On December 31, 2020, the average unused sick leave is 2 days per employee. The management, based
on experience, estimates that in the year 2021, only 10% of the employees will use one day from their
carried forward leave and the rest of the employees will not require more than 10 days of leave. Average
payment per employee per day is `100. How will you treat this?

Illustration 2
Mr. X is an employee of ABC Ltd. His annual salary is `15 lakh. The company follows a 300 working days
policy. As per the policy of the company, Mr. X is entitled to a leave of 10 days for 2020-21. He, however,
utilises 8 days leave. The unutilised leaves are not allowed to be carried forward but are settled by way
of payment to the employee. Compute the total employee benefit expenses of ABC Ltd. in respect of
Mr. X.

Illustration 3
A profit-sharing plan requires an entity to pay a specified proportion of its net profit for the year to
employees who serve throughout the year. If no employee leaves during the year, the total profit-sharing
payments for the year will be 5% of net profit. The entity estimates that some of the staff may leave
during the year and therefore not entitled for profit sharing this will reduce the payment of profit-
sharing plan from 5% to 4% of net profit. Advise the company.

Illustration 4
Consider the following information:
No. of employees (same as the previous year) = 150 Employees’
turnover rate = 6%
Bonus paid to each employee last year = `1,00,000
Increase in bonus rate due to inflation = 7% (as per company’s regular practice)
Determine the liability and expense to be recognised.

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Illustration 5

The following information applies to a company’s defined benefit pension plan for
the year: FMV of plan assets (beginning of the year) `2,00,00
FMV of plan assets (end of the year) `2,85,000
Employer’s contribution ` 70,000
Benefit paid ` 50,000
Calculate the actual return on plan assets.

Illustration 6
Consider the following information provided by Y Ltd:
PV of defined contribution obligations `15 lakh.
Fair value of plan assets `14.12 lakh
How will you treat the above for presentation in the Balance Sheet?

Illustration 7
Consider the following information provided by Z Ltd:
PV of defined contribution obligations `15 lakh.
Fair value of plan assets `15.22 lakh
Asset ceiling `0.19 lakh
How will you treat the above for presentation in the Balance Sheet?

IND AS-33 Earning Per Share

Illustration 1
The following information has been provided by A Ltd.
Paid up capital: 100000 ordinary shares of ` 1.00 = ` 1,00,000
20000, 10% Preference shares of ` 1.00 = `20,000
Gross Profit for the year ended on 31.03.2021 = `3,50,000
Other operating expenses = `1,00,000
Tax rate 30%
Determine profit or loss attributable to ordinary equity holders.

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Illustration 2
01.04.2020 B Ltd. has 3600 ordinary shares outstanding. On 31.08.2021 it issued 1200 ordinary shares for
cash. On 31.01.21 it bought back 600 ordinary shares. Calculate weighted average number of shares as
on 31.03.21.

Illustration 3
Refer to Illustration 2. If profit or loss attributable to ordinary equity holders of B Ltd. for the year ended on
31.03.21 was `21,00,000, calculate Basic EPS.

Illustration 4
D Ltd. had outstanding ordinary shares of 10,00,000on 01.04.2020. Profit for the year is `20,00,000. D
Ltd. had 12% 20,000 convertible debentures outstanding of `100 each to be converted into 10 ordinary
shares. Tax rate is 30%. Calculate (i) Basic EPS (ii) Diluted EPS

Illustration 5
Consider the following information given by F Ltd.
Net Profit for the year ended on 31.03.2021= `86,50,000
Paid-up capital: 25,00,000 ordinary shares of `10 each
100000, 10% Debentures of `100 each were issued on 31.09.2020.
Tax rate 30%
Conversion rate: 10 ordinary shares for each debenture.
Calculate Diluted EPS.

Illustration 6
E Ltd. had 10,00,000 ordinary shares outstanding on 01.04.2020. Profit for 2020-21 was `24,00,000.
Average fair value per share during 2020-21 was ` 20. E Ltd. has given share option to its employees of
2,00,000 shares at option price of `15. Calculate basic EPS and diluted EPS.

Illustration 7
X Ltd. has 320 written put options outstanding on 320 of its ordinary shares, with an exercise price of `

149
10 per option. The put obligation is therefore `3,200. The average market price of the entity’s ordinary
shares is `8 for the period. The company expects to issue 400 ordinary shares at ` 8 per share to raise
the proceeds necessary to satisfy the put option. How will you treat the above?

Illustration 8
Y Ltd. supplied the following information:
Net Profit for 2019-20 = `10,00,000
Net Profit for 2020-21 = `15,00,000
No. of shares prior to right issue = 5,00,000
Terms of right issue: 1 new share for every 4 shares held; right issue price = `20
Fair value of 1 ordinary share immediately prior to exercise of right = `25
Calculate basic EPS.

Illustration 9
C Ltd. had 10,00,000 ordinary shares outstanding as on 01.04.2020. On 01.01.2021 it issued 2 ordinary
shores bonus for each shore outstanding on 31.12.2020, Profit for the year 2019-20 was `9,00,000. Profit
for 2020-21 was `30,00,000. Calculate Basic EPS the year 2020-21 and adjusted EPS for the year 2019-
20.

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IND AS-37 Provision, Contingent Liability & Contingent Assets

Illustration 1
An entity sells goods with a warranty under which customers are covered for the cost of repairs of any
manufacturing defects that become apparent within the first six months after purchase. If minor
defects were detected in all products sold, repair costs of ` 1 lakh would result. If major defects were
detected in all products sold, repair costs of ` 4 lakh would result. The
entity’s past experience and future expectations indicate that, for the coming year, 75 per cent of the
goods sold will have no defects, 20 per cent of the goods sold will have minor defects and 5 per cent of
the goods sold will have major defects.
Calculate the amount to be provided.

Illustration 2
An entity has an obligation to restore an asset for the damage it has in the past. It has `20 lakh cash to
pay on 31.03.2020 relating to this liability. The entity considers that 15% is an appropriate discount rate.
the time value of money is considered material. Calculate the amount to be provided.

Illustration 3
X Ltd. has become subject to an obligating event on 01.04.2020 for which the company is committed
to expenditure of `5,00,000 at the end of 10 years. An appropriate discount rate is 10%. Show how the
same is to be treated by X Ltd. (Show treatment up to 31.03.2022)

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TABLE OF CONTENTS
SN CHAPTER PAGE NO.
1 COMPANY AUDIT CHAPTER – 1 BASICS 2
2 COMPANY AUDIT CHAPTER – 2 COST AUDIT 30
3 COMPANY AUDIT CHAPTER – 3 VOUCHING & VERIFICATION 41
4 SPECIAL AUDIT 81
5 CORE AUDIT CHAPTER – 1 101
6 CORE AUDIT CHAPTER – 2 118
7 CORE AUDIT CHAPTER – 3 124
8 CORE AUDIT CHAPTER – 4 132

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Provisions related to audit under Companies Act, 2013

CHAPTER – 1 STATUTORY AUDIT

Company
As per section 2(20) of The Companies Act, 2013, Company means a company registered under this act or any
previous company laws.

Prof Haney- A company is

- An artificial Person
- Created by law
- Having separate legal entity
- With perpetual succession and
- Common Seal

The term ‘statutory’ signifies anything regulated by laws of the state. Accordingly, an audit which is conducted
under any specific statute or Act may be called ‘statutory audit’.

Company is run by managers not shareholders so, management’s stewardship must be properly vouched by an
independent third party. This is why, audit of the books of accounts by a qualified and independent auditor has
been made mandatory in every company.

According to SA 200, Basic Principles Governing an Audit,

“An audit is an independent examination

of financial information of any entity,

whether profit oriented or not, and

irrespective of its size or legal form,

when such examination is conducted with a view to expressing an opinion thereon”.

SN TOPIC SECTION
1 Appointment of Auditors 139
2 Removal, Resignation of auditor and giving of special notice 140
3 Eligibility, Qualifications and Disqualifications of Auditor 141
4 Remuneration of Auditor 142
5 Powers and Duties of auditor 143
6 Auditor not to render Certain Services 144
7 Auditor to sign audit reports 145
8 Auditor to attend general meeting 146
9 Punishment for Contravention 147
10 Cost Audit 148
11 Audit Committee 177

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Eligibility, Qualification and Disqualification of Company Auditor (Section 141)

1. A person shall be eligible for appointment as an auditor of a company, only if he is a Chartered Accountant
A firm can also be appointed by its firm name to act as the auditor of a company if majority of its partners
practicing in India are qualified for appointment as company auditor
2. Where a firm, including a limited liability partnership, is appointed as an auditor of a company, only the
partners who are Chartered Accountants shall be authorized to act and sign on behalf of the firm
3. the following persons shall not be eligible for appointment as an auditor of a company:
a. a body corporate other than a limited liability partnership registered under the Limited Liability
Partnership Act, 2008; (co-operative society)
b. an officer or employee of the company;
c. a person who is a partner, or
who is in the employment of an officer or employee of the company;
d. a person who, or his relative or partner:
i. is holding any security of or interest in the company or its subsidiary, or of its holding or
associate company or a subsidiary of such holding company, of face value not exceeding
rupees one lakh;

(Note: The relative (not the partner and the auditor) may hold security or interest in the company of face value
not exceeding Rs 1,00,000 or such amount as may be prescribed).

(If a relative acquires any security exceeding Rs 1,00,000, then, the auditor shall take the corrective action within
next 60 days so as to maintain the limit of Rs 1,00,000.)

ii. is indebted to the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, in excess of rupees five lakh;
iii. has given a guarantee or provided any security in connection with the indebtedness of any
third person to the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, in excess of rupees one lakh;

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Relative Section 2(77) of The Companies Act, 2013

“relative”, with reference to any person, means any one who is related to another, if—

(i) they are members of a Hindu Undivided Family;

(ii) they are husband and wife; or.
(iii) one person is related to the other in such manner as may be prescribed.

As per rule 4 of the companies (specification and definition details) rules, 2014, a person shall be deemed to
be the relative of another, if he or she is related to another in the following manner, namely:

a. Father (including step father)

b. Mother (including step mother)
c. Son (including step son)
d. Son’s wife
e. Daughter
f. Daughter’s husband
g. Brother (including step brother)
h. Sister (including step sister)

e. a person or a firm who, whether directly or indirectly, has business relationship with the company,
or its subsidiary, or its holding or associate company or subsidiary of such holding company or
associate company of such nature as may be prescribed

Note: For this purpose, the term ‘business relationship’ shall be construed as any transaction
entered into for a commercial purpose, except –
(a) commercial transaction which are in the nature of professional services permitted to be
rendered by an auditor or audit firm under the Companies Act, 2013 or the Chartered
Accountants Act, 1949 and the rules or regulations made under those Acts;
(b) commercial transactions which are in the ordinary course of business of the company at
arm’s length price– like sale of products or services to the auditor as customer.

f. a person whose relative is a director or is in the employment of the company as a director or key
managerial personnel;
g. a person who is in full time employment elsewhere or a person or a partner of a firm holding
appointment as its auditor, if such persons or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty companies (other than OPC,
dormant companies, small companies, private companies having paid up share capital less than 100
crores)

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Ceiling on the Number of Audit Assignments

• Every qualified chartered accountant who is not in full time employment can be the auditor
of a maximum of twenty companies.
• In case of a partnership firm, the limit will be twenty companies for each individual partner.
Hence, for a firm with three partners, the overall limit will be (20 × 3) = 60 companies.
• While computing the ceiling in case of a partnership firm, a partner with full time
employment elsewhere should not be taken into account.
• If any chartered accountant is a partner in a number of audit firms, then all the firms
together will be entitled to audit 20 companies with respect to such common partner.
• Similarly, if a chartered accountant is practicing individually and is also the partner in other
firm or firms, the overall ceiling with respect to him as individual and also the partner will
be 20 companies.
• While calculating the above ceiling, a joint audit assignment will be taken as one unit.
Moreover, if an auditor is appointed to audit even a part of company’s accounts, it will be
considered as one unit.
• Every auditor, as an individual or as a partner of a firm can accept a maximum of 60 tax
audit assignments.

h. a person who has been convicted by a court of an offence involving fraud and a period of ten years
has not elapsed from the date of such conviction;
i. a person who, directly or indirectly (any person whose subsidiary associate or any other form of
entity), renders any service referred to in Section 144 to the company or its holding company or its
subsidiary company.
4. Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-
section 141(3) after his appointment, he shall vacate his office as such auditor and such vacation shall be
deemed to be a casual vacancy in the office of the auditor.

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Note: According to Section 144 of the Companies Act, 2013, an auditor appointed under this Act shall
provide to the company only such other services as are approved by the Board of Directors or the audit
committee, as the case may be. However, such services shall not include the following services, whether
rendered directly or indirectly to the company or its holding company or subsidiary company.

(a) accounting and book keeping services;

(b) internal audit;

(c) design and implementation of any financial information system;

(d) actuarial services;

(e) investment advisory services;

(f) investment banking services;

(g) rendering of outsourced financial services;

(h) management services; and

(i) any other kind of services as may be prescribed.

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Appointment of Auditor (Section 139)

1. APPOINTMENT OF SUBSEQUENT AUDITORS OF A COMPANY OTHER THAN GOVT.
COMPANY
• Every company shall, at the first annual general meeting,
appoint an individual or a firm as an auditor
who shall hold office from the conclusion of that meeting till the conclusion of its sixth annual
general meeting and
thereafter till the conclusion of every sixth meeting.

• Before such appointment is made,

the written consent of the auditor to such appointment and
a certificate from him or it that the appointment, if made, shall be in accordance with the
conditions as prescribed,
shall be obtained from the auditor.

• The certificate shall also indicate whether the auditor satisfies the criteria provided in Section 141.

• The company shall inform the auditor concerned of his or its appointment, and
also file a notice of such appointment with the Registrar
within fifteen days of the meeting in which the auditor is appointed
in Form ADT-1 [Rule 4(2)]

2. ROTATION OF AUDITOR
a. No individual shall be appointed or reappointed as auditor for more than one term of five
consecutive years.
b. No audit firm shall be appointed or reappointed as auditor for more than two terms of five
consecutive years

Additional Conditions for Rotation

(i) An individual auditor or an audit firm who/which has completed his/its term shall not be eligible
for reappointment as auditor in the same company for five years from the completion of such term.
(ii) On the date of appointment, no audit firm having a common partner or partners to the other audit
firm, whose tenure has expired in a company immediately preceding the financial year, shall be
appointed as auditor of the same company for a period of five years:
(iii) Every company, existing on or before the commencement of this Act, which is required to comply
with provisions of Section 139(2), shall comply with requirements of this sub-section within a
period which not be later than the date of the first AGM of the company held within the period
specified in Section 96(1), after 3 years from the date of commencement of Companies Act.
(iv) The above provisions shall not prejudice the right of the company to remove an auditor or the right
of the auditor to resign from such office of the company.

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Eligible Companies (Rule 5 of Companies (Audit and Auditors) Rules, 2014

The provisions for rotation of auditors shall be applicable to –

(i) Every listed company excluding one person companies and small companies.
(ii) Every unlisted public company having paid up share capital of rupees ten crore or
more;
(iii) Every private limited company having paid up share capital of rupees fifty crore or
more;
(iv) All other companies having public borrowings from financial institutions, banks or
public deposits of rupees fifty crore or more.

SMALL COMPANY

A paid-up share capital equal to or below Rs.4 crore or such a higher amount specified not
exceeding more than Rs.10 crores.

A turnover equal to or below Rs.40 crore or such a higher amount specified not exceeding more
than Rs.100 crore.

3. ROTATION OF PARTNERS IN AUDIT FIRMS

According to Section 139(3), the members of a company may resolve to provide that –
(i) in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals
as may be resolved by members; or
(ii) the audit shall be conducted by more than one auditor.

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4. MANNER OF ROTATION OF AUDITORS BY THE COMPANIES ON EXPIRY OF THEIR TERM

As per Section 139(4), the Central Government may, by rules, prescribe the manner in which the companies
shall rotate their auditors in pursuance of Section 139(2).

Accordingly, the Central Government has prescribed the following provisions under Rule 6 of the
Company (Audit and Auditor) Rules 2014.
(i) Where a company is required to constitute an Audit Committee u/s 177 of the Act, the Audit
Committee shall recommend to the Board, the name of an individual auditor or of an audit firm
who may replace the incumbent auditor on expiry of the term of such incumbent.
(ii) Where a company is not required to constitute an Audit Committee u/s 177 of the Act, the
Board shall consider the matter of rotation of auditors and make its recommendation for
appointment of the next auditor by the members in annual general meeting

Note: For the purpose of the rotation of auditors –

(i) the period for which the individual or the firm has held office as auditor prior to the
commencement of the Act shall be taken into account for calculating the period of five
consecutive years or ten consecutive years, as the case may be;
(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated
with the outgoing auditor or audit firm under the same network of audit firms. The term “same
network” shall include the firms operating or functioning, hitherto or in future, under the same
brand name, trade name or common control.

Note: For the purpose of rotation,

(i) a break in the term for a continuous period of five years shall be considered as fulfilling the
requirement of rotation;
(ii) if a partner, who is in charge of an audit firm and also certifies the financial statements of the
company, retires from the said firm and joins another firm of chartered accountants, such other
firm shall also be ineligible to be appointed for a period of five years.

5. APPOINTMENT OF SUBSEQUENT AUDITOR IN CASE OF GOVT. COMPANY

• In the case of a Government company or any other company owned or controlled, directly or indirectly,
by the Central Government, or by any State Government or Governments, or partly by the Central
Government and partly by one or more State Governments, the Comptroller and Auditor General of
India shall, in respect of a financial year, appoint an auditor duly qualified to be appointed as an auditor
of companies under this Act, within a period of 180 days from the commencement of the financial
year.
• The auditor, so appointed, shall hold office till the conclusion of the annual general meeting.

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Government company Section 2(45)

Any company in which not less than 51% of the paid up share capital is held by

a. CG; or
b. SG(s); or
c. Partly by CG and partly by SG(s)

Govt company includes a company which is subsidiary co of a govt company

6. APPOINTMENT OF FIRST AUDITOR IN CASE OF A COMPANY OTHER THAN A GOVERNMENT COMPANY

• The first auditor of a company, other than a Government company, shall be appointed by the Board
of Directors within thirty days from the date of registration of the company.
• In the case of failure of the Board to appoint such auditor, it shall inform the members of the
company, who shall appoint such auditor within ninety days at an extraordinary general meeting.
• The auditor, so appointed, shall hold office till the conclusion of the first annual general meeting.

7. APPOINTMENT OF FIRST AUDITOR IN CASE OF A GOVERNMENT COMPANY

• In the case of a Government company or any other company owned or controlled, directly or
indirectly, by the Central Government, or by any State Government, or Governments, or partly by
the Central Government and partly by one or more State Governments, the first auditor shall be
appointed by the Comptroller and Auditor-General of India within sixty days from the date of
registration of the company.
• In case the Comptroller and Auditor-General of India does not appoint such auditor within the
aforesaid period, the Board of Directors of the company shall appoint such auditor within the next
thirty days.
• Further, in the case of failure of the Board to appoint such auditor within the next thirty days, it
shall inform the members of the company who shall appoint such auditor within sixty days at an
extraordinary general meeting.
• The auditor, so appointed, shall hold office till the conclusion of the first annual general meeting.

8. APPOINTMENT IN CASE OF FILLING A CASUAL VACANCY

A. In case of a company other than a company whose accounts are subject to audit by an auditor
appointed by the CAG
• Any casual vacancy will be filled by the Board of Directors within thirty days.
• If such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be
approved by the company at a general meeting convened within three months of the
recommendation of the Board.
• The auditor, so appointed, shall hold the office till the conclusion of the next annual general
meeting.

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B. In case of a company whose accounts are subject to audit by an auditor appointed by the CAG
• Any casual vacancy will be filled by the Comptroller and Auditor-General of India within thirty days.
• In case the Comptroller and Auditor-General of India does not fill the vacancy within the aforesaid
period, the Board of Directors shall fill the vacancy within next thirty days.

Note: Though not defined clearly, ‘casual vacancy’ for the aforesaid purpose usually implies cessation
of service of an existing auditor due to his death, resignation, disqualification, etc.

9. RE-APPOINTMENT OF A COMPANY AUDITOR

As per Section 139(9), a retiring auditor may be re-appointed at an annual general meeting, if:
(a) he is not disqualified for re-appointment;
(b) he has not given the company a notice in writing of his unwillingness to be re-appointed; and
(c) a special resolution has not been passed at that meeting appointing some other auditor or providing
expressly that he shall not be re-appointed.

10. AUTOMATIC RE-APPOINTMENT OF A COMPANY AUDITOR

According to Section 139(10), where at any annual general meeting, no auditor is appointed or re-
appointed, the existing auditor shall continue to be the auditor of the company.

11. ROLE OF AUDIT COMMITTEE’S RECOMMENDATION IN APPOINTMENT OF AUDITORS

Where a company is required to constitute an Audit Committee under section 177, all appointments,
including the filling of a casual vacancy of an auditor under this section shall be made after taking into
account the recommendations of such committee.

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Removal, resignation of auditor and giving of special notice – Section 140

1) REMOVAL OF THE AUDITOR BEFORE EXPIRY OF HIS TERM

The auditor appointed under Section 139 may be removed from his office before the expiry of his term,
subject to the fulfilment of the following conditions under Section 140 (1) read with Rule 7 of CAAR 2014:

(i) A special resolution has been passed by the company

(ii) An application to the Central Government for removal of the auditor shall be made
in Form ADT-2. The application shall be accompanied with fees as provided for this
purpose under the Companies (Registration Offices and Fees) Rules, 2014.
(iii) The application shall be made to the Central Government within thirty days of the
resolution passed by the Board.
(iv) The company shall hold the general meeting within sixty days of receipt of approval
of the Central Government for passing the special resolution for removal of the said
auditor.
(v) The auditor concerned shall be given a reasonable opportunity of being heard.

2) RESIGNATION BY A COMPANY AUDITOR

According to Section 140(2) of Companies Act, 2013 read with Rule 8 of Company (Audit and Auditors) Rule
2014, a company auditor resigning from his post must comply with the following steps:
(a) The auditor shall file within a period of thirty days from the date of resignation, a
statement in the prescribed Form ADT-3 with the company and the Registrar, indicating
the reasons and other facts as may be relevant with regard to his resignation.
(b) In case of companies referred to in sub-section (5) of Section 139, i.e., Govt. Companies
or any other company owned or controlled, directly or indirectly, by the Central
Government, or by any State Government or Governments, or partly by the Central
Government and partly by one or more State Governments, the auditor shall file such
statement with the Comptroller and Auditor-General of India.

3) PENALTY FOR NON-FILLING OF STATEMENT

If the auditor does not comply with the above provision, he or it shall be punishable with fine of fifty
thousand rupees or the amount equal to the remuneration of the auditor, whichever is less, and in case of
continuing failure, with further penalty of five hundred rupees for each day after the first during which such
failure continues, subject to a maximum of two lakh rupees.

4) i. Special notice shall be required for a resolution at an annual general meeting appointing as auditor a
person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed,
except where the retiring auditor has completed a consecutive tenure of five years or, as the case may be,
ten years, as provided under sub-section (2) of section 139.
ii. On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring
auditor.

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5) REMOVAL OF THE AUDITOR BY THE TRIBUNAL

As per Section 140(5), an auditor can be removed from his office by the Tribunal in the following manner:

• The Tribunal either suo-motu or on an application made to it by the Central Government or by any
person concerned, may, by order, direct the company to change its auditor, if it is satisfied that the
auditor has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in
any fraud by, or in relation to, the company or its directors or officers.
• If the application is made by the Central Government and the Tribunal is satisfied that any change
of the auditor is required, it shall within fifteen days of receipt of such application, make an order
to the removal of the auditor from his office.
• The Central Government may appoint another auditor in his place.
• An auditor, whether individual or firm, against whom final order has been passed by the Tribunal
under this Section shall not be eligible to be appointed as an auditor of any company for a period
of five years from the date of passing of the order and the auditor shall also be liable for action
under Section 447.

Note: For this purpose, the word ‘auditor’ shall include a firm of auditors. Moreover, in case of a firm, the
liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or
abetted or colluded in any fraud by, or in relation to, the company or its directors or officers.

Section 2 (90) – Tribunal means the national company law tribunal constituted under section 408

Remuneration of Company Auditor (142)

Section 142 of Companies Act, 2013 contains the statutory provisions in relation to remuneration of auditors
are contained in. These are as follows:

(1) The remuneration of the auditor of a company shall be fixed in its general meeting or in such
manner as may be determined therein. The Board may, however, fix remuneration of the first
auditor appointed by it.
(2) The above remuneration shall be in addition to the fee payable to an auditor and shall include
the expenses, if any, incurred by the auditor in connection with the audit of the company and
any facility extended to him. However, it must not include any remuneration paid to him for
any other service rendered by him at the request of the company.

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Rights and Duties of the Company Auditor (143)

Accordingly, the Companies Act, 2013 provides the following statutory rights to a company auditor:

(i) Inspect Books of Accounts and Vouchers: Every auditor of a company shall have the right of
access, at all times, to the books of account and vouchers of the company, whether kept at the
registered office of the company or at any other place. In addition, auditor of a holding company
shall also have the right of access to the records of all its subsidiaries and associate companies
in so far as it relates to the consolidation of its financial statements with that of its subsidiaries
[Section 143(1)].
(ii) Obtain Information and Explanations: The auditor shall be entitled to require from the officers
of the company such information and explanation as he may consider necessary for the
performance of his duties as the auditor
(iii) Inspect Branch Offices and Branch Accounts: The company auditor is also entitled to inspect the
accounts of any branch office in case he considers it necessary in order to discharge his duties as
the company auditor. He can do so, even if a separate auditor has already been appointed to
audit the branch accounts [Section 143(8)].
(iv) Receive the Report of Branch Audit from the Branch Auditor: In case a separate auditor has
been appointed to audit the branch accounts, the company auditor has the right to receive the
branch audit report from the branch auditor so appointed and use it to prepare the overall audit
report [Section 143(8)].
(v) Sign the Audit Report and Other Documents: The company auditor also has the right to sign the
auditor’s report or sign or certify any other document of the company in accordance with the
provisions of sub-section (2) of Section 141 [Section 145].
(vi) Have Audit Report Read at the AGM: The company auditor has the right to have the report read
before the company in the General Meeting (especially in case the qualifications, observations
or comments on financial transactions or matters, mentioned in the auditor’s report, have any
adverse effect on the functioning of the company) and the same shall be open to inspection by
any member of the company [Section 145].
(vii) Receive Notices and Attend General Meetings: The company auditor is entitled to receive all
notices of, and other communications relating to, any general meeting and to attend such
meetings either by himself or through his authorised representative, who shall also be qualified
to be an auditor. The auditor shall also have the right to be heard at such meeting on any part of
the business which concerns him as the auditor [Section 146].
(viii) Attend the Meeting of the Audit Committee: The auditors of a company shall have a right to
attend the meetings of the Audit Committee and to be heard in the meetings when the
Committee considers the auditor’s report, but shall not have the right to vote [Section 177(7)].
(ix) Right to be Indemnified: The auditor of a company shall also have the right to be indemnified
for any expenses incurred by him in defending himself in case the judgement in any law suit
(whether civil or criminal) against the company goes in favour of the auditor.

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The Companies Act, 2013 provides a comprehensive list of duties of a company auditor. These are enumerated
below:

As per Section 143(1), it is the duty of the auditor to inquire into the following matters:

(a) whether loans and advances made by the company on the basis of security have been properly secured and
whether the terms on which they have been made are prejudicial to the interests of the company or its
members;

(b) whether transactions of the company which are represented merely by book entries are prejudicial to the
interests of the company;

(c) In case of a company other than an investment company or a banking company, whether so much of the
assets of the company as consist of shares, debentures and other securities have been sold at a price less than
that at which they were purchased by the company;

(d) whether loans and advances made by the company have been shown as deposits;

(e) whether personal expenses have been charged to revenue account;

(f) where it is stated in the books and documents of the company that any shares have been allotted for cash,
whether cash has actually been received in respect of such allotment, and if no cash has actually been so
received, whether the position as stated in the account books and the balance sheet is correct, regular and not
misleading.

2. DUTY TO REPORT ON FINANCIAL STATEMENTS OF THE COMPANY

As per section 143(2)the auditor shall make a report to the members of the company on the accounts examined
by him and on every financial statements which are required by or under this Act after taking into account the
provisions of this Act, the accounting and auditing standards etc. Additionally, he has also to report whether in
his opinion and according to the best of his information and knowledge, the said accounts, financial statements
give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss
and cash flow for the year.

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3. DUTY REGARDING INCLUSION OF CERTAIN MATTERS IN THE AUDIT REPORT

As per Section 143(3), the auditor’s report shall also clearly state –

(a) Whether he has sought and obtained all the information and explanations which to the best of his knowledge
and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such
information on the financial statements.

(b) Whether, in his opinion, proper books of account as required by the law have been kept by the company and
proper returns adequate for the purposes of his audit have been received from branches not visited by him.

(c) Whether the report on the accounts of any branch office of the company audited by a person other than the
company’s auditor has been sent to him and the manner in which he has dealt with it in preparing his report.

(d) Whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement
with the books of account and returns.

(e) Whether, in his opinion, the financial statements comply with the accounting standards.

(f) The observations or comments of the auditors on financial transactions or matters which have any adverse
effect on the functioning of the company.

(g) Whether any director is disqualified from being appointed as a director under subsection (2) of Section 164.

(h) Any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters
connected therewith.

(i) Whether the company has adequate internal financial controls with reference to financial statements in place
and the operating effectiveness of such controls.

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The auditor’s report shall also include his views and comments on the following matters, namely:

(i) whether the company has disclosed the impact, if any, of pending litigations on its
financial position in its financial statement;
(ii) (ii) whether the company has made provision, as required under any law or accounting
standards, for material foreseeable losses, if any, on long term contracts including
derivative contracts;
(iii) (iii) whether there has been any delay in transferring amounts, required to be
transferred, to the Investor Education and Protection Fund by the company;
(iv) (1) whether the management has represented that, to the best of its knowledge and
belief, other than as disclosed in the notes to the accounts, no funds have been
advanced or loaned or invested (either from borrowed funds or share premium or any
other sources or kind of funds) by the company to or in any other person(s) or
entity(ies), including foreign entities (“Intermediaries”), with the understanding,
whether recorded in writing or otherwise, that the Intermediary shall, whether, directly
or indirectly lend or invest in other persons or entities identified in any manner
whatsoever by or on behalf of the company (“Ultimate Beneficiaries”) or provide any
guarantee, security or the like on behalf of the Ultimate Beneficiaries.

(2) whether the management has represented, that, to the best of it’s knowledge and
belief, other than as disclosed in the notes to the accounts, no funds have been received
by the company from any person(s) or entity(ies), including foreign entities (“Funding
Parties”), with the understanding, whether recorded in writing or otherwise, that the
company shall, whether, directly or indirectly, lend or invest in other persons or entities
identified in any manner whatsoever by or on behalf of the Funding Party (“Ultimate
Beneficiaries”) or provide any guarantee, security or the like on behalf of the Ultimate
Beneficiaries; and

(3) based on such audit procedures that the auditor has considered reasonable and
appropriate in the circumstances, nothing has come to their notice that has caused
them to believe that the representations under sub-clause (1) and (2) contain any
material mis-statement.

(v) whether the dividend declared or paid during the year by the company is in compliance
with section 123 of the Companies Act, 2013.
(vi) whether the company, in respect of financial years commencing on or after the 1st April,
2022, has used such accounting software for maintaining its books of account which has
a feature of recording audit trail (edit log) facility and the same has been operated
throughout the year for all transactions recorded in the software and the audit trail
feature has not been tampered with and the audit trail has been preserved by the
company as per the statutory requirements for record retention.

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4. DUTY TO PROVIDE REASONS FOR ANY NEGATIVE REMARKS/QUALIFICATION

According to Section 143(4), where any of the above-mentioned matters required to be included in the
audit report is answered in the negative or with a qualification, the report shall state the reasons
therefor.

5. DUTY TO COMPLY WITH THE DIRECTIONS OF CAG

As per section 143(5), in the case of a Government company or any other company owned or controlled,
directly or indirectly, by the Central Government, or by any State Government or Governments, or
partly by the Central Government and partly by one or more State Governments, the auditor shall, in
his report, include–
(i) The directions, if any, issued by the Comptroller and Auditor-General of
India regarding the manner of audit of accounts; and
(ii) The action taken on such directions and its impact on the accounts and
financial statement of the company.

8 ACCOUNTS OF A BRANCH OFFICE OF A COMPANY

(i) Where a company has a branch office, the accounts of that office shall be audited either by
the auditor appointed for the company (herein referred to as the company’s auditor) under
this Act or by any other person qualified for appointment as an auditor of the company under
this Act and appointed as such under Section 139.
(ii) Where the branch office is situated in a country outside India, the accounts of the branch office
shall be audited either by the company’s auditor or by an accountant or by any other person
duly qualified to act as an auditor of the accounts of the branch office in accordance with the
laws of that country.
(iii) The duties and powers of the company’s auditor with reference to the audit of the branch and
the branch auditor, if any, shall be as contained in sub-sections (1) to (4) of Section 143.
(iv) Similarly, if the branch auditor is appointed separately, the duties and powers of the branch
auditor shall be as same as applicable to the company auditor under sub-sections (1) to (4) of
Section 143.
(v) The branch auditor shall submit his report to the company’s auditor.
(vi) Provisions of sub-section (12) of Section 143 regarding reporting of fraud by the auditor shall
also extend to the branch auditor to the extent it relates to the concerned branch

9. DUTY TO COMPLY WITH AUDITING STANDARDS

Section 143(9) provides that it is the duty of every company auditor to comply with the applicable auditing
standards in conduct of his audit.

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12 DUTY TO REPORT ANY FRAUD TO THE CENTRAL GOVERNMENT

According to Section 143(12) read with Rule 13 of the Company (Audit and Auditors) Rules 2014 –

(1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to
believe that an offence of fraud, which involves or is expected to involve individually an amount of rupees one
crore or above, is being or has been committed against the company by its officers or employees, the auditor
shall report the matter to the Central Government.

(2) The auditor shall report the matter to the Central Government as under:

(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be,
immediately but not later than two days of his knowledge of the fraud, seeking their reply or
observations within forty-five days;

(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or
observations of the Board or the Audit Committee along with his comments (on such reply or
observations of the Board or the Audit Committee) to the Central Government within fifteen days from
the date of receipt of such reply or observations;

(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee
within the stipulated period of forty-five days, he shall forward his report to the Central Government
along with a note containing the details of his report that was earlier forwarded to the Board or the
Audit Committee for which he has not received any reply or observations;

(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered
Post with Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same;

(e) the report shall be on the letter-head of the auditor containing postal address, e-mail address and
contact telephone number or mobile number and be signed by the auditor with his seal and shall
indicate his Membership Number; and

(f) The report shall be in the form of a statement as specified in Form ADT-4.

(3) In case of a fraud involving lesser than the amount specified in sub-rule (1), the auditor shall report the matter
to Audit Committee constituted under Section 177 or to the Board immediately but not later than two days of
his knowledge of the fraud and he shall report the matter specifying the following:

(a) Nature of Fraud with description;

(b) Approximate amount involved; and

(c) Parties involved.

The provisions of this section regarding the duties of an auditor also apply to the cost accountant conducting
cost audit under Section 148 and the company secretary in practice conducting secretarial audit under Section
204.

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15 DUTY TO PAY PENALTY

As per Section 143 (15), if any auditor, cost accountant or company secretary in practice fails to comply with the
provisions of sub-section (12) of Section 143, he will be liable –

(a) in case of a listed company, to pay a penalty of five lakh rupees; and

(b) in case of any other company, to pay a penalty of one lakh rupees.

Branch audit (128)

Section 128(1) of the Companies Act, 2013 provides that every company shall prepare and keep at its registered
office books of account and other relevant books and papers and financial statements for every financial year
which give a true and fair view of the state of the affairs of the company, including that of its branch office or
offices, if any, and explain the transactions effected both at the registered office and its branches and such books
shall be kept on accrual basis and according to the double entry system of accounting. The Board of Directors
may, however, decide to keep all or any of the aforesaid books of account and other relevant papers at such
other place in India. In such circumstances, the company shall, within seven days thereof, file with the Registrar
a notice in writing giving the full address of that other place.

Section 128(2) further specifies that, where a company has a branch office in India or outside India, it shall be
deemed to have complied with the provisions of Section 128(1), if proper books of account relating to the
transactions effected at the branch office are kept at that office and proper summarised returns periodically are
sent by the branch office to the company at its registered office or the other place as decided.

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Joint audit

Joint audit refers to the process of conducting the audit of a single organisation by more than one auditor. Large
Companies with diversified business operations often resort to this process of auditing where they employ
multiple auditors to conduct statutory audit. The basic aim in applying joint audit is to pull the resources of
multiple auditors to conduct audit efficiently and within lesser amount of time.

Benefits of joint audit

a) Joint audit reduces the workload of a single auditor.

b) Since different auditors may be engaged to handle different parts of accounts, timely completion of work is
possible even in a large organisation.

c) The auditors may share their expertise and solve critical problems in the process.

d) Joint audit improves the quality of audit work to a great extent.

e) There may be healthy competition among the auditors which improves the quality and speed of the audit
work.

f) Under joint audit, it is possible to get the benefit of extensive knowledge of different auditors at the same
time.

Limitations of joint audit

i. Established auditors may have a superiority complex over the less experienced one.
ii. It is not suitable for a small entity due to substantial cost burden.
iii. At times, lack of coordination among the auditors may slow down the speed of work.
iv. There may be uncertainty about the liability of any work.
v. Areas of common concern may be neglected.
vi. The auditors have to share the fees.

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Guidelines on joint audit (SA 299)

SA 299, Responsibility of Joint Auditor, has prescribed the following guidelines with respect to joint audit:

A. Division of Work:

a) Where joint auditors are appointed, they should, by mutual discussion, divide the audit work among
themselves. The division of work would usually be in terms of audit of identifiable units or specified
areas. In some cases, due to the nature of the business of the entity under audit, such a division of work
may not be possible.

b) In such situations, the division of work may be with reference to items of assets or liabilities or
income or expenditure or with reference to periods of time.

c) Certain areas of work, owing to their importance or owing to the nature of the work involved, would
often not be divided and would be covered by all the joint auditors.

d) The division of work among joint auditors as well as the areas of work to be covered by all of them
should be adequately documented and preferably communicated to the entity.

B. Co-ordination Where, in the course of his work, a joint auditor comes across matters which are relevant to
the areas of responsibility of other joint auditors and which deserve their attention, or which require disclosure
or require discussion with, or application of judgement by, other joint auditors, he should communicate the
same to all the other joint auditors in writing. This should be done by the submission of a report or note prior to
the finalisation of the audit.

C. Relationship among Joint Auditors and Their Responsibility In respect of audit work divided among the joint
auditors, each joint auditor is responsible only for the work allocated to him, whether or not he has prepared a
separate report on the work performed by him. On the other hand, all the joint auditors are jointly and severally
responsible

(a) in respect of the audit work which is not divided among the joint auditors and is carried out by all of
them;

(b) in respect of decisions taken by all the joint auditors concerning the nature, timing or extent of the
audit procedures to be performed by any of the joint auditors. It may, however, be clarified that all the
joint auditors are responsible only in respect of the appropriateness of the decisions concerning the
nature, timing or extent of the audit procedures agreed upon among them; proper execution of these
audit procedures is the separate and specific responsibility of the joint auditor concerned;

(c) in respect of matters which are brought to the notice of the joint auditors by any one of them and
on which there is an agreement among the joint auditors;

(d) for examining that the financial statements of the entity comply with the disclosure requirements
of the relevant statute; and

(e) for ensuring that the audit report complies with the requirements of the relevant statute. If any
matters of the nature referred to in (B) above are brought to the attention of the entity or other joint
auditors by an auditor after the audit report has been submitted, the other joint auditors would not be
responsible for those matters.

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D. Dependence on Other Auditors Each joint auditor is entitled to assume that the other joint auditors have
carried out their part of the audit work in accordance with the generally accepted audit procedures. It is not
necessary for a joint auditor to review the work performed by other joint auditors or perform any tests in order
to ascertain whether the work has actually been performed in such a manner. Each joint auditor is entitled to
rely upon the other joint auditors for bringing to his notice any departure from generally accepted accounting
principles or any material error noticed in the course of the audit.

E. Reporting Responsibilities Normally, the joint auditors are able to arrive at an agreed report. However, where
the joint auditors are in disagreement with regard to any matters to be covered by the report, each one of them
should express his own opinion through a separate report. A joint auditor is not bound by the views of the
majority of the joint auditors regarding matters to be covered in the report and should express his opinion in a
separate report in case of a disagreement.

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Liabilities of the Company Auditor

A. Statutory Liabilities

I. Under Companies Act, 2013

⊙ Civil Liabilities: The civil liabilities as per Companies Act, 2013 are stated below:

(a) For Misstatement in the Prospectus: As per Section 35, where a person has subscribed for securities
of a company acting on any statement included in the prospectus, or on the inclusion or omission of
any matter in the prospectus which is misleading and thereby has sustained any loss or damage and
where the auditor as an expert has either made such statement or has given written consent to the
issue of the prospectus, he shall be held liable.

(b) Liability for Misfeasance: Misfeasance implies breach of trust or negligence in the performance of
duties. As per Section 340, a company auditor may be charged with misfeasance only at the time of
liquidation of the company, if it is found that he –

(i) has misapplied, or retained, or become liable or accountable for, any money or property of
the company; or

(ii) has been guilty of any misfeasance or breach of trust in relation to the company.

⊙ Criminal Liability: The criminal liabilities of an auditor under the Companies Act, 2013 are as follows:

(a) Criminal Liability for Misstatement in the Prospectus: As per Section 34, where the auditor has
authorised the issue of any prospectus which includes any statement which is untrue or misleading
or where the prospectus has included or omitted any matter which may mislead, the auditor shall
be held liable under Section 447.
Accordingly (i.e., as per Section 447), for any fraud, involving an amount of at least ten lakh rupees
or one per cent of the turnover of the company, whichever is lower, the auditor shall be punishable
with imprisonment for a term which shall not be less than six months but which may extend to ten
years and shall also be liable to fine which shall not be less than the amount involved in the fraud,
but which may extend to three times the amount involved in the fraud. Moreover, where the fraud
in question involves public interest, the term of imprisonment shall not be less than three years.
However, where the fraud involves an amount less than ten lakh rupees or one per cent of the
turnover of the company, whichever is lower, and does not involve public interest, any person
guilty of such fraud shall be punishable with imprisonment for a term which may extend to five
years or with fine which may extend to fifty lakh rupees or with both.

(b) Punishment for Non-compliance with Sections 139, 144 and 145 of the Act: As per Section 147 –

(i) If an auditor contravenes the provisions of Section 139, 144 or 145, he shall be punishable
with fine which shall not be less than `25,000 but which may extend to `5,00,000 or four times
the remuneration of the auditor, whichever is less.

(ii) If an auditor has contravened the above provisions knowingly or wilfully with the intention
to deceive the company or its shareholders or creditors or tax authorities, he shall be
punishable with imprisonment for a term which may extend to 1 year and with fine which shall
not be less than `50,000 but which may extend to `25,00,000 or eight times the remuneration
of the auditor, whichever is less.

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iii) Convicted auditor shall be liable to refund the remuneration received by him from the company
and pay for damages to the company, statutory bodies or authorities or to members or creditors
of the company for loss arising out of incorrect or misleading statements of particulars made in his
audit report.

Iv) In case where the audit of a company is being conducted by an audit firm, if it is proved that the
partner or partners of the audit firm has or have acted in a fraudulent manner or abetted or
colluded in any fraud by, or in relation to, the company or its directors or officers, the partner or
partners concerned of the audit firm as well as the firm itself shall be liable for fine jointly and
severally. However, for criminal liability other than fine, only the partner or partners will be liable.

(c) Punishment for Refusal or Failure to Produce Documents: As per Section 217, if any auditor fails
without reasonable cause or refuses to produce to an inspector or any person authorised by him in this
behalf any book or paper, to furnish any information, to appear before the inspector personally when
required, to answer any question which is put to him by the inspector, or to sign the notes of any
examination referred to in sub-section (7) of Section 217, he shall be punishable with imprisonment for
a term which may extend to six months and with fine ranging from twenty-five thousand rupees to one
lakh rupees, and also with a further fine which may extend to two thousand rupees for every day after
the first during which the failure or refusal continues.

(d) Fraud in Relation to a Company in Winding-up: As per Section 336, if any auditor is engaged in any
fraudulent activities in relation to any company in winding up, he shall be punishable with
imprisonment for a term which shall not be less than three years but which may extend to five years
and with fine which shall not be less than one lakh rupees but which may extend to three lakh rupees.

(e) Punishment for False Statement: As per Section 448, if any auditor deliberately makes any false
statement in any return, report, certificate, financial statement, prospectus, statement or other
document required by the act or deliberately omits any material fact, he shall be liable under Section
447 and shall be subject to the punishment as stated earlier in point (a).

(f) Punishment for False Evidence: As per Section 449, if the auditor intentionally gives false evidence
upon any examination on oath or solemn affirmation or in any affidavit, deposition or solemn
affirmation, in or about the winding up of any company or about any matter under this Act, he shall be
punishable with imprisonment for a term which shall not be less than three years but which may extend
to seven years and with fine which may extend to ten lakh rupees.

II. Under Other Acts

⊙ Liabilities under Income Tax Act, 1961: As per Section 278 of the Act, if any auditor abets or induces
in any manner another person to make and deliver an account, statement or declaration relating to any
income chargeable to tax which is false and which the auditor either knows or does not believe to be
true, the auditor shall be punished.

⊙ Liabilities under Chartered Accountants Act, 1949: Schedule I and II of the Act contains a list of
instances where a Chartered Accountant shall be held guilty of professional misconduct under Section
22 of the Act

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⊙ Liabilities under Life Insurance Act, 1956: As per Section 104 of the Act, if an auditor makes any false
statement in any return, report or other such forms to be issued under this Act, he shall be sentenced
to imprisonment or fine or both.

⊙ Liabilities under Banking Regulation Act, 1949: As per Section 46 of the Act, if an auditor in any
return, balance sheet, or other document wilfully makes a statement, which is false in any material
particulars, knowing it to be false, or wilfully omits to make a material statement, he shall be held liable.

B. Contractual Liabilities
The scope of any audit work is determined by the written contract entered into between the auditor
and the client. Thus, if any of the terms of the said contract is contravened, the auditor may be held
liable under the Indian Contract Act, 1872. In case of absence of any written contract between the
auditor and the appointing authority, the auditor is expected to conduct complete audit. Hence, if in
such a circumstance, he conducts only partial audit and any error or fraud is discovered later on, he
shall be held liable. Moreover, an auditor shall also be held liable if he discloses any secret information
of the client to any third party. In the case Wilde and Others vs. Cape and Dalgeish (1897) also, it was
held that if the client suffers any loss due to the auditor not complying with the contract, the auditor
will have to compensate the client for such loss.

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AUDIT COMMITTEE SECTION 177

1 FORMATION OF AUDIT COMMITTEE

As per Section 177(1) read with Companies (Meetings of Board and its Powers) Rules, 2014, the Board of
directors of every listed company and the following classes of companies shall constitute an Audit Committee
of the Board-

(i) all public companies with a paid-up capital of ten crore rupees or more;
(ii) all public companies having turnover of one hundred crore rupees or more;
(iii) all public companies, having in aggregate, outstanding loans or borrowings or debentures or
deposits exceeding fifty crore rupees or more.

2 COMPOSITION OF AUDIT COMMITTEE

The Audit Committee shall consist of a minimum of three directors with independent directors forming a
majority: Moreover, majority of members of Audit Committee including its Chairperson shall be persons with
ability to read and understand, the financial statement.

4 FUNCTIONS OF AUDIT COMMITTEE

The Board shall specify, in writing, the terms of reference for the Audit Committee which shall, inter alia, include
—

(i) the recommendation for appointment, remuneration and terms of appointment of auditors of the
company;
(ii) review and monitor the auditor’s independence and performance, and effectiveness of audit
process;
(iii) examination of the financial statement and the auditors’ report thereon;
(iv) approval or any subsequent modification of transactions of the company with related parties:
(v) scrutiny of inter-corporate loans and investments;
(vi) valuation of undertakings or assets of the company, wherever it is necessary;
(vii) evaluation of internal financial controls and risk management systems;
(viii) monitoring the end use of funds raised through public offers and related matters.

POWER OF AUDIT COMMITTEE

5 Committee may ask for Auditor’s Comment: The Audit Committee may call for the comments of the auditors
about internal control systems, the scope of audit, the observations of the auditors and review of financial
statement before their submission to the Board. The Committee may also discuss any related issues with the
internal and statutory auditors and the management of the company.

6 Investigation: The Audit Committee shall have authority to investigate into any matter in relation to the items
specified in Section 177(4) or referred to it by the Board. For this purpose, the Committee shall have power to
obtain professional advice from external sources and have full access to information contained in the records of
the company.

8 Board’s Report and Audit Committee: The Board’s report under sub-section (3) of section 134 shall disclose
the composition of an Audit Committee and where the Board had not accepted any recommendation of the
Audit Committee, the same shall be disclosed in such report along with the reasons therefor.

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9 Whistle Blowing Policy: Every listed company and company accepting public deposits or borrowing in excess
of fifty crore rupees from banks and financial institutions shall establish a vigil mechanism for directors and
employees to report genuine concerns in such manner as may be prescribed.

10 Safeguards against Victimization: The vigil mechanism under sub-section (9) shall provide for adequate
safeguards against victimization of persons who use such mechanism and make provision for direct access to
the chairperson of the Audit Committee in appropriate or exceptional cases. The company shall disclose
establishment of such mechanism on its website, if any, and in the Board’s report.

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Section 447 – Fraud

1 fraud under the Act is defined under section 447 (1) of the Act which defines it as “any act or omission,
including a misrepresentation, by a director or any other person, whether a party to the fraud or not, which
involves any fraud by him or any other person, or a willful concealment of any material facts from any person
with the intent to deceive, and thereby prejudice the interests of the company, its shareholders or creditors”.
This Section further states that if a company has been already established, the intention of the directors or
other persons involved in the fraud must be to cause wrongful loss to the company or wrongful gain to
themselves or any other person.

2 Section 447 (2) provides that if it appears to the Central Government or any other regulatory body that any
person has committed any fraud in connection with the promotion, formation, management or winding up of
any company, then the Central Government may, either suo-motu or upon complaint, direct the Serious Fraud
Investigation Office under the control of Central Government to investigate the fraud and submit a report of
such investigation to Central Government.

Applicability of Section 447

The applicability of Section 447 extends to all the “Companies” as defined under the Companies Act, 2013
which include all public and private companies, limited liability partnerships and association of persons. It
applies to any act or omission including fraud by any director or other person in relation to the promotion,
formation, management or winding up of a company.

Punishment for Fraud

If any person is found to be guilty of fraud as defined under Section 447 (1), then, on conviction, he/she shall
be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10
or 10 years and shall be liable to fine which may extend to 1 lakh rupees or an amount equivalent to 3 times
the amount of fraud whichever is higher.

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Provisions related to audit under Companies Act, 2013

CHAPTER -2 COST AUDIT ( SECTION 148 )

According to the Institute of Cost and Management Accountants of England, cost audit represents the
verification of cost accounts and a check on the adherence to cost accounting plan. Cost audit, therefore,
comprises:

(a) Verification of cost accounting records such as the accuracy of the cost accounts, cost reports, cost
statement, cost data and costing techniques, and

(b) Examination of these records to ensure that they adhere to the cost accounting principles, plans,
procedures and objectives.

According to The Institute of Cost Accountants of India, cost audit is an independent examination of cost and
other related information in respect of a product or group of products of an entity whether profit oriented or
not, irrespective of its size or legal form, when such an examination is conducted with a view to expressing an
opinion thereon.

IMPORTANCE OF COST AUDIT

The growing importance of cost audit can be attributed to the following facts:

a) Cost audit provides authentic data on cost data and thereby helps in making decisions on pricing policy,
product mix, outsourcing, discontinuance of product etc.

b) Cost audit identifies the inefficiencies and thereby helps in improving the productivity.

c) Cost audit helps in ensuring the optimum utilization of limited resources. The benefits are extended to the
customers.

d) Cost audit appraises the cost control mechanism followed in the organisation.

e) Audited cost data may form the basis for determining the standard cost data.

f) Government often decides on extending or abolishing tariff protection based on audited data on cost
structure of the product.

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Section 148(1) of the Companies Act 2013 authorizes the Central Government to make it mandatory, by order,
the maintenance of cost records (relating to the utilisation of material or labour or to other items of cost as
may be prescribed) for certain classes of companies.

RULE 3 OF COMPANIES (COST RECORDS AND AUDIT) RULES, 2014

APPLICATION OF COST RECORDS

A. Regulated sectors
a. Telecommunication services made available to users by means of any transmission or reception of
signs, signals, writing, images and sounds or intelligence of any nature and regulated by the Telecom
Regulatory Authority of India under the Telecom Regulatory Authority of India Act, 1997 (24 of 1997);
including activities that requires authorisation or license issued by the Department of
Telecommunications, Government of India under Indian Telegraph Act, 1885
b. Generation, transmission, distribution and supply of electricity regulated by the relevant regulatory
body or authority under the Electricity Act, 2003;
c. Petroleum products; including activities regulated by the Petroleum and Natural Gas Regulatory Board
under the Petroleum and Natural Gas Regulatory Board Act, 2006
d. Drugs and pharmaceuticals;
e. Fertilisers;
f. Sugar and industrial alcohol;
B. Non-Regulated sectors (so many refer book page no. 543)

It also provides that all companies under regulated and non-regulated list, engaged in the production of goods or
providing services, having an overall turnover from all its products and services of `35 crore or more during the
immediately preceding financial year, are required to include cost records in their books of account. These companies
shall also include Foreign Companies defined in Sub-section (42) of Section 2 of the Act, but exclude a company classified
as a Micro Enterprise or a Small Enterprise as per the turnover criteria provided under Micro, Small and Medium
Enterprise Development, 2006.

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Section 148(2) also empowers the Central Government to issue orders to make audit of cost records of above-
mentioned companies mandatory.

Applicability for Cost Audit [Rule 4]

1) Every company specified in item (A) of rule 3 shall get its cost records audited in accordance with these rules if the
overall annual turnover of the company from all its products and services during the immediately preceding financial year
is rupees fifty crore or more and the aggregate turnover of the individual product or products or service or services for
which cost records are required to be maintained under rule 3 is rupees twenty-five crore or more.

2) Every company specified in item (B) of rule 3 shall get its cost records audited in accordance with these rules if the
overall annual turnover of the company from all its products and services during the immediately preceding financial year
is rupees one hundred crore or more and the aggregate turnover of the individual product or products or service or
services for which cost records are required to be maintained under rule 3 is rupees thirty-five crore or more.

3) The requirement for cost audit under these rules shall not apply to a company which is covered in rule 3; and

(i). whose revenue from exports, in foreign exchange, exceeds seventy-five per cent of its total revenue; or

(ii). which is operating from a special economic zone; or

(iii). which is engaged in generation of electricity for captive consumption through Captive Generating Plant.

For this purpose, the term “Captive Generating Plant” shall have the same meaning as assigned in rule 3 of the
Electricity Rules, 2005”

Maintenance of Records [Rule 5]

1) Every company under these rules including all units and branches thereof, shall, in respect of each of its financial
year commencing on or after the 1st day of April, 2014, maintain cost records in form CRA-1.
Provided that in case of company covered in serial number 12 and serial numbers 24 to 32 of item (B) of Rule 3
(i.e., Non-regulated sectors), the requirement under this rule shall apply in respect of each of its financial year
commencing on or after 1st day of April, 2015.

2) The cost records referred to in sub-rule (1) shall be maintained on regular basis in such manner as to facilitate
calculation of per unit cost of production or cost of operations, cost of sales and margin for each of its products
and activities for every financial year on monthly or quarterly or half-yearly or annual basis.

3) The cost records shall be maintained in such manner so as to enable the company to exercise, as far as possible,
control over the various operations and costs to achieve optimum economies in utilisation of resources and
these records shall also provide necessary data which is required to be furnished under these rules.

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Appointment of Cost Auditor [Rule 6]

1) The category of companies specified in rule 3 and the thresholds limits laid down in rule 4, shall within one
hundred and eighty days of the commencement of every financial year, appoint a cost auditor. Provided that
before such appointment is made, the written consent of the cost auditor to such appointment, and a
certificate from him or it, as provided in sub-rule

(1A), shall be obtained. 1A) The cost auditor appointed under sub-rule (1) shall submit a certificate that –

(a) the individual or the firm, as the case may be, is eligible for appointment and is not disqualified for
appointment under the Act, the Cost and Works Accountants Act, 1959(23 of 1959) and the rules or
regulations made thereunder;

(b) the individual or the firm, as the case may be, satisfies the criteria provided in section 141 of the Act, so
far as may be applicable;

(c) the proposed appointment is within the limits laid down by or under the authority of the Act; and

(d) the list of proceedings against the cost auditor or audit firm or any partner of the audit firm pending with
respect to professional matters of conduct, as disclosed in the certificate, is true and correct.”

2) Every company referred to in sub-rule (1) shall inform the cost auditor concerned of his or its appointment as
such and file a notice of such appointment with the Central Government within a period of 30 days of the
Board meeting in which such appointment is made or within a period of 180 days of the commencement of
the financial year, whichever is earlier, through electronic mode, in Form CRA-2, along with the fee as
specified in Companies (Registration Offices and Fees) Rules, 2014.

3) Every cost auditor appointed as such shall continue in such capacity till the expiry of 180 days from the closure
of the financial year or till, he submits the cost audit report, for the financial year for which he has been
appointed.

However, the cost auditor appointed under these rules may be removed from his office before the expiry of
his term, through a board resolution after giving a reasonable opportunity of being heard to the Cost Auditor
and recording the reasons for such removal in writing.

Provided further that the Form CRA-2 to be filed with the Central Government for intimating appointment of
another cost auditor shall enclose the relevant Board Resolution to the effect;

Provided also that nothing contained in this sub-rule shall prejudice the right of the cost auditor to resign
from such office of the company

3A) Any casual vacancy in the office of a cost auditor, whether due to resignation, death or removal, shall be
filled by the Board of Directors within thirty days of occurrence of such vacancy and the company shall inform
the Central Government in Form CRA-2 within 30 days of such appointment of cost auditor.

3B) The cost statements, including other statements to be annexed to the cost audit report, shall be approved by
the Board of Directors before they are signed on behalf of the Board by any of the director authorised by the
Board, for submission to the cost auditor to report thereon.

Note: in the case of companies which are required to constitute an audit committee, the Board shall appoint an
individual, who is a cost accountant, or a firm of cost accountants in practice, as cost auditor on the
recommendations of the Audit committee.
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As per Section 148(3) of the Companies Act 2013, cost audit shall be conducted by a Cost Accountant who shall
be appointed by the Board. No person appointed under Section 139 as an auditor of the company shall be
appointed for conducting the audit of cost records. The auditor so appointed shall comply with the cost
auditing standards.

As per Section 148(3) of the Companies Act 2013 read with Rule 14 of the Companies (Audit and Auditors)
Rules 2014, the remuneration of the cost auditor shall be decided by the Board as recommended by the Audit
Committee, if any, which shall be ratified by the shareholders subsequently. In the case of companies which
are not required to constitute an audit committee, the Board shall appoint an individual who is a cost
accountant or a firm of cost accountants in practice as cost auditor and the remuneration of such cost auditor
shall be ratified by shareholders subsequently

Section 148(4) of Companies Act, 2013 further states that an audit conducted under this section shall be in
addition to the audit conducted under Section 143.

Persons disqualified u/s 141(3) shall not be appointed as the cost auditor of a company. Similarly, auditor of a
company appointed u/s 139 shall not act as the cost auditor of the company.

The rights, duties and obligations as applicable to the company auditors shall also apply to a cost auditor
appointed under Section 148 and it shall be the duty of the company to give all assistance and facilities to the
cost auditor appointed under this section for auditing the cost records of the company.

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As per Section 148(5) read with Rule 6 of the Companies (Cost Records and Audit) Rules 2014:

(a) Every cost auditor, who conducts an audit of the cost records of a company, shall submit the cost audit
report along with his or its reservations or qualifications or observations or suggestions, if any, in Form CRA-3.

(b) The cost auditor shall forward his duly signed report to the Board of Directors of the company within a
period of 180 days from the closure of the financial year to which the report relates and the Board of Directors
shall consider and examine such report, particularly any reservation or qualification contained therein.

(c) The company covered under these rules shall, within a period of 30 days from the date of receipt of a copy
of the cost audit report, furnish the Central Government with such report along with full information and
explanation on every reservation or qualification contained therein, in Form CRA-4 in Extensible Business
Reporting Language format in the manner as specified in the Companies (Filing of Documents and Forms in
Extensible Business Reporting language) Rules, 2015 along with fees specified in the Companies (Registration
Offices and Fees) Rules, 2014”.

Provided that the Companies which have got extension of time of holding Annual General Meeting under
section 96 (1) of the Companies Act, 2013, may file Form CRA-4 within resultant extended period of filing
financial statements under section 137 of the Companies Act, 2013.

(d) If the Central Government is of the opinion that any further information or explanation is necessary, it may
call for such further information and explanation and the company shall furnish the same within such time as
may be specified by that government.

Forms Relevant to Cost Records and Cost Audit

Companies (Cost records and Audit) Rules 2014 provides for four different forms for separate purposes as
follows:

(i) CRA-1 for the manner in which cost records shall be maintained.
(ii) CRA-2 for intimation of appointment of cost auditor by the company to Central Government
(iii) CRA-3 for cost audit report
(iv) CRA-4 for filing of cost audit report with the Central Government

According to Section 148(8), while complying with the aforesaid provisions if any default takes place –

(i) On the part of the company, the company shall be punishable with fine between `25,000 and
`5,00,000 and every officer of the company who is in default shall be punishable with
imprisonment for a term which may extend to one year or with fine between `10,000 and
`1,00,000. [sub-section (1) of Section 147]
(ii) The cost auditor of the company who is in default shall be punishable in the manner as provided
in sub-sections (2) to (4) of Section 147.

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Reporting Requirements of Cost Audit as per CRA-3

As per Companies (Cost Records and Audit) Rules 2014 as amended up to date, a cost auditor needs to
report the following in CRA-3.

(a) Whether he has obtained all the information and explanations, which to the best of his knowledge
and belief were necessary for the purpose of the audit.

(b) Whether in his opinion, proper cost records, as per rule 5 of the Companies (Cost Records and Audit)
Rules, 2014 have been maintained by the company in respect of its product(s)/ service(s) under
reference.

(c) Whether in his opinion, proper returns adequate for the purpose of the cost audit have been
received from the branches not visited by him.

(d) Whether in his opinion, and to the best of his information, the said books and records give the
information required by the Companies Act, 2013, in the manner so required.

(e) Whether in his opinion, the company has adequate system of internal audit of cost records which to
his opinion is commensurate to its nature and size of the business.

(f) Whether in his opinion, information, statements in the annexure to the cost audit report give a true
and fair view of the cost of production of product(s)/rendering of service(s), cost of sales, margin and
other information relating to product(s)/service(s) under reference.

(g) Whether detailed unit-wise and product/service-wise cost statements and schedules thereto in
respect of the product /service of the company duly audited and certified by him are kept in the
company.

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Auditor to Sign Audit Report (Section 145)

The person appointed as an auditor of the company shall

• Sign the Auditor’s Report

• Sign or certify any other document of the company in accordance with the provisions of Sub Section 2
of Section 141 and
• The Qualifications, Observations or Comments on the financial transactions or matter, which have any
adverse effect on the functioning of the company mentioned in the auditor’s report shall be read
before the company in general meeting and shall be open to inspection by any member of the
company.

Auditor to attend General Meeting (Section 146)

All notices of, and other communications relating to, any general meeting shall be forwarded to the auditor of
the company, and the auditor shall, unless otherwise exempted by the company, attend either by himself or
through his authorised representative, who shall also be qualified to be an auditor, any general meeting and
shall have the right to be heard at such meeting on any part of the business which concerns him as the auditor.

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Punishment for Contravention (Section 147)

1. If any of the provisions of sections 139 to 146 (both inclusive) is contravened, the company shall be
punishable with fine which shall not be less than twenty-five thousand rupees but which may extend
to five lakh rupees and every officer of the company who is in default shall be punishable with fine
which shall not be less than ten thousand rupees but which may extend to one lakh rupees.
2. If an auditor of a company contravenes any of the provisions of section 139, section 144 or section
145, the auditor shall be punishable with fine which shall not be less than twenty-five thousand
rupees but which may extend to five lakh rupees or four times the remuneration of the auditor,
whichever is less:

Provided that if an auditor has contravened such provisions knowingly or wilfully with the intention to deceive
the company or its shareholders or creditors or tax authorities, he shall be punishable with imprisonment for a
term which may extend to one year and with fine which shall not be less than fifty thousand rupees but which
may extend to twenty-five lakh rupees or eight times the remuneration of the auditor, whichever is less.

3. Where an auditor has been convicted under sub-section (2), he shall be liable to—
a. refund the remuneration received by him to the company; and
b. pay for damages to the company, statutory bodies or authorities or to members or creditors
of the company for loss arising out of incorrect or misleading statements of particulars made
in his audit report.

4. The Central Government shall, by notification, specify any statutory body or authority or an officer for
ensuring prompt payment of damages to the company or the persons under clause (ii) of sub-section
(3) and such body, authority or officer shall after payment of damages to such company or persons
file a report with the Central Government in respect of making such damages in such manner as may
be specified in the said notification

5. Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner
or partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in any
fraud by, or in relation to or by, the company or its directors or officers, the liability, whether civil or
criminal as provided in this Act or in any other law for the time being in force, for such act shall be of
the partner or partners concerned of the audit firm and of the firm jointly and severally.

Provided that in case of criminal liability of an audit firm, in respect of liability other than fine, the concerned
partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud
shall only be liable.

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Applicability and Conduct of Secretarial Audit (204)

(a) The Companies Act 2013:

As per the provision of Section 204(1) of the Companies Act, 2013 read with Rule 9 of the Companies
(Appointment and Remuneration of Managerial Personnel) Rules, 2014:

1. Every listed company;

2. Every public company having a paid-up share capital of 50 crore rupees or more; or

3. Every public company having a turnover of 250 crore rupees or more; or

4. Every company having outstanding loans or borrowings from banks or public financial institutions
of 100 crore rupees or more.

- is required to annex with its Board’s Report made in terms of Section 134(3) of the Companies Act,
2013, a Secretarial Audit Report, given by a Company Secretary in practice, in Form MR-3.

As per Section 204(2), it shall be the duty of the company to give all assistance and facilities to the company
secretary in practice, for auditing the secretarial and related records of the company.

As per Section 204(3), the Board of Directors, in its report, shall explain in full any qualification or observation
or other remarks made by the company secretary in practice in the secretarial audit report.

Moreover, Section 204(4) further provides that if a company or any officer of the company or the company
secretary in practice, contravenes the provisions of this section, the company, every officer of the company or
the company secretary in practice, who is in default, shall be liable to a penalty of two lakh rupees.

(b) SEBI Regulations: As per Regulation 24A of the SEBI(LODR) Regulations, 2015, every listed entity and its
material unlisted subsidiaries incorporated in India shall undertake secretarial audit and shall annex a
secretarial audit report given by a company secretary in practice, in such form as specified, with the annual
report of the listed entity.

In addition to the above, every listed entity shall submit a secretarial compliance report in such form as
specified, to stock exchanges, within sixty days from end of each financial year. (Amended by the SEBI (Listing
Obligations and Disclosure Requirements) (Second Amendment) Regulations, 2021 w.e.f. 5.5.2021).

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Qualification of a Secretarial Auditor

According to the provisions of Section 204, only a member of the Institute of Company Secretaries of India
holding a certificate of Practice (i.e., PCS) is qualified to conduct secretarial audit of the company.

Appointment of Secretarial Auditor

As per Rule 8 of the Companies (Meetings of Board and its Powers) Rules, 2014, read with Section 179 of the
Companies Act, 2013, secretarial auditor is required to be appointed by means of resolution at a duly
convened board meeting.

It is advisable for the Secretarial Auditor to get a letter of engagement from the company. Secretarial Auditor
should accept the letter of engagement.

The company shall report any change in the secretarial auditor during the financial year to the members
through the Board’s Report. The qualifications, observations or comments / remarks of the secretarial Audit
Report shall be read at the annual general meeting of the company along with the explanation and comments
of the Board of Directors (Clause 13 of Secretarial Standard 2).

Secretarial Audit Report

Section 204 of Companies Act, 2013 provides that Secretarial Audit Report is to be submitted in a format
prescribed under Rules. As per sub-rule (2) of Rule 9 of the Companies (Appointment and Remuneration of
Managerial Personnel) Rules, 2014, the format of the Secretarial Audit Report shall be in Form MR-3.

In addition, Regulation 24A of the SEBI (LODR) Regulations, 2015 requires that every listed entity and its
material unlisted subsidiaries incorporated in India shall undertake secretarial audit and shall annex a
Secretarial Audit Report given by a company secretary in practice, in such form as specified, with the annual
report of the listed entity. Every listed entity shall submit a Secretarial Compliance Report in such form as
specified, to stock exchanges, within sixty days from end of each financial year. SEBI vide its Circular dated
February 08, 2019 notified the formats for Annual Secretarial Audit Report and Annual Secretarial Compliance
Report for listed entities and their material subsidiaries, effective from the financial year ended March 31,
2019.

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Provisions related to audit under Companies Act, 2013

CHAPTER – 3 Vouching and Verification
Audit of Financial Statement Items

Concept In India, the preparation of financial statements of companies are guided by accounting standards
issued by The Institute of Chartered Accountants of India. These accounting standards constitute the broader
framework of generally accepted accounting principles, also known as the Indian GAAP.

In addition, the Companies Act, 2013, through Schedule III, provides the format to be followed while preparing
the financial statements. Audit of financial statements, therefore, refers to the process of examination of a
company’s financial statements and related disclosures in the ‘Note to Accounts’ section with respect to various
items recorded in the financial statements.

Vouching and Verification

The traditional methods associated with the audit of financial statement items are known as Vouching and
Verification.

Vouching refers to the examination of accuracy, authority and authenticity of transactions that appear in the
books of accounts with the help of vouchers of these transactions. So, we can say examining voucher means
vouching. Vouching is done in order to check the authenticity and genuineness of transaction.

Thus, vouching examines whether –

(i) All transactions undertaken by the entity have been recorded and nothing has been purposefully left
out.
(ii) Transactions recorded in the books of accounts are supported by documentary evidence.
(iii) No fraudulent transaction has been recorded in the books of accounts.
(iv) Transactions that have been recorded belong to the current accounting year (in case of accrual basis of
accounting).
(v) Necessary vouchers relating to entries recorded in books are with the client.
(vi) All transactions are properly authorised by the person responsible to do so.
(vii) Transactions have been recorded at the correct value and such values have been calculated correctly.
(viii) Transactions recorded in the books of accounts are related to the organisation.
(ix) Proper accounting entries have been made against the transactions.

Verification, on the other hand, can be defined as a process of substantiation of assets and liabilities recorded
in the books of account, by means of physical inspection and examination of legal and official documents, and
then forming expert opinion as to the existence, ownership, possession, classification and valuation of assets
and liabilities of an entity. Thus, verification includes –

(i) Examination of existence of the assets or liabilities on the reporting date.

(ii) Examination of ownership and control of the asset or liabilities on the reporting date.
(iii) Examination of possession of the assets on the reporting date.
(iv) Examination of charges, if any, against the assets.
(v) Examination of accounting of assets or liabilities.
(vi) Examination of correctness of valuation of assets or liabilities.
(vii) Examination of adequacy of disclosures as required by the relevant regulation.

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Audit of financial statements applies both vouching and verification in examining various items of financial
statements.

Role of Management Assertions in Designing the Audit Procedure in Audit of Financial Statements

The dictionary meaning of the term ‘assertion’ is ‘a confident and forceful statement of fact or belief’. However,
when used in the context of auditing, it refers to some implicit or explicit claims.

While preparing the financial statements of an entity, company’s management makes various implicit or explicit
claims i.e., assertions with regard to completeness, cut-off, existence/occurrence, valuation/ measurement,
rights and obligations and presentation of assets, liabilities, income and expenditures and disclosure in
accordance with the applicable accounting or financial reporting standards.

Since an auditor is to appraise the truthfulness and fairness of financial performance and position as exhibited
in the financial statements, he must design the audit procedure in such a way that these assertions by
management are verified appropriately.

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Audit of Income Statement Items

INCOME STATEMENT
FOR THE YEAR ENDED…......
PARTICULARS CY PY
I. REVENUE FROM OPERATIONS XXX XXXX
II. OTHER INCOME XXX XXXX
III. TOTAL REVENUE XXX XXX
IV. EXPENSES
A. COST OF MATERIALS CONSUMED XX XX
B. PURCHASE OF STOCK IN TRADE XX XX
C. CHANGES IN INVENTORIES OF FG, WIP AND STOCK IN TRADE XX XX
D. EMPLOYEE BENEFIT EXPENSES XX XX
E. FINANCE COST XX XX
F. DEPRECIATION & AMORTISATION XX XX
G. OTHER EXPENSES XX XX

TOTAL EXPENSES XXX XXX

V. PROFIT BEFORE TAX XXX XXX
LESS - INCOME TAX XXX XXX
VI. PROFIT AFTER TAX XXX XXX

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A. Revenue from Operation

Revenue from operation comprises sale of goods, sale of services and other operating revenues. Other
operating revenue includes any revenue earned by the company from its operations other than its
principal activities. For example, Discount Received, Bad Debt Recovery etc.

For a finance company, revenue from operation primarily includes interest income and income from
other financial services.

a. Occurrence (i) The auditor should ensure that all revenue items recognised are
genuine and no sale transactions have been recorded twice.
(ii) He may test check a few invoices with accounting entries. Further,
he should check the sequence of sales invoices, review the
recording of unusual transactions, verify the return transactions
with sales invoice, challan, credit note and stock records.
(iii) He should also obtain confirmation from few customers to check
whether the transactions are genuine.
(iv) He should ensure that no fake sale transactions have been
recorded.
(v) For services, he must see that revenue has been recognised based
on the policy undertaken.
b. Cut-off He shall see whether revenue from operation includes the sale made and
services performed during the year only.
c. Completeness The auditor should verify that all sales effected during the year have been
included in revenue. He should apply the cut-off procedure to ensure that
revenues are recognised in the current accounting period and check if year end
sale transactions have been tempered.
d. Measurement (i) The auditor shall see that revenues are accurately measured
based on applicable Accounting Standards.
(ii) Trade discount allowed to the customers should be checked. No
separate entry for trade discount should be passed in the books.
If there is any significant variation in trade discount allowed to
different customers, the auditor is required to inquire into the
reason for such variations.
(iii) The sales tax, insurance charges, etc. collected through sales
invoices must be recorded under separate accounts.
e. Presentation & The auditor shall ensure the following disclosure for revenue from operation in
Disclosure respect of a company other than a finance company as per Schedule III (Part 2):
(i) Disclosure should be available for each class of goods.
(ii) Revenue from operations shall disclose separately in the notes
revenue from –
(a) Sale of products; (b) Sale of services;
(c) Other operating revenues; Less: (d) Excise duty.
(iii) In respect of a finance company, revenue from operations shall
include revenue from –
(a) Interest; and (b) Other financial services
(iv) Discount other than usual trade discount must be disclosed.
Similarly, transactions with related parties should be separately
disclosed in the Notes.
(v) In the case of companies rendering or supplying services, gross
income derived from services rendered or supplied under broad
heads.

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B. Other Income
Other income comprises interest income (for companies other than a finance company), dividend
income, net gain on sale of investments and other non-operating income such as royalties, lease rentals
etc.

a. Occurrence (i) The auditor shall obtain a list of new fixed deposits opened during
the year along with the information on rate, tenure and date of
investment.
(ii) He shall obtain a confirmation of interest income from bank. Also
obtain a copy of Form 26AS of Income Tax to confirm the interest
income and related TDS.
(iii) He should investigate the investment ledger further to see the
new investments made in other securities such as corporate
bonds, debentures and shares and check the interest and
dividend income generated therefrom.
(iv) He should trace a sample of dividend/interest received from the
cash book through dividend/interest warrants to investment
certificates and their deposit into the bank.
(v) He should also check the net gain or loss on sale of investment
based on relevant documents such as DEMAT and Trading
Account details, transfer deeds etc.
b. Cut-off The auditor must ensure that interest income does not include any unearned
interest and includes interest accrued on investment.
c. Completeness The auditor must ensure that all interest received and accrued and dividend
received have been recorded and the recording has been done appropriately.
d. Measurement (i) The auditor must check the accuracy of interest calculation on
new fixed deposits and fixed deposits existing on the opening date
of the year.
(ii) He should also see that dividend income received is accurate.
(iii) In certain cases, dividends and interest are received by the client
after deduction of tax at source. The auditor should ensure that
dividends and interests are recorded at gross amounts.
(iv) If interest or dividend is received for the pre-acquisition period,
the auditor should see whether proper adjustment has been
made with the cost of investment for this preacquisition dividend
or interest.
e. Presentation & The auditor shall ensure the following disclosure as per Schedule III (Part 2):
Disclosure (i) Other income shall be classified as:
(i)Interest Income (in case of a company other than a finance
company);
(ii) Dividend Income;
(iii) Net gain/loss on sale of investments;
(iv) Other non-operating income (net of expenses directly attributable
to such income).

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C. Purchases
It is another important element of financial statements and is includes purchase of raw materials to be
included in the cost of materials consumed in case of a manufacturing organisation and purchase of
merchandise in case of a trading organisation. As a part of an audit exercise, the auditor examines the
purchase transactions and related internal control to ensure that there is no material misstatement in
the amount of purchase and accounts payable reported in the financial statements.

a. Occurrence (i) The auditor must ensure that only genuine purchases have been
recorded in the books of accounts. He may examine the purchase
orders, goods received notes and purchase invoices to satisfy
himself.
(ii) Photocopy of purchase invoices should not be allowed. Moreover,
purchase invoices must be in the name of the entity.
(iii) He shall see whether all the purchases are approved by the
relevant authority. The same is extremely important for
purchases from related parties.
b. Cut-off The auditor shall see that only purchases during the year have been recognised
as expense.
c. Completeness (i) He should apply the cut-off procedure to ensure that purchases
effected during the year are only recognised in the current
accounting period.
(ii) The auditor should see that purchase invoice should be booked
only once the risk and reward incidental to the ownership has
been transferred. He should be careful with delivery terms such
as F.O.B and C.I.F etc.
(iii) The auditor must check the return transactions carefully based on
relevant documents.
(iv) He shall ensure correct accounting for goods-in-transit.
d. Measurement (i) The auditor shall see that purchase transaction values have been
correctly calculated considering the trade discount applied.
(ii) Information relating to input tax credit shall be verified. The
auditor shall see that appropriate adjustments have been made
in this respect.
e. Presentation & The auditor shall see that the following disclosure as per Schedule III (Part 1)
Disclosure has been appropriately done:
(i) In the case of manufacturing companies, —
(1) raw materials under broad heads;
(2) goods purchased under broad heads;
(ii) In the case of trading companies, purchases in respect of goods traded in by
the company under broad heads.

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D. Employee Benefit Expenses

Employee benefit expenses represents the total amount payable by the organisation to its employees
and essentially includes, apart from the wages and salaries in cash, all types of perquisites, post-
employment benefits including gratuity, superannuation, leave encashment, provident fund
contribution, ESI contribution as well as employee welfare expenses etc. In a company, often, these
expenses constitute a significant portion of total cost and hence an auditor must put especial emphasis
while auditing these items. While conducting an audit of employee benefit expenses, an auditor must,
at the beginning, obtain a detail understanding of the company’s recruitment, promotion and
retirement policies, remuneration schemes, various post-employment benefits. He should evaluate the
internal control associated with these expenses. He should also apply substantive procedure to
determine the reasonability of monthly cash outflow, consistency with the previous year’s figures etc.
so as to determine an expectation of monthly expenses and whether the same is consistent with peers.

a. Occurrence (i) The auditor should ensure that all expenses included in the
‘employee benefit expenses’ are genuine.
(ii) He should obtain a complete list of employees with data on new
hires, their appointment dates and remuneration terms and
conditions.
(iii) For a sample of newly appointed employees, he may conduct a
complete examination of their appointment and remuneration
paid as per terms.
(iv) Similarly, he may collect a list of employees resigned or
terminated during the year and see that their payments have
been appropriately decided and settled.
(v) He should obtain the pay roll register and conduct and
examination of reasonability of remuneration and investigate
irregularities, if any.
(vi) He should also see that all adjustments such as outstanding salary,
PF contribution, deposit of TDS, PF and ESI premium have been
appropriately recorded.
b. Cut-off The auditor must ensure that only employee benefit expenses relating to
current year have been recognised.
c. Completeness (i) The auditor shall see that all the employee benefit expenses have
been appropriately recorded in the books of accounts.
(ii) He should also check whether all the amount of money deducted
from salary have been duly deposited and if not, the same have
been shown as a current liability.
d. Measurement (i) The auditor must see that the total amount of remuneration is
correctly determined. He may conduct a test on a sample to check
the same.
(ii) He should check whether statutory deductions have been
accurate and post-employment benefits have been determined as
per the policy adopted.
e. Presentation & The auditor must see that the following disclosure requirements as per
Disclosure Schedule III (Part 1) have been duly complied with:
Employee Benefits Expense shall be shown separately as
(i) salaries and wages,
(ii) contribution to provident and other funds,
(iii) expense on Employee Stock Option Scheme (ESOP) and Employee
Stock Purchase Plan (ESPP),
(iv) staff welfare expenses.

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F. Depreciation and Amortisation

Depreciation is the charge representing the cost of a tangible asset allocated over its effective life. The
similar charge for an intangible asset is known as amortization. Depreciation and amortisation
constitute a significant portion of a company’s total expenditure and hence have a direct bearing on
profitability. Hence, the auditor needs to be extra careful in determining the appropriateness, accuracy
and accounting of depreciation and amortization. While conducting the audit of depreciation and
amortization charges, the auditor should obtain a detail understanding of the organisation’s
depreciation policy, accounting policy relating to depreciation and should check the validity of the
charge and calculation accuracy.

a. Occurrence (i) The auditor shall obtain the fixed asset register and identify the
items of assets acquired, sold and discarded during the year. This
will help him to determine the items of assets eligible for
depreciation and amortisation during the year.
(ii) He may select a sample of assets on materiality considerations
and verify the rates and amount of depreciation and amortisation
calculated.
b. Cut-off The auditor needs to ensure that depreciation is charged on the assets
purchased from its date of put to use and not form purchase date. Moreover,
he shall also see that, in case the company has a policy of charging depreciation
on time basis, deprecation on items acquired during the year is calculated from
the date of put to use to year end and for items sold, from the beginning of the
year up to the date of sale.
c. Completeness (i) He must ensure that depreciation and amortisation have been
charged on all eligible tangible and intangible assets respectively
and no fake assets have been considered for this purpose.
(ii) The auditor shall see that the amount of depreciation and
amortisation have been appropriately accounted in primary
books and posted to appropriate accounts.
(iii) He shall also ensure that depreciation on revalued amount has
been properly accounted from revaluation reserve.
(iv) He should also ensure that for any retrospective change in the
method of depreciation, due effect has been given in the Income
Statement.
d. Measurement (i) The auditor shall see that the rate of depreciation is consistent
with the rates suggested in Schedule II and the amount of
depreciation and amortisation has been calculated accurately
based on the rates and time involved.
(ii) He shall ensure that the rates have been decided in conformity
with the effective life of assets.
(iii) He should also see that residual value has been properly
determined.
(iv) The auditor shall also see that in case of change in estimation of
useful life or in case of impairment, the amount of depreciation
has been calculated appropriately
e. Presentation & The auditor must see that the following disclosure requirements as per
Disclosure Schedule III (Part 1) have been duly complied with:
(i) Accounting policy for depreciation and amortisation.
(ii) Useful life of assets as per Schedule II.
(iii) Residual value and the method of depreciation

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G. Finance Cost
Generally, Finance Cost comprises of interest cost on structured debt instruments such as Debentures
as well as traditional institutional finance such as Bank Loan, secured or unsecured. In order to conduct
the audit of finance cost, the auditor must procure the schedule of loan and information relating to all
structured debt instruments, the rate of interest applicable and the tenure of such loan based on which
he shall be able to determine the amount of interest.

a. Occurrence (i) The auditor shall see whether interest has been provided on all
eligible debt instruments and loans.
(ii) He shall verify the amount of interest payment form bank
statement and shall check the same with accounting entries in the
cash book and general ledger.
(iii) He shall see that interest was paid and provided only in respect of
loans outstanding either for a part of the year or for entire year.
b. Cut-off The auditor shall ensure that interest has been provided only for the period the
loan was outstanding during the year.
c. Completeness The auditor shall ensure that interest due but not paid has also been considered
as Accrued Interest and the same is appropriately accounted and shown in the
financial statement.
d. Measurement (i) The auditor must verify the calculation of interest payable based
on the rate, loan amount outstanding and the period for which
the loan remains outstanding during the year.
(ii) He shall be extra careful with loan items repaid during the year
and debentures redeemed during the year.
e. Presentation & The auditor must see that the disclosure requirements as per Schedule III (Part
Disclosure 1) and various Accounting Standards (or Ind ASs) have been duly complied with.

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H. Other Expenses
Other Expenses in the Statement of Profit and Loss include Power and Fuel, Rent, Repairs, Insurance,
Travelling and Miscellaneous Expenses. These are some essential and incidental expenses to run the
organisation. While conducting the audit of these expense, the auditor generally investigates whether
the expenditure relates to the current accounting year, whether the same is a revenue expenditure and
is valid as per the policy of the organisation, its classification in appropriate heading, authorisation and
relevance for the business.

a. Occurrence (i) The auditor needs to ensure that all expenditure charged against
the revenue are genuine. For this purpose, he should vouch the
expenditure based on relevant documents.
(ii) With respect to rent he should obtain a monthly expense
schedule along with the rent agreements and verify whether the
agreement is in the name of the company and whether the rent
for all the months has been recorded.
(iii) With respect to power and fuel expenses, the auditor should
collect a monthly expense schedule and see that the expense for
all the months has been recorded.
(iv) With respect to insurance expenses, the auditor should obtain a
summary of insurance policies taken along with their validity
period and see that the expense shown is genuine.
(v) With respect to legal and professional expenses, the auditor
should collect a consultation-wise summary and see that the
expense is genuine. For monthly retainership agreements, he
shall verify that expense for all 12 months has been recorded. For
non-recurring expenses a test on selected sample may be
preferable.
(vi) For all other expenses, the auditor shall conduct examination on
selected sample of transaction to ensure their validity
b. Cut-off The auditor should ensure that expenses charged against the revenue are
related to current year only. He should be extra cautious with rent and
insurance expenses as the often involve advance payments.
c. Completeness The auditor should ensure that the transactions are properly authenticated as
per the policy of the company, appropriately classified and proper accounting
entry has been done for their payment and adjustments (e.g., outstanding and
prepaid expenses).
d. Measurement In case of monthly expenses as per agreement, the auditor should verify the
calculation of the expense and adjustment for outstanding and prepaid
expense, if any. He should be extra careful with escalation clause and rent
agreements terminated during the year. For other expenses he shall evaluate
whether the same is reasonable based on the data available for past years. He
may perform analytical procedures such as expenditure per unit of production
analysis to assess overall reasonableness of expenditure.
e. Presentation & The auditor must see that the disclosure requirements as per Schedule III (Part
Disclosure 1) have been duly complied with, especially whether other expenses have been
classified in appropriate heads.

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Audit of Balance Sheet Items

BALANCE SHEET
AS ON …............
PARTICULARS NOTES TO ACCOUNTS CY PY
I EQUITY AND LIABILITIES
1. SHAREHOLDERS' FUNDS
A. SHARE CAPITAL
i. EQUITY SHARE CAPITAL XX XX
ii. Preference share capital XX XX
B. RESERVES AND SURPLUS XX XX
2. SHARE APPLICATION MONEY PENDING ALLOTMENT XX XX

3. NON CURRENT LIABILITIES

A. LONG TERM BORROWINGS XX XX
B. DEFFRED TAX LIABILITY XX XX
C. OTHER LONG TERM LIABILITIES XX XX
D. LONG TERM PROVISIONS XX XX

4. CURRENT LIABILITIES
A. SHORT TERM BORROWINGS XX XX
B. TRADE PAYABLES XX XX
C. OTHER CURRENT LIABILITIES XX XX
D. SHORT TERM PROVISIONS XX XX
TOTAL XXX XXX

II. ASSETS
1. NON CURRENT ASSETS
A. PROPERTY PLANT AND EQUIPMENTS AND INTANGIBLE ASSETS
a. PROPERTY PLANT AND EQUIPMENTS XX XX
b. INTANGIBLE ASSETS XX XX
c. CAPITAL WORK IN PROGRESS XX XX
B. NON CURRENT INVESTMENTS XX XX
C. DEFFERED TAX ASSETS XX XX
D. LONG TERM LOANS AND ADVANCES XX XX

2. CURRENT ASSETS
A. CURRENT INVESTMENTS XX XX
B. INVENTORIES XX XX
C. TRADE RECEIVABLES XX XX
D. CASH AND CASH EQUIVALENTS XX XX
E. SHORT TERM LOANS AND ADVANCES XX XX
F. OTHER CURRENT ASSETS XX XX
TOTAL XXX XXX

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A. Property, Plant and Equipment

Property, Plant and Equipment constitute a significant portion of total assets of an entity. According to
the Guidance Note on Audit of Property, Plant and Equipment issued by The Institute of Chartered
Accountants of India, the term ‘Property, Plant and Equipment’ refers to such tangible items that (a)
are held for use in the production or supply of goods or services, for rental to others or for
administration purposes; and (b) are expected to be used during more than one period. Thus, PPE
includes land, buildings, plant and equipment, furniture and fixture, vehicle, office equipment,
computers etc. In addition to the Guidance note, audit process for PPE is also governed by the relevant
Accounting Standard (AS 10 or Ind AS 16) in organisations which are required to comply with Accounting
Standards.

a. Existence

(i) The auditor must ensure physical verification of the assets to confirm that they exist and are
under the possession of the client.
(ii) He must tally the physical verification report with the asset register maintained by the company
as at the reporting date. He shall ensure that PPE additions up to the date of verification have
been updated in the register.
(iii) He shall demand explanations for any discrepancies found in the above process.
(iv) He shall specifically ensure that assets that are not in the working condition have been
accounted for as deletions

b. Rights and Obligations

(i) The auditor should verify that PPE additions have been approved by the responsible official
and such additions are as per the capital expenditure budget approved by the board for the
financial year concerned.
(ii) He shall also verify whether appropriate internal processes and procedures like inviting
competitive quotations or floating tenders were done before finalising the vendor.
(iii) The auditor shall check that PPE purchase invoices are in the name of the client that entails the
legal ownership. For land and building, the auditor shall verify the title deed of the property. In
case any charge is created on any immovable property due to any loan taken from a bank or
financial institution and hence the original title deed is with the lender, the auditor shall ask
the management to obtain a written confirmation from the lender in this respect.
(iv) In relation to all deletions, he shall verify management’s rationale for deletion. He may also
seek any report from the technical expert, if any, that led to such decision of deletion.
(v) He shall also verify whether such deletions are appropriately authorised, followed the
established internal procedures (like inviting tenders etc.) and properly recorded in
the books of accounts.
c. Cut-off

The auditor shall see that the Net Block of assets shown in the Balance Sheet comprises all
assets existed and under the ownership of the company on the reporting date and
depreciation pertains to the current period only.

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d. Completeness

(i) He shall also verify the PPE schedule (asset class wise) maintained by the management and
tally the closing balances to the entity’s books of accounts.
(ii) He should check the arithmetical accuracy of the movement in PPE schedule and
reconcile the opening balance with the closing balance of each class of asset by
considering the additions and disposals during the year.

Valuation

(i) The auditor shall see that all items of PPE have been carried at cost less accumulated
depreciation less accumulated impairment loss. The cost, for this purpose, includes all costs
incurred to acquire or construct the PPE and all subsequent costs to replace part of it. However,
day-to-day servicing cost should not be included. They should be charged to profit and loss.
(ii) He shall also verify the installation certificate to know the date of installation of the asset. This
information will be important in calculating the pro-rata depreciation.
(iii) The auditor shall verify whether depreciation has been charged on all items except the freehold
land. He shall also see that the depreciation method reflects the pattern in which the future
economic benefits are expected to be derived from the assets. In case of company, the auditor
shall also ensure that depreciation has been calculated in compliance with Schedule II of the
Companies Act 2013.
(iv) He shall verify whether the management has undertaken any impairment assessment
for any item of PPE and if so, the auditor shall verify the calculation of recoverable value
and subsequent adjustment in the carrying amount of the said asset. He shall also check
the accounting treatment.
e. Presentation and Disclosure

(i) In case of a company, the auditor should ensure that the all items of PPE have been disclosed in
the balance sheet of the company under the head ‘Non-current Assets’ and subhead ‘Fixed
Assets’ as ‘Tangible Asset’ as per Schedule III of the Companies Act 2013
(ii) He shall also ensure that all the relevant information has also been disclosed in the
‘Notes to Accounts’ section.

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A. Patents and Copyright

A patent is an exclusive right granted by the Government to the manufacturer to dispose of or
otherwise benefit from the result of the invention of a production process. It is an official document,
which secures to an investor exclusive right to make, use and sell his invention. On the other hand, a
copyright is an exclusive right granted by the Government to publish or republish a book, report, or
any other literary work, music composition or other work of art etc. The right is primarily granted to
the author of the literature or creator of the art work. However, the author/ creator may transfer the
same to any other person for using the same for commercial purpose. In India, copyright is valid for
the lifetime of the author/creator and even fifty years after his death.

a. Existence

(i) A schedule of patents and copyright held by the company should be procured from the
management.
(ii) The document of each patent and contract paper of each copyright should be physically verified
by the auditor to ensure that it has been duly registered.
(iii) The auditor shall ensure that the patent is in active use in production of goods or rendering
services.

b. Rights and Obligations

(i) The ownership of patents and copyrights should be verified by inspection of the certificate of
patent issued in the name of the client and the contract paper of copyright
(ii) If it has been purchased, the agreement surrendering it in favour of the client should be
examined.
(iii) The last renewal receipt should be examined to ascertain that the patent has not lapsed.
(iv) The auditor has to verify that renewal fees have been paid on due dates by being charged to
revenue and not to the patent account.
(v) The auditor must ensure that the copyrights shown in the financial statement are yet to
expire.
c. Cut-off

The auditor shall see that the value of these assets shown in the Balance Sheet comprises all assets
existed and under the ownership of the company on the reporting date and amortization pertains to
the current period only.
d. Completeness

(i) The auditor should check the patent and copyright register carefully in order to verify that all
the items have been properly included therein. He must ensure that patents and copyrights
acquired during the year has been entered in the register and items lapsed during the year has
been removed properly.
(ii) He shall verify the arithmetical accuracy of the above movements in asset schedule.

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e. Valuation

(i) The auditor should ensure that patents and copyrights are being shown at cost less
amortisation charges.
(ii) He shall also see that the amortisation rate follows the pattern in which the benefits are
expected to be consumed.
(iii) In case it is purchased from a third party, the cost of the patent and copyright is the acquisition
cost. Also, the cost of registration of the same in the client’s name should be included in the
valuation, while the renewal fees for patents should be charged off to revenue. The auditor
should examine the same.
(iv) If the patent has been developed by the client in house, all development expenses, legal
charges, including registration fees and other direct costs incurred in creating it, should be
capitalized (as per Ind AS 38 or AS 26).
(v) The cost of patent should be written off over the legal term of its validity or over its useful
commercial life, whichever is shorter. The cost of the copyright should be written off over the
legal term of its validity.
f. Presentation and Disclosure

(i) In case of a company, the auditor should ensure that the patents and copyright have
been disclosed in the balance sheet of the company under the head ‘Non-current
Assets’ and subhead ‘Other Intangible Asset’ as per Schedule III of the Companies Act
2013.
(ii) He shall also ensure that all the relevant information has also been disclosed in the
‘Notes to Accounts’ section

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B. Investments
Investments are the assets held by an enterprise for earning income by way of dividends, interest and
rentals, for capital appreciation, or for other benefits to the investing enterprise. An investment
constitutes a significant portion of the total assets. As per Schedule III of the Companies Act 2013,
investments can be (a) Non-Current investments or (b) Current Investments. An investment may be
represented by investments in government securities, shares, debentures, mutual funds, etc.

a. Existence

(i) The auditor shall collect a schedule of all short and long-term investments from the
management with all possible details including their name, nature, investee entity, purchase
price, date of purchase, tenure, date of interest payment (for debt securities), rate of interest
(for debt securities), past year’s rate of dividend (for share and mutual funds).
(ii) He shall tally the aggregate figure of the schedule with the figure shown in the balance sheet.
He shall also examine the investment register and verify the amount shown in schedule with the
register. The auditor must ensure that only those investments which belong to the client are
shown in the balance sheet.
(iii) He shall physically verify all the certificates, and de-mat statement details to check that they are
in the name of the client on the reporting date. Verification of certificates should be done in a
single sitting to avoid producing same certificates more than once.
(iv) In case the certificate of investment is yet to be received, purchase of the same should be
verified based on allotment advice, broker’s note and receipt, etc. Similarly, for sale of
investment between the balance sheet date and date of verification, broker’s note may be
checked. For sale of shares or other listed securities, trading account statement may be verified.
(v) In case investments are not held by the entity in its own custody, then a certificate should be
obtained from the relevant authority.
b. Rights and Obligations

(i) The auditor shall verify the Memorandum and Article of the company to determine the power
of the company to invest the surplus funds outside.
(ii) By verifying all the certificates, he shall determine the rights of the company in respect of the
investments made, especially, the interest and dividend.
(iii) The auditor shall also see that all interest has been duly received and included in income.
Outstanding interest if any should be recalculated and verified with the figure shown.
c. Cut-off

The auditor shall see that the value of investments shown in the Balance Sheet comprises all
investments existed and under the ownership of the company on the reporting date.
d. Completeness

(i) The auditor shall ensure that the schedule of investment is exhaustive.
(ii) He shall also ensure that all movements in the investment ledger have been appropriately
recorded.

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e. Valuation

(i) The auditor shall see that all costs incurred in connection with purchase of investments have
been capitalised. However, in case the investment is purchased at cum-interest price, he shall
see that cost doesn’t include the interest component.
(ii) He shall also see that bonus shares received by the company are recorded in the investment
ledger without attributing any cost to it. In case of right shares purchased by purchasing the
right also, the cost of right entitlement must also be capitalised.
(iii) He shall see that any pre-acquisition dividend is credited to the investment account itself and
not considered in the Statement of Profit and Loss.
(iv) The auditor shall also verify that the value of the investment has been determined following
the relevant accounting standards keeping in mind the nature of investments.
f. Presentation and Disclosure

(i) In case of a company, the auditor should ensure that the investments have been disclosed in
the balance sheet of the company under the head ‘Non-current Assets’ and ‘Current Asset’
within the subhead ‘Financial Assets’ as per Schedule III of the Companies Act 2013.
(ii) The auditor shall also ensure that all the relevant information has also been disclosed in the
‘Notes to Accounts’ section.

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C. Inventories/Stock in Trade
Inventory includes raw materials, loose tools, spare parts, semi-finished goods or work-in- progress,
packing materials as well as finished goods ready for sale. Even for some organisations it includes
stock at branch (in case of branch accounting), stock with customers (in case of hire purchase
accounting), stock with consignee (in consignment arrangement), stock with customer on sale or
approval (in case of sales on approval). The responsibility for properly determining the quantity and
value of inventories rests with the management of the entity. The management satisfies this
responsibility by carrying out appropriate procedures which include verification of all items of
inventory at least once in every financial year. This responsibility is not reduced even where the
auditor attends any physical count of inventories in order to obtain the audit evidence. However,
mere presence at the time of physical stock count does not relieve the auditor from his duty, rather
the auditor is required to follow a detailed procedure to verify the inventories.

a. Existence
(i) The auditor should review the client’s plan to verify inventory physically. He shall see
that the process is properly supervised. He must ensure that all stock count sheets are
signed by a responsible official of the client.
(ii) Where the client follows periodic system stock count should be done at the end of the
period. On the other hand, where the client follows perpetual system, stock count
should be done at interim dates.
(iii) The auditor must satisfy himself about any inventory lying at public warehouses or with
third party.

b. Rights and Obligations

(i) The auditor shall also vouch recorded purchases to underlying documentation such as
purchase invoice, purchase order, Goods Received Notes etc to determine that client is
the owner of such goods.
(ii) He shall evaluate consignment agreement and any collateral agreement and examine
the terms and conditions binding on the client.
(iii) He shall also obtain confirmation from the third parties for inventories lying with them.
c. Cut-off
The auditor shall see that the value of investments shown in the Balance Sheet comprises all
investments existed and under the ownership of the company on the reporting date.
d. Completeness
(i) The auditor should perform analytical procedure to identify any abnormality.
(ii) He should collect non-financial information such as weights and measures and check
the same with physical verification reports.
(iii) He shall also perform purchase and sale cut-off test to identify misappropriation near
the year end. He shall also ensure that no item is omitted from inventories and no
invalid item is included in inventories. For this purpose, information of all stock lying
with customers (under hire purchase system or sale on approval system), at branch and
with consignee must be procured and verified.
(iv) He shall reconcile physical inventory amounts with perpetual records including stores
ledger. The value of the inventory should also be tallied with the amount recorded in
the books as adjustment entry of closing stock.

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e. Valuation
(i) The auditor must determine the appropriateness of the method of issuing inventory
(LIFO, FIFO, Weighted Average, etc.) for valuation purpose.
(ii) Value of raw materials must be examined based on the cost of purchase, carriage
inwards, duties paid, market price of raw materials and estimated cost of disposal. The
auditor shall see that lower of cost and NRV has been considered as the value. Relevant
documents for this purpose would be purchase invoice, voucher for transport cost, etc.
(iii) He shall also ensure that work-in-progress has been valued considering the completed
stage of production and all direct and relevant indirect costs (up to works cost).
(iv) He shall ensure that cost of finished goods includes all direct and relevant indirect costs.
In case the finished goods are expected to fetch value lower than the cost, the auditor
shall see that the same is valued at NRV.
(v) He shall also see that damaged goods are valued at net realisable value. Moreover, he
shall ensure that all obsolete goods have been written off fully.

f. Presentation and Disclosure

(i) In case of companies, as per Part I of Schedule III of the Companies Act, 2013 all items
of inventories shall be included in the head ‘Current Assets’ under the subhead
‘Inventories’.
(ii) Additionally, in notes to accounts the following disclosures shall be made.
- Inventories shall be classified as – (a) Raw materials (b) Work-in-progress (c)
Finished goods (d) Stock in trade (in respect of goods acquired for trading) (e)
Stores and spares (f) Loose goods (g) Others (specify nature).
- Goods-in-transit shall be disclosed under the relevant sub-head of inventories.
- Mode of valuation shall be stated.

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D. Loans
With reference to Part I of Schedule III of the Companies Act 2013, the format of Balance Sheet, loans
represent long term as well as short term loans and advances.

a. Existence
(i) At first, the auditor must obtain separate schedules of long-term and short-term
loans and advances. He should verify whether the balances shown in the
schedule agree with the respective ledger accounts.
(ii) He should also attempt to obtain written confirmation from those who have
been granted the loans and advances.
(iii) In case of claims made against insurance companies, railways, etc. the auditor
should verify that only claims that were admitted have been shown as loans and
advances. For this purpose, all the related correspondence has to be examined.
(iv) He shall also obtain the copies of statutory returns like IT return and GST return
filed with appropriate authorities and verify whether the amount recorded as per
the books tallies with the claims actually made.
b. Rights and Obligations
(i) The auditor should see that loans and advances have been authorised by the
Memorandum and Articles of Association.
(ii) He shall be extra cautious in verifying the authorisation for related party loans
and advances.
(iii) In case loans and advances have been granted against any security, the auditor
shall verify the mortgage deed for the terms and conditions. For unsecured loans,
he shall judge the possibility of its recovery.
(iv) In case advances granted to the employees, the auditor shall examine whether
the instalments have been deducted from their salary regularly.
c. Cut-off
The auditor shall see that the value of loans shown in the Balance Sheet comprises all
loans given by the company and outstanding on the reporting date.
d. Completeness
(i) The auditor should see that all the loans and advances that are outstanding on
the reporting date have been recorded.
(ii) He should also see that all the money recovered against the advances have been
appropriately recorded against the respective advances.
e. Valuation
(i) He shall obtain an aging schedule of different loans and a list of loans under
litigations.
(ii) He should also verify the previous year’s estimate of doubtful loans and after a
discussion with the management verify the adequacy of the allowances for
doubtful accounts during the current year.
(iii) The auditor shall also assess the movement of bad loans to Provision Account or
write offs. He shall see that write-offs are properly authorised by a responsible
official.
f. Presentation and Disclosure
(i) In case of a company, the auditor must see that loans and advances have been
shown under Non-current Assets and Current Assets under subheads Loans as
per Part I of Schedule III of the Companies Act 2013.
(ii) He shall also ensure that all the relevant information has also been disclosed in
the ‘Notes to Accounts’ section.

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E. Trade Receivable
A receivable shall be classified as a trade receivable, if it is in respect of the amount due on account of
goods and services rendered in the normal course of business, the term trade receivable suggests
particularly the amount recoverable from customers, but in practice, it is applied to a wide range of
claims which a business may carry as an asset in its books. Advances or loans cannot, however, be
included under this head.

a. Existence
i. The auditor should obtain a schedule of debtors duly signed by a responsible officer and examine it
with reference to individual debtors’ accounts.
ii. The auditor should carry out an examination of the relevant records himself about the validity,
accuracy and recoverability of the trade receivables balances.
iii. The auditor should check the agreement of balances as shown in the schedules of trade receivable
with those in the ledger accounts.
iv. While examining the schedules of trade receivables with reference to the trade receivables’ ledger
accounts, the auditor should pay special attention to the following aspects:
- Where the schedules show the age of the debts, the auditor should examine
whether the age of the debts has been properly determined.
- Where the amount outstanding are made up of items which are not overdue,
having regard to the credit terms of the entity.
- Whether transfer from one account to another are properly evidenced.
b. Rights and Obligations
i. The auditor must ensure that the company has valid claims in respect to the amount shown as debtors.
ii. He shall examine the bills and notes receivables to see whether those are legally held by the company.
c. Cut-off
The receivable balance must represent the sundry debtors and other receivables held by the company
on the reporting date only.
d. Completeness
i. The auditor should ensure that all debtors and receivables have been included in Trade Receivables. In
case of dispute, he must obtain confirmation from debtors in this respect.
ii. Inspect relevant correspondence such as court order declaring insolvency of a debtor. Correspondence
between the client and his lawyer for bad debts written off.
iii. Verification of subsequent realisations is a widely used procedure, even in cases where direct
confirmation procedure is followed.
e. Valuation
(i) The provision for bad and doubtful debts is to be recomputed and compared it with past period for
assessing its reasonableness.
(ii) The calculation of discount on bills must be verified.
(iii) Rebates and discount allowed in excess of normal terms should be investigated.
(iv) Bad debt written off should be examined.
f.Presentation and Disclosure
The auditor must ensure the following reclosures as per Part I of Schedule III with respect to “Trade
Receivable” in notes to accounts:
(i) Trade receivables shall be sub-classified as:
- Secured, considered good
- Unsecured, considered good
- Trade Receivables which have significant increase in Credit Risk; and
- Trade Receivables - credit impaired.
(ii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately.
(iii) Debts due by directors or other officers of the company or any of them either severally or jointly with
any other person or debts due by firms or private companies respectively in which any director is a
partner or a director or a member should be separately stated.
(iv) For trade receivables outstanding ageing schedule shall be given.

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F. Cash and Cash Equivalents

Cash and Cash equivalent includes cash in hand, stamps in hand, balances held with bank in current
accounts/ margin money accounts, cash credit accounts (debit balance), fixed deposits, and cheques in
hand, etc. It is the most liquid form of assets of an organisation and hence utmost professional
scepticism needs to be exercised while auditing such balances.

a. Existence
(i) The auditor shall exercise special care to verify cash balances. They shall be
preferably checked by surprise. Physical verification of cash in hand would
be utmost essential in this context.
(ii) If the company maintains any rough Cash Book or details of daily balances,
the auditor shall perform test check to see that entries in the Cash Book
are accurate. In case he finds any slip indicating temporary advance given
to an employee which has been included in the cash balance, he should
have them initiated by responsible official.
(iii) The auditor shall also perform a cash sensitivity analysis (by calculating
total receipts and payments month wise) to determine if there is any
abnormal variation in the same in a month. In such a case the auditor shall
enquire into the same and demand explanation from the management.
(iv) He shall also obtain the Bank reconciliation Statements for every bank
account as at the reporting date to rule out possibility of any error in the
cash book. The BRSs must be signed by the accountant and approved by
responsible official. He shall also ask the management to reconcile all
discrepancies.
(v) He shall also communicate with the respective banks and obtain written
confirmation regarding the balances held in different bank accounts and
deposits.
b. Rights and Obligations
The auditor shall verify that all the deposits are in the name of the client. For this
purpose, the confirmation of the banker and certificate of such deposits shall be
examined.
c. Cut-Off
The cash balances must represent the amount of cash and cash equivalents on the
reporting date.
d. Completeness
The auditor shall ensure confirmation of 100% of the bank accounts. He shall also
be careful to include all items of cash in hand in the total balance.
e. Valuation
In addition to performing the above steps, the auditor shall also see that all bank
balances representing holding of foreign currencies have been appropriately
restated at the exchange rate prevailing on the date of reporting.
f. Presentation and Disclosure
The auditor shall ensure the disclosures as per the relevant Accounting Standards
and Part 1 of Schedule III of the Companies Act 2013.

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G. Share Capital
Every company starts with procurement of capital. In case of public limited companies, applications are
invited for subscription to shares from the public. For this purpose, the company issues a prospectus or
statement in lieu of prospectus. On receipt of applications, company makes allotment to eligible
applicants and eventually they become the members of the company. Also, in this process companies
often appoint underwriters to underwrite the issue. An auditor while auditing the Share Capital of the
company must carefully examine all these related aspects.

a. Existence
(i) The auditor must conduct a reconciliation between the opening and closing
balance of share capital to know whether there was any new issue,
capitalisation or buyback of equity shares or redemption of preference
share.
(ii) In case of change he must ensure that the revised capital is within the limit
of authorised capital of the company.
(iii) He must examine that the transactions effecting the change in share capital
are genuine and properly authorised. He should examine the resolutions of
meetings of the BOD and shareholders for this purpose.
b. Rights and Obligations
(i) He should ensure that the new issue satisfies all the regulatory
requirements of Companies Act, 2013, SEBI regulations and guidelines.
(ii) In specific, he shall see that no shares have been issued at discount. In case
shares have been issued at premium, he shall see that the balance of Share
Premium has been utilised only for the purposes permitted.
(iii) With respect to issue of sweat equity shares, right shares, bonus shares etc.
he shall ensure that the rules have been duly complied with.
c. Cut-off
The balance of Share Capital must represent the amount of share capital on the
reporting date.
d. Completeness
The auditor must ensure that all changes made in share capital have been duly
given effect and accounting entries are adequate.
e. Valuation
The auditor must verify that the proceeds collected are correct. For this purpose,
he shall verify the calculation of total proceeds received, its allocation to various
heads and also underwriter’s commission payable and settlement of their accounts
with liability.

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f. Presentation and Disclosure

The auditor shall ensure the following disclosures as per the Part 1 of Schedule III
of the Companies Act 2013: 🟀 For each class of equity shares, the company must
disclose
(i) no. and amount of shares authorised,
(ii) the number of sharesissued, subscribed and fully paid, and subscribed but
not fully paid;
(iii) par value per Share;
(iv) a reconciliation of the number of shares outstanding at the beginning and
at the end of the period,
(v) the rights, preferences and restrictions attaching to each class of shares;
shares in the company held by each shareholder holding more than five per
cent. shares specifying the number of shares held,
(vi) shares reserved for issue under options and contracts or commitments for
the sale of shares or disinvestment, including the terms and amounts;
(vii) terms of any securities convertible into equity shares issued along with the
earliest date of conversion in descending order starting from the farthest
such date;
(viii) calls unpaid (showing aggregate value of calls unpaid by Directors and
officers);
(ix) forfeited shares (amount originally paid up),
(x) shareholding of promoters etc.

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H. Other Equity
As per Schedule III, Division 2, Other Equity comprises of the following elements:
(i) Share application money pending allotment;
(ii) Equity component of compound financial instruments;
(iii) Reserves and Surplus including Capital Total reserve, Securities Premium, Other Reserves and
Retained Earnings;
(iv) Debt instruments through Other Comprehensive Income;
(v) Equity Instruments through Other Comprehensive Income;
(vi) Effective portion of Cash Flow Hedges;
(vii) Revaluation Surplus;
(viii) Exchange differences on translating the financial statements of a foreign operation;
(ix) Other items of Other Comprehensive Income;
(x) Money received against share warrants.

While some of the above sources are eligible for dividend payment, others must be utilised for specified
purposes only – such as Securities Premium and Capital Redemption Reserve. In Schedule III, Division I,
these are however excluded or shown as separate line item.

a. Existence
(i) The auditor must trace and tally the opening balance of reserves with their
closing balances and needs to identify the changes, if any.
(ii) In case there is addition during the year, such as issue of new shares at
premium, transfer to General Reserve from current year’s profit,
revaluation profit etc., the auditor needs to ensure that such additions are
genuine, properly authorised by appropriate resolutions in the meetings of
BOD and members. Similarly, for any reduction in balances, the auditor
needs to find out the resultant transaction and its validity.
b. Rights and Obligations
The auditor must ensure that addition and utilisation of balances of various items
have been in compliance with the relevant Act and Regulations. The utilization of
reserves must be for specified purposes only, as applicable.
c. Cut-off
The balance of each item of Other Equity must represent the amount of share
capital on the reporting date only.
d. Completeness
The auditor must ensure that all changes made in Other Equity items have been
duly given effect and accounting entries are adequate.
e. Valuation
The auditor must ensure that the additions and utilisations from various balances
of Other Equity have been calculated appropriately. For example, in case of
utilization of accumulated profits for dividend payment, the amount so utilised
must satisfy the conditions laid down in Companies (Declaration and Payment of
Dividend) Rules, 2014.

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f. Presentation and Disclosure

The auditor shall ensure the following disclosures as per the Part 1 of Schedule III
of the Companies Act 2013:
(i) ‘Other Reserves’ shall be classified in the notes as- 🟀 Capital Redemption
Reserve; 🟀 Debenture Redemption Reserve; 🟀 Share Options Outstanding
Account; and 🟀 others- (specify the nature and purpose of each reserve and
the amount in respect thereof); (Additions and deductions since last
balance sheet to be shown under each of the specified heads)
(ii) Retained Earnings represents surplus i.e balance of the relevant column in
the Statement of Changes in Equity;
(iii) A reserve specifically represented by earmarked investments shall disclose
the fact that it is so represented;
(iv) Debit balance of Statement of Profit and Loss shall be shown as a negative
figure under the head ‘retained earning’. Similarly, the balance of ‘Other
Equity’, after adjusting negative balance of retained earnings, if any, shall
be shown under the head ‘Other Equity’ even if the resulting figure is in the
negative; and
(v) Under the sub-head ‘Other Equity’, disclosure shall be made for the nature
and amount of each item.

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I. Borrowings
Borrowings represent loans of both long term and short term in nature. While long term borrowings
are procured for business expansion or buying any fixed assets, short term borrowings are done mostly
for working capital financing.

a. Existence
(i) The auditor should collect a schedule of all borrowings with details
regarding the date of procurement of the loan, period of loan, rate of
interest, amount of loan and assets pledged against the loan, if any.
(ii) He shall examine the loan agreements to ensure that the loans have been
taken in name of the client. He shall tally the loan recorded with the loan
agreement.
(iii) In case of bank loan, he shall obtain a confirmation from the bank regarding
the amount of loan outstanding and shall tally the same with the balance
of loan shown in the books.
b. Rights and Obligations
(i) He must examine the Articles of Association and Memorandum of
Association and take note of the rules and regulations in this respect. He
shall ensure that the loan agreement adheres to all such rules.
(ii) He shall verify that the procurement of loan has been properly authorised.
In case of a company, such authorisation must be in the form of a resolution
of the Board.
(iii) He shall examine the loan agreements and take note of the conditions of
such loan. He shall also verify that all such conditions are duly complied
with.
(iv) The auditor should collect a certificate from the lender regarding the asset
pledged with the lender and shall verify the information from the register
of mortgage maintained by the client. He shall also enquire about the
nature of the charge - fixed or floating as a pledged asset with fixed charge
cannot be sold without the permission of the lender. The auditor shall
verify any irregularities in this regard.
c. Completeness
(i) The auditor shall ensure that information regarding all loans has been
produced before him and no loan that was paid earlier in full has been
shown as outstanding. Also, he must ensure that information about the
assets pledged and the nature of charge is complete.
(ii) He shall verify all new loans taken during the year and check the minutes
of the meetings of the Board for authorisation of the same.
d. Valuation
(i) The auditor shall check whether the accounting policies and methods of
recording the loan are appropriate and applied consistently.
(ii) He shall also examine whether the interest payable on such loan has been
paid in due time and the same has been accounted for accordingly. In case
any interest is outstanding, the auditor shall verify the same.
(iii) In case of amortizing loan (i.e., loans of which principal amount is repayable
in instalments) taken by a company, the auditor shall determine the
current maturities of the loan.

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e. Presentation and Disclosure

(i) The auditor must see that the outstanding amount of loan (non-current
portion) has been shown under NonCurrent Liabilities or Current Liabilities
and under subhead Borrowings as per Part 1 of Schedule III of the
Companies Act 2013.
(ii) In case of long-term amortizing loans, the auditor shall see that all current
maturities (instalments falling due within next twelve months) are shown
under the head Current Liabilities and disclosure of the same is given in
form of a footnote.
(iii) He shall also ensure that all restrictive covenants (i.e., conditions) are
appropriately disclosed in the financial statements.
(iv) The auditor shall also see that the charge has been appropriately reported
in the Balance Sheet.
(v) In case the value of the security falls short of the amount of loan
outstanding, he shall examine whether the loan is classified as secured only
to the extent of market value of the security.

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J. Trade Payable
The term ‘Trade Payable’ comprises both trade creditors (i.e., sundry creditors) as well as bills payable.
This represents the liability of an organisation to its suppliers.

a. Sundry Creditors

a. Existence
(i) At first, the auditor shall examine whether an effective internal control system
exists in the organisation relating to the transactions with creditors.
(ii) He shall collect a schedule of trade creditors from the management with all
possible details including the name of the creditor and amount payable. He
shall verify the same with the balance of individual creditor’s account in the
ledger.
(iii) With prior permission from the client, he shall collect confirmation from some
selected creditors regarding the amount payable to them. Such information
shall be checked with the balances of creditors.
(iv) If the ledgers are maintained under self-balancing system, information from
the General Ledger shall be cross verified from the Creditors’ Ledger Control/
Adjustment Account.
b. Rights and Obligations
The auditor shall also examine that all the terms and conditions of the contract with
the supplier have been duly complied. He shall ensure that the goods purchased have
actually been received and/or services have been provided in due course. For this
purpose, Goods Inward Book may be examined.
c. Cut-off
The balance of sundry creditors must represent only the balances outstanding on the
date of reporting.
d. Completeness
(i) The auditor shall ensure that no trade creditor is excluded from the schedule.
He may collect a confirmation from the management in this respect.
(ii) He shall be extra cautious while verifying the transactions near the end of the
year.
e. Valuation
(i) The auditor shall see that the total of balances as per the schedule of creditors
tallies with the total of balances of all creditors’ account.
(ii) He may select a few sample credit sale transactions and shall verify the
correctness of recording the same based on invoice, Goods Received Note,
Purchase Day Book and respective ledger heads.
(iii) The auditor shall also verify the transactions relating to return of goods from
Return Outward Book and see that the same has been correctly posted to
creditors’ accounts.
(iv) In case any discount is received from the supplier, the same shall be examined
from the correspondence with creditors. Its accounting treatment shall also be
verified.
(v) If any amount payable to a specified creditor remains outstanding for long or
if any cheque issued to a creditor is not encashed for long, the same should be
examined to avoid possibility of fraud.

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f. Presentation and Disclosure

The auditor shall ensure the following disclosures as per Part 1 of Schedule III of the
Companies Act 2013.
(i) In case of a company, the auditor must see that the total balance of creditors
has been shown under Current Liabilities and under subhead Trade Payables
as per Schedule III of the Companies Act 2013. It shall further be segregated
into (i) total outstanding dues of micro enterprises and small enterprises; and
(ii) total outstanding dues of creditors other than micro enterprises and small
enterprises.
(ii) He shall also ensure that all the relevant information has also been disclosed in
the ‘Notes to Accounts’ section.

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b. Bills Payable
These are negotiable instruments used by creditors to discharge their liabilities. Basically, a creditor
accepts a bill in favour of the debtor i.e., the client in this case.

a. Existence
(i) The auditor shall collect a schedule of bills payable from the management with
all possible details including the name of the creditor and amount payable,
date when the bill will become due etc. He shall verify the same from Bills
Payable Book and Bills Payable Account. He shall specifically ensure that the
bills are still outstanding and their due date has not expired.
(ii) He shall also see that the acceptance and dishonour of bills have been recorded
in the respective creditors account.
b. Rights and Obligations
(i) He shall examine the bills payable and identify the conditions therein. He shall
see that the conditions have been duly complied with. He must also see that
they met the legal requirements.
(ii) In case acceptance of a bill creates any charge on any asset, the auditor shall
see that the same has been reported in the Balance Sheet.
c. Cut-off
The balance of Bills Payable must represent only the balances outstanding on the date
of reporting.
d. Completeness
(i) The auditor shall see that the schedule collective from the management is
exhaustive and no bills payable is excluded from it. He may collect a written
confirmation from the management in this respect.
(ii) The auditor shall be extra cautious to verify that no bill which has already
expired has been included in the above schedule.
e. Valuation
(i) The auditor shall ensure that total of the schedule tallies with the balance of
the bills payable account.
(ii) To verify the dishonoured bills, the auditor shall examine the correspondence
between the client and the creditor. He shall also verify the notification issued
by the notary public and bank statement.
(iii) In case of renewal of bills dishonoured, the auditor shall examine the
correspondence between the client and the creditor. If any interest was
payable for such renewal, he shall see that the same has been properly
recorded in the creditor’s account.
f. Presentation and Disclosure
(i) In case of a company, the auditor must see that the total balance of bills
payable has been shown under Current Liabilities and under subhead Trade
Payables as per Schedule III of the Companies Act 2013. It shall further be
segregated into (i) total outstanding dues of micro enterprises and small
enterprises; and (ii) total outstanding dues of creditors other than micro
enterprises and small enterprises.
(ii) He shall also ensure that all the relevant information has also been disclosed in
the ‘Notes to Accounts’ section.

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Audit of Some Special Transactions

A. Alteration of Share Capital (Section 61)

The audit procedure to be applied in this context are:
(i) The auditor must confirm that alteration was authorised by articles.
(ii) He shall verify the minutes of the Board meeting and ordinary resolution passed in the general
meeting in which the approval of members is obtained.
(iii) He shall verify that alteration had been effected in copies of Memorandum, Articles, etc.
(iv) He shall obtain the reasons for which the memorandum of the company is altered.
(v) He shall check whether there is any change in the voting percentage of shareholders due to
consolidate and divide all or any of its share capital into shares of a larger amount than its
existing shares.
(vi) He has to confirm that the alter share capital’s denomination should be more than rupee one.
(vii) He has to verify that proper accounting entries have been passed. Register of members may
also be checked to see that the necessary alterations have been effected therein.

B. Issue of Bonus Shares (Section 63)

The audit procedure to be applied in this context are:
(i) The auditor must confirm that issue of Bonus Share was authorized by articles.
(ii) He shall verify the minutes of the Board meeting and ordinary resolution passed in the general
meeting in which the approval of members is obtained.
(iii) He shall check that the company has issue fully paid-up bonus shares to its members only.
(iv) He shall confirm that the issue of bonus shares shall not be made by capitalising reserves
created by the revaluation of assets.
(v) He shall check whether the company has made any default in payment of interest or principal
in respect of fixed deposits or debt securities issued by it.
(vi) He must check whether the company has made any default in payment of statutory dues of
the employees, such as, contribution to provident fund, gratuity and bonus.
(vii) He shall check whether the partly paid-up shares are made fully paid-up.
(viii) He must check whether the bonus shares shall not be issued in lieu of dividend.

C. Splitting of Shares
The audit procedure to be applied in this context are:
(i) The auditor shall confirm that alteration was authorised by articles.
(ii) He should verify the minutes of the Board meeting and ordinary resolution passed in the
general meeting in which the approval of members is obtained.
(iii) He should verify that alteration had been effected in copies of Memorandum, Articles, etc.
(iv) He should verify that proper accounting entries have been passed. Register of members may
also be checked to see that the necessary alterations have been effected therein.

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D. Re-Issue of Forfeited Shares

The audit procedure to be applied in this context are:
(i) The auditor should ascertain that the board of directors has the authority under the Articles
of Association of the company to reissue forfeited shares. Check the relevant resolution of the
Board of Directors.
(ii) He should vouch the amounts collected from persons to whom the shares have been allotted
and verify the entries recorded from re-allotment. The auditor should check the total amount
received on the shares including received prior to forfeiture, is not less than the par value of
shares.
(iii) He should verify that computation of surplus amount arising on the reissue of shares credited
to Capital Reserve Account and
(iv) Where partly paid shares are forfeited for non-payment of call, and re-issued as fully paid, the
reissue is considered as an allotment at a discount and compliance of the provisions of Section
53 is essential. The auditor needs to ensure the same.

E. Issue of Debentures
The term “Debenture” includes debenture stock, bonds or any other instrument of a company
evidencing a debt, whether constituting a charge on the assets of the company or not. Debenture is an
important source of long-term debt capital of a company. A company may issue debentures with an
option to convert such debentures into shares, either wholly or partly at the time of redemption.
Provided that the issue of debentures with an option to convert such debentures into shares, wholly or
partly, shall be approved by a special resolution passed at a general meeting. No company shall issue
any debentures carrying any voting rights. Secured debentures may be issued by a company subject to
such terms and conditions as may be prescribed. The audit procedure to be applied in this context are:
(i) The auditor should verify that the prospectus had been duly filed with the registrar before the
date of allotment of debentures.
(ii) He should check the amount collected in the cash book with the counterfoils of receipts issued
to the applicants and also cross check the amount into the application and allotment book.
(iii) He should examine the debenture trust deed and note the conditions contained therein as to
issue and repayment.
(iv) If the debentures are covered by a mortgage of a charge, it should be verified that the charge
has been correctly recorded in the register of mortgage and charges and it has also been
registered with the registrar of the companies.
(v) Compliance with SEBI guidelines should also be ensured.

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F. Redemption of Debentures
A company may issue debentures with an option to convert such debentures into shares, either wholly
or partly at the time of redemption. If debentures are redeemable, it can be redeemed in any of the
following way:
(i) By way of periodical drawing i.e., by creating Debenture Redemption Reserve Account.
(ii) By way of payment on fixed date.
(iii) By payment whenever the company desires to do so.

The audit procedure to be applied in this context are:

(i) The auditor should inspect the debentures or trust deed for the terms and conditions
regarding redemption of debentures.
(ii) He should see the Director’s minute book authorizing the redemption of debentures.
(iii) He should also vouch the redemption with the help of debenture bonds cancelled and the cash
book.
(iv) He should also examine the accounting treatment thoroughly.

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G. Payment of Dividend

Provisions of Companies Act, 2013 Regarding Payment of Dividend

Dividend is the part of the divisible profits of the company which is actually paid to the shareholders.
Companies Act, 2013 provides detailed provisions regarding declaration and payment of dividend as
follows:

I. Sources of Dividend:
As per Section 123(1), No dividend shall be declared or paid by a company for any financial year except
–
(a) out of the profits of the company for that year arrived at after providing for depreciation in
accordance with the provisions of sub-section (2), or out of the profits of the company for any previous
financial year or years arrived at after providing for depreciation in accordance with the provisions of
that sub-section and remaining undistributed, or out of both; or
(b) out of money provided by the Central Government or a State Government for the payment of
dividend by the company in pursuance of a guarantee given by that Government:

II. Transfer to Reserves:

A company may, before the declaration of any dividend in any financial year, transfer such
percentage of its profits for that financial year as it may consider appropriate to the reserves of the
company.

III. Payment of Dividend out of Accumulated Profit:

Where, owing to inadequacy or absence of profits in any financial year, any company proposes to
declare dividend out of the accumulated profits earned by it in previous years and transferred by
the company to the free reserves, such declaration of dividend shall not be made except in
accordance with such rules as may be prescribed in this behalf. Accordingly, Companies
(Declaration and Payment of Dividend) Rules, 2014 provides that in the event of inadequacy or
absence of profits in any year, a company may declare dividend out of free reserves subject to the
fulfilment of the following conditions:
(i) The rate of dividend declared shall not exceed the average of the rates at which dividend
was declared by it in the three years immediately preceding that year: However, this rule
will not be applicable to a company, which has not declared any dividend in each of the
three preceding financial years.
(ii) The total amount to be drawn from such accumulated profits shall not exceed one-tenth
of the sum of its paid-up share capital and free reserves as appearing in the latest audited
financial statement.
(iii) The amount so drawn shall first be utilised to set off the losses incurred in the financial
year in which dividend is declared before any dividend in respect of equity shares is
declared.
(iv) The balance of reserves after such withdrawal shall not fall below fifteen per cent of its
paid-up share capital as appearing in the latest audited financial statement.

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Section 123(1) further provides that –

(i) No dividend shall be declared or paid by a company from its reserves other than free reserves.
(ii) No company shall declare dividend unless carried over previous losses and depreciation not
provided in previous year or years are set off against profit of the company for the current year.

Note: ‘Free Reserves’ for this purpose shall mean such reserves which are available for distribution as
dividend. It shall not include any amount representing unrealised gains, notional gains or revaluation of
assets, or any change in carrying amount of an asset or of a liability recognised in equity, including surplus
in profit and loss account on measurement of the asset or the liability at fair value.

IV. Interim Dividend

The Board of Directors of a company may declare interim dividend during any financial year or at
any time during the period from closure of financial year till holding of the annual general meeting
out of the surplus in the profit and loss account or out of profits of the financial year for which such
interim dividend is sought to be declared or out of profits generated in the financial year till the
quarter preceding the date of declaration of the interim dividend. In case the company has incurred
loss during the current financial year up to the end of the quarter immediately preceding the date
of declaration of interim dividend, such interim dividend shall not be declared at a rate higher than
the average dividends declared by the company during the immediately preceding three financial
years.

V. Procedure of Dividend Payment:

Section 123(4) states that the amount of the dividend, including interim dividend, shall be
deposited in a scheduled bank in a separate account within five days from the date of declaration
of such dividend.
Moreover, as per Section 123(5), no dividend shall be paid by a company in respect of any share
therein except to the registered shareholder of such share or to his order or to his banker and shall
not be payable except in cash. However, the company may capitalise its profits or reserves for the
purpose of issuing fully paid-up bonus shares or paying up any amount for the time being unpaid
on any shares held by the members of the company.
Any dividend payable in cash may be paid by cheque or warrant or in any electronic mode to the
shareholder entitled to the payment of the dividend.

VI. Restriction on Declaration of Dividend:

As per Section 123(6), a company which fails to comply with the provisions of sections 73 and 74
shall not, so long as such failure continues, declare any dividend on its equity shares.

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VII. Unpaid Dividend

Section 124 of the Companies Act, 2013 states that –
(1) Where a dividend has been declared by a company but has not been paid or claimed within
thirty days from the date of the declaration to any shareholder entitled to the payment of the
dividend, the company shall, within seven days from the date of expiry of the said period of
thirty days, transfer the total amount of dividend which remains unpaid or unclaimed to a
special account to be opened by the company in that behalf in any scheduled bank to be called
the Unpaid Dividend Account.
(2) The company shall, within a period of ninety days of making any transfer of an amount under
sub-section (1) to the Unpaid Dividend Account, prepare a statement containing the names,
their last known addresses and the unpaid dividend to be paid to each person and place it on
the web-site of the company, if any, and also on any other web-site of the company, if any,
and also on any other web-site approved by the Central Government for this purpose, in such
form, manner and other particulars as may be prescribed.
(3) If any default is made in transferring the total amount referred to in sub-section (1) or any part
thereof to the Unpaid Dividend Account of the company, it shall pay, from the date of such
default, interest on so much of the amount as has not been transferred to the said account, at
the rate of twelve per cent per annum and the interest accruing on such amount shall ensure
to the benefit of the members of the company in proportion to the amount remaining unpaid
to them.
(4) Any person claiming to be entitled to any money transferred under sub-section (1) to the
Unpaid Dividend Account of the company may apply to the company for payment of the
money claimed.
(5) Any money transferred to the Unpaid Dividend Account of a company in pursuance of this
section which remains unpaid or unclaimed for a period of seven years from the date of such
transfer shall be transferred by the company along with interest accrued, if any, thereon to
the Fund established under sub-section (1) of section 125 and the company shall send a
statement in the prescribed form of the details of such transfer to the authority which
administers the said Fund and that authority shall issue a receipt to the company as evidence
of such transfer.
(6) All shares in respect of which dividend has not been paid or claimed for seven consecutive
years or more shall be transferred by the company in the name of Investor Education and
Protection Fund along with a statement containing such details as may be prescribed: Provided
that any claimant of shares transferred above shall be entitled to claim the transfer of shares
from Investor Education and Protection Fund (IEPF) in accordance with such procedure and on
submission of such documents as may be prescribed.
(7) If a company fails to comply with any of the requirements of this section, such company shall
be liable to a penalty of one lakh rupees and in case of continuing failure, with a further penalty
of five hundred rupees for each day after the first during which such failure continues, subject
to a maximum of ten lakh rupees and every officer of the company who is in default shall be
liable to a penalty of twenty-five thousand rupees and in case of continuing failure, with a
further penalty of one hundred rupees for each day after the first during which such failure
continues, subject to a maximum of two lakh rupees. According to Section 125(5), any person
claiming to be entitled to any unclaimed dividend may apply to the authority of IEPF for the
payment of the money claimed.

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VIII. Punishment for Failure to Distribute Dividends [Section 127]

Once a dividend is declared, a company must pay such dividend or at least post the warrant in
respect thereof to every shareholder entitled to the payment of such dividend within a period of
thirty days from the declaration of the dividend.
However, if the company fails to do so, then every director of the company shall, if he is knowingly
a party to the default, be punishable with imprisonment which may extend to two years and with
fine which shall not be less than one thousand rupees for every day during which such default
continues.
Moreover, the company shall be liable to pay simple interest at the rate of eighteen per cent per
annum during the period for which such default continues.
However, no offence under this section shall be deemed to have been committed:
(i) where the dividend could not be paid by reason of the operation of any law;
(ii) where a shareholder has given directions to the company regarding the payment of the
dividend and those directions cannot be complied with and the same has been
communicated to him;
(iii) where there is a dispute regarding the right to receive the dividend;
(iv) where the dividend has been lawfully adjusted by the company against any sum due to it
from the shareholder; or
(v) where, for any other reason, the failure to pay the dividend or to post the warrant within
the period under this section was not due to any default on the part of the company.

Audit Procedure for Final Dividend

(i) The auditor should examine the Articles of Association of the company to ascertain the differential
rights of the shareholders, if any.
(ii) The auditor should also examine the minute book of directors’ and shareholders’ meetings to verify
the dividend was properly recommended by the directors and whether it was passed by a
resolution in the shareholders’ meeting.
(iii) The auditor should verify whether the amount of dividend paid was calculated accurately.
(iv) He should ensure that the provisions of Companies Act, 2013 and Companies (Declaration and
Payment of Dividend) Rules, 2014 have been complied with.
(v) Based on the bank statements, the auditor must verify whether the total amount of dividend was
transferred to a separate bank account in a scheduled bank within five days from the declaration
of such dividend and whether dividend was paid to shareholders only out that account.
(vi) The auditor must ensure that dividend has been paid to the rightful owner. He should verify the
Dividend Register and bank statements for this purpose. The auditor shall also reconcile the
amount of dividend warrants outstanding with the Dividend Register and the balance in the Bank
Account.
(vii) The auditor shall also verify whether sufficient effort was made by the management to distribute
the dividend within 30 days from its declaration and shall enquire into all the cases where the
dividend could not be paid within such time.

If the auditor comes across any irregularities regarding the above areas, he shall immediately enquire into
the matter with the management and if not satisfied, shall also bring such irregularities to the notice of the
shareholders.

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Audit Procedure for Interim Dividend

(i) The auditor should examine the Articles of Association of the company to ascertain whether
payment of interim dividend is permitted by the articles or not.
(ii) The auditor should also examine the minute book of directors’ meeting to verify resolution
approving the payment of interim dividend.
(iii) The auditor must critically appraise the justification in paying interim dividend based on interim
accounts.
(iv) The amount of interim dividend shall be deposited in a scheduled bank in a separate account
within five days from the date of declaration of such dividend.
(v) The auditor must ensure that dividend has been paid to the rightful owner. He should verify the
Dividend Register and bank statements for this purpose. The auditor shall also reconcile the
amount of dividend warrants outstanding with the Dividend Register and the balance in the Bank
Account.

Audit Procedure for Unpaid Dividend

(i) The auditor should collect a statement or list containing every detail regarding the unpaid
dividend such as the names of the shareholders, dividend payable to them, dividend warrant
number, reason for the dividend remaining unpaid etc.
(ii) The auditor shall conduct an enquiry to identify whether there was any fault on the part of the
company and if so, what action has been taken against the company.
(iii) The auditor shall verify the statement provided by the management in this respect with other
supporting documents like Dividend Register, Returned Warrants, bank statement, etc. and shall
determine whether the dividend amount has been accurately calculated.
(iv) The auditor shall also verify whether the unpaid dividend has been transferred to a separate
account namely Unpaid Dividend Account within seven days from the expiry of 30 days allowed
for declaration and payment of dividend.
(v) The auditor must verify whether there is any fault on the part of the company and if so whether
they have deposited the interest and the penalty.
(vi) The auditor shall also verify whether the company has published the details of unpaid dividend in
its own website and also in other website(s) approved by the government for this purpose.
(vii) Any payment of previously unpaid dividend must be verified by the auditor to see that the same
has been paid to the rightful owner.
(viii) In case any amount of dividend is remaining unpaid for more than seven years, the auditor shall
verify whether the same along with the interest accrued thereon has been transferred by the
company to IEPF.
(ix) The auditor shall also verify whether all the shares in respect of which unpaid dividend has been
transferred to IEPF, have also been transferred to such fund.

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SPECIAL AUDIT

AUDIT OF EDUCATIONAL INSTITUTIONS

Educational institutions of any state in India are generally established and run under the Societies Registration
Act 1960 or Public Trust Act of the state concerned. Similarly, central educational institutions are guided by the
respective regulations issued by the Ministry of Education from time to time. In some cases, large educational
institutions like universities are established by Central or State governments by enacting special legislation.
Accordingly, the audit of accounts of these institutions is carried out as per the provisions of the legislation or
the Trust Deed concerned. In addition, various circulars issued by the Central or State Government for
institutions are also considered relevant in this respect.

The audit procedure for these institutions must consider the following aspects:

a. Understand the Constitution:

Study the Trust deed, Regulation or Act under which the institution has been established and should
take note of the provisions regarding the maintenance of accounts. In case of State or Central
University, established under the Special Act, study the regulations framed under the Act.

b. Assess the Internal Control System:

Normally, these institutions have a well-organised internal control system. So, evaluate the internal
control system associated with acquisition and maintenance of assets, authorization of transactions,
etc. before finalising the audit programme.

c. Consult the Minute Book:

Carefully examine all notices and minutes of the meeting of Governing Body (in case of colleges),
Senate, Syndicate, Court and Council (in case of universities) and other committees which affect the
accounts and finance of the institute. Confirm that the decisions taken for operation of bank accounts,
approval of expenditure etc. have been duly complied with.

d. Consult the Budget:

Check the budget allocation to different heads and confirm that all amount sanctioned beyond budget
has been duly approved.

e. Verify the Receipts Related Transactions:

I. Tuition Fees: Tally the counterfoils of fee receipt with fee register to see whether they have
been duly recorded or not. Check the register to identify whether all the students have paid
their fees in due time. If any student has deposited the fees beyond the due date, check
whether late fine has been charged or not and whether the same has been properly recorded.
See whether all collections are deposited in the bank account at the end of the day. Total up
the various columns of the Fees Register for each month or term to ascertain that fee paid in
advance have been carried forward and the arrears that are irrecoverable have been written
off under the sanction of an appropriate authority.

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II. Admission Fees: Check admission fees with admission slips signed by the head of the
institution and confirm that the amount had been credited to a Capital Fund, unless the
Managing - Committee has taken a decision to the contrary.
III. Other Fees: Verify the collection of other fees such as library fees, session fees or development
fees, fees for hostel etc. based on the counterfoils and fee registered and ensure that the fees
have been accounted for in appropriate heads.
IV. See that all arrears on account of fees, fines, etc. have been taken into consideration at the
end of accounting period.
V. See that free studentship and concessions have been granted by a person authorised to do so,
having regard to the prescribed Rules.
VI. Confirm that hostel dues were recovered before students’ accounts were closed and their
deposits of caution money refunded.
VII. Verify grants received from Government or other organisations based on the sanction letter
and bank statement.
VIII. Ensure that donation received, if any, has been acknowledged and recorded properly in the
books of accounts.
IX. Check income from letting out institutional properties based on the counterfoil of receipts
issued to parties.
X. Vouch income from endowments and legacies, as well as interest and dividends from
investment; also inspect the securities in respect of investments held.

f. Verify the Payments Related Transactions:

I. Verify the salary and wages paid to the employees. In case of Govt. or aided colleges, verify
that the claims have been properly prepared and the amount sanctioned has been distributed
to the right person. Check the calculation and accounting of arrear salary and see whether the
deductibles from salary, such as Provident Fund Contribution and Income Tax deducted at
source, have been deposited with the authority concerned in due time and if not, whether the
same have been accounted for appropriately.
II. Examine whether all the expenditure associated with special events like seminar or symposium
etc. has been accounted for by matching the expenditure in this regard against the amount
obtained from any organisation or sanctioned by the institution itself.
III. Vouch all the regular expenses such as electricity, telephone or broadband bills, travelling
expenses, etc. based on available vouchers and accounting records.
IV. Vouch purchase of fixed assets, expenditure for construction of college buildings based on the
available vouchers, resolution of the meetings of purchase/finance committee. Similarly,
utilization of grants for purchase of fixed assets, library books and laboratory equipment must
be separately vouched.
V. Vouch the refund of Caution Deposit from the students based on receipts and accounting
records.
VI. Examine the payments on account of hostel facilities including repairs and maintenance of
hostel building, electricity charges, purchase of food items etc.
VII. See that the investments representing endowment funds for prizes are kept separate and any
income in excess of the prizes has been accumulated and invested along with the corpus.

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g. Verification of Assets and Liabilities:

I. Conduct physical verification of tangible fixed assets as shown in the Fixed Asset Register.
Verify investments based on Investment Register.
II. Check whether depreciation and amortization has been provided as per the policy adopted.
III. Verify the refund of TDS in respect of interest on investment, if any.
IV. Carefully examine all outstanding liabilities such as electricity and telephone bills outstanding,
TDS and PF not yet deposited.
V. Verify the inventories of furniture, stationery, clothing, provision and all equipment, etc. These
should be checked by reference to Stock Register and values applied to various items should
be test checked.
VI. Ascertain that the system ordering inspection on receipt and issue of provisions, foodstuffs,
clothing and other equipment is efficient and all bills are duly authorised and passed before
payment.

h. Verification of Financial Statements:

Verify that the financial statements (i.e., Income and Expenditure Account and Balance Sheet) have
been prepared in the form and manner as specified by the regulatory authority complying with the
account standards and applicable legal requirements.

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AUDIT OF HEALTHCARE ORGANISATIONS

Healthcare Organisations primarily include hospitals and nursing homes. They are established to provide medical
services to the public. There may be hospitals run and funded by the Government or local authorities or by any
charitable trust. These are generally non-profit seeking organisations. However, hospitals may also be
established by private sector organisations. These are profit seeking organisations (and are popularly known as
private nursing homes). Since healthcare organisations largely differs from other commercial organisations on
account of their business processes, an auditor needs to prepare a sound audit plan to cover typical aspects of
these organisations.

Accordingly, the audit procedure must highlight the following steps:

a. Understand the Constitution:

Study all the relevant documents to determine its nature and ownership structure (i.e., trust,
partnership or company). Study the trust deed (in case of trust), partnership agreement (in case of
partnership business) and articles and memorandum of association (in case of a company) and
accordingly identify the rules and regulation relating to its management and process of preparation
of accounts.

b. Assess the Internal Control System:

Evaluate the internal control system associated with acquisition and maintenance of assets,
authorisation of transactions, etc. and determine the scope of the audit work.

c. Consult the Minute Book:

Carefully examine the notices and minutes of the meeting of Board of Directors, Managing
Committee and other committees (such as purchase committee) and identify the decisions which
may affect the accounting. Confirm that the decisions undertaken with respect to operation of bank
accounts, approval of expenditure, etc. have been duly complied with.

d. Verify the Receipts Related Transactions:

I. In case of a hospital run by state government or any local authority, vouch the grants
received from the state or the local authority based on Govt. Orders, sanction letters,
counterfoil of receipts.
II. Vouch collection from patients admitted to the paying beds based on the Patient Admission
Registrar and counterfoil of receipts/ copies of bills.
III. Vouch collection from various pathological tests based on the counterfoils of receipts/
copies of bills.
IV. Vouch donations based on the counterfoils of receipts.
V. In case hospitals having guest houses, assess the collections based on the register,
counterfoils of receipts and accounting entries.
VI. Interest and/ or dividend income should be vouched with reference to the Investment
Register and Interest and Dividend warrants.
VII. In case of legacies and donations which are received for specific purposes, it should be
ensured that any income therefrom is not utilized for any other purposes.

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e. Verify the Payments Related Transactions:

I. Verify that all capital expenditure associated with machineries, furniture, vehicle, etc. is
approved and supported by documentary evidences such as counterfoils cheque, invoices,
tenders, etc.
II. Vouch the salary paid to staff based on attendance register, payroll, etc. Examine that the
appointment of casual staff and payment of their salaries are duly authorized.
III. Verify doctor’s remuneration should be verified based on the list of visits and operations
performed.
IV. Verify the purchases of pathological test kits, X-ray plate and other consumables based on
tenders, orders placed and invoices received.
V. Vouch all other overhead expenses like telephone bills, electricity bills, fuel bills, etc. based
on appropriate documentary evidences.

f. Verification of Assets and Liabilities:

I. Verify the stock registers of medicines, food items and other equipment and check their
valuations.
II. Conduct physical verification of fixed assets and investments based on Fixed Asset Register
and Investment Register respectively.
III. Check the adequacy of depreciated and its accounting.
IV. Collect the list of all liabilities and verify them based on the contracts and arrear bills.

g. Verification of Financial Statements:

Verify that the financial statements have been prepared in the manner and format appropriate
to the nature (profit seeking or non-profit seeking) and ownership structure of the
organisation.

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AUDIT OF HOSPITALITY SECTOR

Hospitality sector covers a wide range of organisations which can broadly be divided into four categories, viz.
(A) Food and Beverages i.e., Restaurants,

(B) Travel and Tourism,

(C) Lodging i.e., Hotels and Guest Houses and

(D) Recreation such as Cinema Halls, Theme Parks etc.

Since, the organisations in the above categories largely differ in their business processes, auditing procedures
will certainly be different for each of them, barring a few common areas.

The steps to be followed are discussed below:

• Steps Common for All Organisations

a. Understand the ownership structure of the organisation (such as sole proprietorship, partnership,
private limited companies or public limited companies) and determine the regulatory
requirements to be examined relating to management as well as accounting.
b. Evaluate the internal control system and determine the nature, timing and the extent of the audit
procedures.
c. Check that the organisation has a valid licence from an appropriate authority to run the business.

• Steps Common for the Category

A. Restaurants (Food and Beverages)

a. Verify the total revenue recognised based on the daily and monthly sales report.
b. Check that the revenue has been realised in cash based on bank statements. Check whether arrears
written off, if any, has been duly approved by the person responsible.
c. Vouch all payments made to suppliers based on documentary evidences such as orders placed,
invoices and bank records.
d. Carefully examine the petty cash book. Any irregularity should be examined further.
e. Vouch payments on account of rent, electricity and other overhead expenses.
f. Vouch the payment of salary based on payroll, attendance register and bank records.
g. Carefully examine the valuation of stock. Large writing off of any perishable item should be
carefully examined.
h. Conduct physical verification of fixed assets and investments based on Fixed Asset Register and
Investment Register respectively.
i. Check the adequacy of depreciated and its accounting.
j. Collect the list of all liabilities and verify them based on the contracts and arrear bills.

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B. Travel and Tourism

a. Vouch the collections from customers based on their booking details, counterfoil of receipts etc.
Determine arrears, if any, at the end of the year.
b. Vouch revenue out of commissions from various companies and tour partners.
c. Vouch the payment made on account of tour bookings (divided into Air Travel, Rail, Road, Sea etc.),
hotel accommodations.
d. Vouch transactions related with cancellation of bookings.
e. Check that discounts offered to individual customers are approved by the competent authority.
f. All overhead expenses including electricity bills, telephone and broadband bills, taxes to local
authorities, etc. should be vouched based on the respective bills.
g. Verify the salary paid to permanent staff based on their payroll, attendance records and leave
applications. Payment of incentives should be checked carefully.
h. Conduct physical verification of fixed assets and investments based on Fixed Asset Register and
Investment Register respectively.
i. Collect the list of all liabilities and verify them based on the contracts and arrear bills.

C. Hotels and Guest Houses (Lodging)

a. Vouch the collections from boarders based on their check-in and check-out information recorded
in the register, counterfoils of bills and cash book.
b. Verify the room rent receipts and daily occupancy reports. Ask for proper clarification for
differential rent charged from any boarder. Be careful while verifying the adjustment of unrealised
room rent, cancellation charges of booking accommodation at the time of closing of accounts.
c. Vouch collections on account of special events such as conferences, wedding ceremony etc.
separately based on counterfoil of receipts and cash book.
d. Income from bar, casino, health centre, etc. associated with the hotel should be vouched based on
counterfoils of bills and cash book. Vouch the rent from shops situated in the premises of the hotel,
if any.
e. Vouch transactions relating to purchase of food materials, drinks and other materials. Check
whether the payments have been made based on purchase orders or contracts, invoice, etc.
f. Verify the salary paid to permanent staff based on their payroll. Salary paid to casual and
contractual employees should be verified based on documentary evidences like authorisation by
management.
g. All overhead expenses including electricity bills, telephone and broadband bills, taxes to local
authorities, etc. should be vouched based on the respective bills.
h. Carefully examine the valuation of stock. If possible, remain physically present at the time of stock
taking.
i. Conduct physical verification of fixed assets and investments based on Fixed Asset Register and
Investment Register respectively. Check the adequacy of depreciation and its proper accounting.
j. Collect the list of all liabilities and verify them based on the contracts and arrear bills.

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D. Recreations

1. Cinema Halls
a. Check whether appropriate control is in force over tickets of different denominations. Verify
whether unsold tickets are kept under lock and key under the responsibility of any official.
b. Vouch the collections based on daily sales report of tickets and entries in the cash book.
c. Check whether collections from advance bookings have been duly adjusted.
d. Vouch collections on account of rental income due to hiring of the hall for special events based
on the respective contract and counterfoil of receipt.
e. Vouch collection from sale of drinks, refreshments etc based on their daily sales report and
entries in the cash book.
f. Check whether the entertainment tax collected as a part of the ticket value has been
appropriately accounted and deposited within due dates. See that entertainment tax collected
but not deposited has been considered as a liability in the financial statement.
g. Vouch payments relating to hiring of films based on relevant contract with the distributor and
receipts.
h. Vouch payment on account of advertisement with the advertising agencies based on the
agreements and receipts.
i. Payment to suppliers of refreshments should be vouched based on orders placed, invoices and
entries in the cash book.
j. Vouch salary paid to staff based on payroll, attendance register and leave applications.
Appointment of casual staff must be verified based on appointment letter issued by the
responsible authority only.
k. Conduct physical verification of fixed assets and investments based on Fixed Asset Register
and Investment Register respectively. Check the adequacy of depreciation and its proper
accounting.

2. Amusement Park
a. Check whether appropriate control is in force over tickets of different denominations. Verify
whether unsold tickets are kept under lock and key under the responsibility of any official.
b. Vouch the collections based on daily sales report of tickets and entries in the cash book.
c. Check whether collections from advance bookings have been duly adjusted.
d. Vouch collection from sale of drinks, refreshments etc based on their daily sales report and entries
in the cash book.
e. Vouch payment on account of advertisement with the advertising agencies based on the
agreements and receipts.
f. Payment to suppliers of refreshments should be vouched based on orders placed, invoices and
entries in the cash book.
g. Vouch salary paid to staff based on payroll, attendance register and leave applications.
Appointment of casual staff must be verified based on appointment letter issued by the
responsible authority only.
h. Conduct physical verification of fixed assets and investments based on Fixed Asset Register and
Investment Register respectively. Check the adequacy of depreciation and its proper accounting.

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Audit of Banks
Importance of Banking Institutions in Economy

The banking industry is the pivot of any economy and its financial system. Banks are one of the foremost agents
of financial intermediation in an economy like India and, therefore, development of a strong banking system is
of utmost importance. Under the able leadership of RBI, the banking institutions in the country are working in a
competitive environment and their regulatory framework is aligned with the international best practices. As a
result, financial deepening has taken place in India and continues to be in progress with a focus on orderly
conditions in financial markets while sustaining the growth momentum.

Different Types of Banks

In India, banks are generally classified into the following broad categories:

a) Commercial Banks

b) Regional Rural Banks

c) Co-operative Banks

d) Development Banks

e) Payment Banks

f) Small Finance Banks

Though all of them are guided by RBI, they are fundamentally different with respect to their nature, mode of
operation and power and target customer group.

Regulatory Framework of Banks in India

In India, banks are guided by a whole host of Acts and associated Rules. However, not all are applicable to each
and every banking institutions.

These are as follows:

a) Banking Regulation Act, 1949 b) Companies Act, 2013

c) State Bank of India Act, 1955 d) State Bank of India Act (Subsidiary Banks) Act, 1959

e) Regional Rural Banks Act, 1976 f) Information Technology Act, 2000

g) Prevention of Money Laundering Act, 2002

h) Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980

i) Credit Information Companies Regulation Act, 2005

j) Payment and Settlement Act, 2007 In addition, Reserve Bank of India Act, 1934 also affect the functioning of
banks in India.

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Form and Content of Financial Statements of a Bank

Section 29(1) and (2) of Banking Regulations Act, 1949 deal with the form and content of financial
statements of a banking company. The provisions are applicable to nationalised banks, State Bank of
India and Regional Rural Banks.

Accordingly, every banking company is required to prepare a Balance Sheet and a Profit and Loss
Account in the forms set out in the Third Schedule to the Act or as near thereto as the circumstances
admit. Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form of Balance
Sheet and Form B contains the form of Profit and Loss Account.

Statutory Audit in Banks

As per section 30(1) of Banking Regulations Act, 1949, the balance sheet and profit and loss account of
a banking company should be audited by a person duly qualified under any law for the time being in
force to be an auditor of companies.

Accordingly, the auditor of a banking company is to be appointed at AGM of the shareholders. The
auditor of a nationalised bank is to be appointed by the bank concerned acting through its Board of
Directors. The auditor of State Bank of India (SBI) is appointed by the CAG of India while the auditors of
Regional Rural Banks are appointed by the bank concerned with the approval of the Central
government.

The remuneration of the auditor, so appointed, is fixed as per Section 142 of Companies Act, 2013 in
case of banking companies while in case of nationalised banks, the remuneration is fixed by RBI in
consultation with the Central government.

The power of an auditor in a bank is almost similar to that of a company auditor.

Auditor’s Report – Content

The auditor of a nationalised bank is primarily required to comment on the following aspects in its
report to the Central Government:

a) whether the financial statements present a true and fair view of the affairs of the bank and whether
all necessary explanation and information has been made available to him;
b) whether or not the transactions of the bank, which have come to his notice, have been within the
powers of that bank;
c) whether or not the returns received from the offices and branches of the bank have been found
adequate for the purpose of his audit; and
d) any other matter which he considers should be brought to the notice of the Central Government.

Audit of other banks require more or less the same assessment. In addition, the auditor of a banking
company requires to report the matters covered by Section 143 of the Companies Act, 2013. However,
Companies (Auditor’s Report) Order, 2020 is not applicable to a banking company.

Auditors of Public Sector Banks, Private Sector Banks & Foreign Banks (as well as their Branches), are
required to submit Long Form Audit Report (LFAR) on various matters specified by RBI. In addition to
Reports, the Auditors of Bank Branches as well as Central Statutory Auditors of Banks, have to furnish
/ issue various ‘Certificates’ as required by RBI and other Regulations.

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Auditing Aspects of Banks’ Financial Statements

Apart from the general considerations such as confirming the validity of his appointment,
communicating with the previous auditor, agreeing on the terms of audit engagements etc. the auditor
should consider the following aspects in conducting the audit of a bank.

• General Issues:
a) Understand the Bank and its Environment:
Obtain an understanding of the bank and the control environment to identify and assess risk and
develop an audit plan to determine the effectiveness of controls and address specific risk issues.

b) Understand the Accounting Process:

Obtain an understanding of the accounting process – computerised or manual – of the bank.

c) Understand the Risk Management Process:

Obtain a clear understanding of the process adopted by the bank for managing financial as well as
operational risks.

d) Develop a detail audit plan.

e) Determine audit materiality

f) Obtain a detail understanding of the relevant BASEL framework applicable for the bank.

g) Determine the extent of reliance on reports of previous auditor, RBI reports , internal audit
report etc.

• Specific Issues:

A. Advances: In relation to advances made by bank an auditor needs to review the followings:
i. Ensure that the internal control is in place in relation to advances made.
ii. Scrutinise the subsidiary, ledger, & control accounts
iii. Ensure the proper documentation of account.
iv. Scrutinise the overdue account and scheme for recovery of such amount.

B. Cash in hand: The auditor should

i. Ensure that the internal control is in place.
ii. Visit the bank branch and inspect physical cash and ensure that it tallies with the bank’s cash
book balance.
iii. Verify the amount of foreign currency held by bank and its translation at market rate on the date
at which financial statement is prepared.

C. Balance with RBI: The auditor should

i. Inspect the ledger balance in each account with
a. bank confirmation certificates from Reserve Bank of India and
b. Reconciliation Statement.

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D. Balance with Other Bank: The auditor should

i. Inspect the reconciliation statement to ensure that no debit or credit for interest have been
taken to Revenue account to the year.
ii. Examine the large transition and balances with banks outside India.
iii. Ensure that they are converted at market rate as on financial statement preparation date.

E. Money at call & short notice: He should

i. Examine the system of authorisation for money at call and short notice.
ii. Ensure that call loan made by bank are not netted off against call loan received by it.
iii. Ensure that money market lending for more than 6th days are not classified under this head but
as a deposit or advance based on their nature of lending.

F. Fixed and other Assets:

The auditor has to ensure the following while auditing the fixed assets held by banks:
i. Ensure that accounting method of bank is appropriate and ownership document is adequate.
ii. Examine with reference to schedule of fixed assets to find new assets acquired.
iii. Examine sale deed in relation to sale of assets by bank.
iv. Ensure appropriateness of basis of revaluation of fixed assets.
v. Ensure compliance of Section 9 of Banking Regulation Act, 1949.

G. Barrowings: He should
i. Ensure that the amount has been properly disclosed for borrowing in India from RBI and
barrowing from outside India.
ii. Ensure that the rate of interest is commensurate with the duration of borrowing.
iii. Verify whether the barrowings of money at call and short notice are property authorized.

H. Deposits: He should
i. Ensure that the interest accrued but not due on deposits has not been taken under other
liabilities and provision
ii. See whether there is any instance of window dressing.

I. Capital: He should
i. Examine the opening balance of capital.
ii. Examine the special resolution of shareholders’ meeting or MOA about increase in authorized
capital during the year.
iii. Examine the prospectus regarding increase in subscribed/ paid up capital.
iv. Examine the Government notification for any fresh contribution from them.

J. Reserve and Surplus: He should

i. Examine the opening balance of different type of reserve, addition/ deduction from reserves,
reason for appropriation from such account and dividend paid by bank.
ii. In respect of foreign branch ensure compliance with foreign laws.

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K. Bills Payable:
i. He should Evaluate the existence, effectiveness and continuity of internal controls over bills
payable.
Such controls should usually include the following:
o Drafts, mail transfers, traveller’s cheques, etc., should be made out in standard printed
forms.
o Unused forms relating to drafts, traveller’s cheques, etc., should be kept under the
custody of a responsible officer.
ii. The bank should have a reliable private code known only to the responsible officers of its
branches. Coding and decoding of the telegrams should be done only by such officers.
iii. The signatures on a demand draft should be checked by an officer with the specimen signature
book.
iv. The telegraphic transfers and demand drafts issued by a branch should be immediately
confirmed by advices to the branches concerned. On payment of these instruments, the paying
branch should send a debit advice to the originating branch.
v. If the paying branch does not receive proper confirmation of any telegraphic transfers or demand
draft from the issuing branch, it should take immediate steps to ascertain the reasons. In case
an instrument prepared on a security paper, e.g., draft, has to be cancelled (say, due to error in
preparation), it should be examined whether the manner of cancellation is such that the
instrument cannot be misused. Cases of frequent cancellation and reissuance of drafts, pay
orders, etc., should be carefully looked into by a responsible official.

L. Contingent Liabilities:
i. In respect of contingent liabilities, the auditor is primarily concerned with seeking reasonable
assurance that all contingent liabilities are identified and properly valued. To this end, the
auditor should generally follow the audit procedures given below:
ii. The auditor should verify whether there exists a system whereby the non-fund-based facilities
to parties are extended only to their regular constituents, etc.
iii. Ascertain whether there are adequate internal controls to ensure that transactions giving rise to
contingent liabilities are executed only by persons authorised to do so and in accordance with
the laid down procedures.
iv. The auditor should also examine whether in case of LCs (Letter of Credits) for import of goods,
the payment to the overseas suppliers is made on the basis of shipping documents and after
ensuring that the said documents are in strict conformity with the terms of LCs.
v. He should also ascertain whether the accounting system of the bank provides for maintenance
of adequate records in respect of such obligations and whether the internal controls ensure that
contingent liabilities are properly identified and recorded.
vi. He must perform substantive audit tests to establish the completeness of the recorded
obligations. Such tests include confirmation procedures as well as examination of relevant
records in appropriate cases.
vii. He should review the reasonableness of the year-end amount of contingent liabilities in the light
of previous experience and knowledge of the current year’s activities.
viii. He should also review whether comfort letters issued by the bank has been considered for
disclosure of contingent liabilities.

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M. Bills for Collection

i. The auditor should examine whether the bills drawn on other branches of the bank are not
included in bills for collection.
ii. Inward bills are generally available with the bank on the closing day and the auditor may inspect
them at that time. The bank dispatches outward bills for collection soon after they are received.
They are, therefore, not likely to be in hand at the date of the balance sheet. The auditor may
verify them with reference to the register maintained for outward bills for collection.
iii. The auditor should also examine collections made subsequent to the date of the balance sheet
to obtain further evidence about the existence and completeness of bills for collection.
iv. In regard to bills for collection, the auditor should also examine the procedure for crediting the
party on whose behalf the bill has been collected. The procedure is usually such that the
customer’s account is credited only after the bill has actually been collected from the drawee
either by the bank itself or through its agents, etc. This procedure is in consonance with the
nature of obligations of the bank in respect of bills for collection.

N. Treasury Operation-Foreign Exchange and Derivatives:

While innovative products and ways of trading create new possibilities for earnings for the bank,
they also introduce novel and sometimes unfamiliar risks that must be identified and managed.
Failure to do so can result losses entailing financial and reputational consequences that linger
long after the loss has been recognized in financial statements. Hence, auditor should assess
controls as part of audit work.

It is imperative that an auditor obtains a complete overview of the treasury operations of a bank
before the commencement of the statutory audit. After conducting appropriate risk assessment
of the treasury processes, the audit program needs to be designed in a manner that it dovetails
into not just the control assessments of the treasury process but there is an assurance that the
figures appearing in the financial statements as well as the disclosures are true and reflect fairly
the affairs of the bank treasury.

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Audit of Cooperative Societies

Unique Features of Co-Operative Societies

Co-operative society may broadly be defined as an association of persons who have voluntarily joined together
to achieve a common economic objective through the formation of a democratically-controlled business
organisation, making equitable contributions to the capital as required, and accepting a fair share of risks and
benefits of the undertaking. Elimination of middlemen and sharing of gains of economic activities seems to be
the hallmark of a co-operative society.

A co-operative society may be formed for different purposes. Accordingly, there may be consumers’ co-
operative societies, housing co-operative societies, industrial co-operative societies, urban and rural co-
operative banks, etc.

Statutory Audit Requirement in Co-Operative Societies

As per Section 17 of the Co-Operative Societies Act, 1912 –

i. The Registrar shall audit or cause to be audited by some person authorised by him by general or special
order in writing in this behalf, the accounts of every registered society once at least in every year.
ii. The audit under sub-section (1) shall include an examination of overdue debts, if any, and a valuation
of the assets and liabilities of the society.
iii. The Registrar, the Collector or any person authorised by general or special order in writing in this behalf
by the Registrar, shall at all times have access to all the books, accounts, papers and securities of a
society, and every officer of the society shall furnish such information in regard to the transactions and
working of the society as the person making such inspection may require.
iv. Here, ‘Registrar’ means a person appointed to perform the duties of a Registrar of co-operative
societies under this Act.

The following additional points should be kept in mind while auditing a co-operative society:

i. Qualifications of auditor: Generally, only a chartered accountant within the meaning of the Chartered
Accountants Act 1949, can be appointed as the auditor of a co-operative society. However, in certain
State Co-operative Societies Act, a person holding a government diploma in co-operative accounts, or
in co-operation and accounts, or a person who has served as an auditor in the Co-operative Department
of Government, may also be appointed as the auditor.

ii. Appointment of the Auditor: An auditor of a co-operative society is appointed by the Registrar of Co-
operative Societies-and the auditor so appointed conducts the audit on behalf of the Registrar and
submits his report to him as also to the society. The audit fees are paid by the society on the basis of
statutory scale of fees prescribed by the Registrar, according to the category of the society audited. For
example, the audit fees of co-operative credit society and Urban Co-operative Banks are to be
calculated with reference to working capital at the prescribed rates. ‘Working Capital’ here means funds
at the disposal of the society inclusive of paid-up share capital, funds built up out of profits and monies
raised by borrowing and by other means.

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iii. Books of accounting records: Under section 43(h) of the Co-operative Societies Act, a state government
can frame rules prescribing the books and accounts to be kept by a co-operative society. For example,
In Maharashtra the co-operative societies are required to maintain cash book, general ledger, personal
ledger, stock register, property register, etc.

Generally, the following records are maintained by co-operative societies –

o Cash book: It may be maintained to record particulars regarding cash receipts and expenses under
suitable heads, with clear distinction between capital and revenue items of receipts and expenses.
o Stock register: It may contain detailed information as regards receipts, issues and balances of stock-
in- trade, date-wise. In a producers’ co-operative society, perpetual inventory records may be
maintained based on an appropriate costing method.
o Register of assets and investments: It will contain detailed particulars regarding the various
immovable and movable assets belonging to the society, such as, types of assets, location, date of
acquisition, cost, depreciation provided, and so on.
o Register of fixed deposits: In the case of a co-operative credit society, or a co-operative bank, or
any other society which is authorised by its bye-laws to accept deposits from members/non-
members, a register of fixed deposits may be maintained giving details as regards the dates of
acceptance, maturity, interest accrual, repayment, etc.
o Register of sureties: In the case of a co-operative credit society, loans are given against personal
security of members as also surety (guarantee) provided by two other members. The Register of
Sureties will give particulars about the number of borrowers in respect of which a member has stood
surety, and show whether it is within the overall limit of surety-ship that may.

iv. Restriction on shareholding: Shareholding in a co-operative society is subject to the limit prescribed in
Sec. 5 of the Co-operative Societies Act 1912. Accordingly, no member of the society, other than a
registered society, can hold more than twenty per cent of the total number of shares of the society, or
such number of shares which in value exceeds `1,000. A co-operative society cannot prescribe any other
limit in its bye-laws which is violative of this provision. In addition to this, the Acts passed by the states
may also prescribe other restrictions as regards shareholding. The auditor should see that the provision
regarding shareholding is duly followed.

v. Restriction on Loan: As per Section 29 of Co-operative Societies Act, 1912, a registered co-operative
society can only grant loans to its members, though, with prior approval of the Registrar, it may grant
loans to other registered co-operative societies. The auditor should see that the loans granted by the
society are in conformity with this provision.

vi. Restriction on Borrowing: Subject to the restrictions imposed by its bye-laws, a co-operative society
may accept loans and deposits from its members as well as non-members. It is the auditor’s duty to
ascertain that the restrictions, if any, laid down by the bye-laws are carefully observed.

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vii. Investment of Funds: There are restrictions on investment of funds belonging to a co-operative society.
Accordingly, a society may invest its funds in any of the following (Sec.32 of the Central Co-operative
Societies Act):
o Central or State Co-operative Bank,
o Any securities specified in Section 20 of the Indian Trusts Act, 1882.
o Any shares, securities, bonds or debentures of any other Co-operative society with limited liability.
o Any bank, or person carrying on banking business or a Co- operative bank, other than a Central or
State co-operative bank, as duly approved by the Registrar;
o In any other manners as duly permitted by the requisite authority. It shall be the duty of the auditor
to ascertain whether the requirement as to investment of the society funds are being observed.

It shall be the duty of the auditor to ascertain whether the requirement as to investment of the society funds
are being observed.

viii. Appropriation of profits: According to the Central Co-operatives Societies Act, 25% of the profits of a
co-operative society should be transferred to a Reserve Fund before distribution of dividend or
payment of bonus to its members. However, the Registrar may, having regard to the financial position
of the society, reduce the percentage of profits to be transferred to the Reserve Fund. But in any case,
he cannot reduce it to less than 10% of the profits of the society. Apart from the above mandatory
provision, a co-operative society may, subject to the provisions of its bye-laws, appropriate its profits
by way of transfer to other reserves, distribution of dividends to members, etc. However, appropriation
of profits must be duly approved by the members of the society in the general meeting called for the
purpose.

ix. Contributions to charitable Purposes: According to Section 34 of Co-operative Societies Act, 1912, a
registered society may, with the sanction of the Registrar, contribute an amount not exceeding 10% of
the net profits remaining after the compulsory transfer to the reserve fund for any charitable purpose
as defined in Section 2 of the Charitable Endowments Act, 1890.

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Steps to be Taken by an Auditor of a Co-Operative Society

a. General Points: In general, while conducting audit of Co-operative society, the auditor needs to look
into the following: -
o The auditor should carefully go through the bye-laws of the society and see that they are being
observed both in letter and spirit.
o He should examine the Register of Members of the society and individual shareholdings.
o He should test-check the internal check and control system operated by the society and model
his audit examination based on its strengths and weaknesses.

b. Audit of income: He should carefully vouch the receipt of cash. Cash receipts on account of share
capital should be vouched with the Register of Members. Cash received against sales should be
vouched with the cash memos and invoices issued to customers as also Sales Account. Receipt of
cash in respect of payment of interest and repayment of loans advanced by the society should be
vouched with the loan agreements. Cash received from members towards construction of houses or
their maintenance, should be vouched with the Register of Members, demands made by the society
from time to time, and money receipts.

c. Audit of Expenditure:

o He should vouch all expenditure with reference to authorisation from the Managing
Committee, particularly in the case of large capital expenditure, as also the bills received from
individual parties, the money receipts obtained from them, and entries in the Bank Pass Book
along with counter-foils of cheques.
o He should vouch the payment of loans from the loan agreements entered into with borrower
members.
o He should vouch establishment expenses with reference to the resolutions of the Managing
Committee, agreements with the persons concerned, and money receipts obtained from
them.

d. Other points:
o He should appropriately classify overdue debts for a period from six months to five years and
more, and report them to the members, with a note regarding the effects these might have
on the financial position of the society. He should also put a note regarding the probability of
recovery of such debts.
o Similarly, he should make a special reference to the overdue amount of interest from
members. Generally, interest on overdue debts should not be credited to Interest Account but
to the Overdue Interest Reserve Account.
o Writing off of bad debts should be after prior authorisation from the Managing Committee of
the society. According to the Maharashtra Co-operative Societies Rules, a bad debt can be
written off only when it is certified to be irrecoverable by the auditor. This casts a special
obligation on the auditor to ascertain whether the debt in question was created within the
Rules of the society, and whether it has now really become bad and irrecoverable.

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Audit of Local Self – Government

In India, local self-government refers to governmental jurisdictions below the level of the state. With the
introduction of 73rd and 74th amendments to the Indian Constitution, the local self-governance system has
been recognised as the formal system of governance at the local level in both rural and urban areas throughout
the country. In addition, state legislations also have given power to these organisations.

The urban local self-governance bodies are further divided into Municipal Corporation or Nagar Nigam,
Municipality or Nagar Palika and Notified Area Council or Town Panchayat or Nagar Panchayat. Similarly, the
rural self-governance in India is structured in three layers, viz. Gram Panchayat (at village level), Panchayat Samiti
(at block level) and Zilla Parishad (at district level). All these local bodies are operated by representatives elected
through a democratic process by participation of every Indian citizen.

Grants are issued by the States and these are to be utilized by the local bodies within the set parameters to
execute the sanctioned projects. In addition, several local taxes are also the sources of revenue for them and
they employ such funds for development and maintenance of public assets and similar other works. For example,
urban local bodies are required to perform functions including general administration and revenue collection,
public health, public safety, education, public works, and others such as interest payments. Similarly, rural local
bodies are primarily required to help plan, coordinate, monitor and wherever required regulate the
implementation of various national programmes. The responsibility of maintaining the assets created through
various programmes also lies on them.

Since these organisations deal with public money, audit or the accounts of these bodies are of immense
importance to ensure transparency and accountability.

The major objective of audit of Municipalities and Panchayats are enumerated below:

a. To ensure on the fairness and correctness of contents in the Financial Statement

b. To report on adequacy of Internal control
c. To ensure value of money is fully received on amount spent.
d. To detect the frauds and errors.

Accordingly, the auditor is supposed to consider the following general points in conducting the audit of local
bodies:

a. Ensure that his appointment is in line with the respective regulation of the local body and approved by
the appropriate authority.
b. Obtain a detail understanding of the rules and regulations that governs the operations, especially the
financial control and accounting of the organisation.
c. Consult the relevant documents, minutes and resolutions of various meetings of different committees.
d. With regards to various government schemes which are implemented through local bodies, check the
utilization of grant, appropriate authorization being maintained throughout and adequacy of
accounting.
e. Apply in depth investigation in areas with potential fraud such as revenue collection, various waiver
schemes, use of casual labour etc.
f. Whenever there is a provision of funds, ensure that the expenditure is incurred from the provision and
the same has been authorized by the competent authority.
g. Ensure that where huge financial expenditure is involved, the schemes are running economically and is
expected to generate the targeted outcome.

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CHAPTER – 1 Basic Concepts of Auditing

Nature, Scope, Objectives and Significance of Auditing

Concept and Definitions of Auditing

The concept of audit has undergone continuous change over the period. Hence it is required that the meaning
of the term ‘audit’ is analysed both in the (traditional) narrow and (modern) broad sense of the term.

A. Narrow Perspective
The term “audit” has been derived from the Latin word “audire” which means ‘to hear’. In early days,
the person appointed to check the accounts, used to hear the explanations required from responsible
officers and that’s why, he was called as an “auditor”.

Some of the definitions given by a few well-known experts in the field indeed highlight the above
narrow perspective.

Taylor and Perry - “Audit is defined as an investigation of some statements of figures involving
examination of certain evidence, so as to enable an auditor to make a report on the statement.

F.R.M De Paula- “An audit denotes the examination of Balance Sheet and Profit and Loss Account
prepared by others together with the books of accounts and vouchers relating thereto in such a manner
that the auditor may be able to satisfy himself and honestly report that, in his opinion, such Balance
Sheet is properly drawn up so as to exhibit a true and correct view of the state of affairs of the particular
concern according to the information and explanations given to him and as shown by the books”.

Prof. Montgomery- “Auditing is a systematic examination of the books and records of business or other
organisation, in order to ascertain or verify and to report upon the facts regarding its financial
operations and the result thereof.

B. Broader Perspective
Over time, with the changes in socio-economic environment, the concept of audit has also changed.
Today auditing is not confined to mere authentication of financial accounting records. It is now
considered to be an independent appraisal activity that extends itself towards evaluation of non-
financial aspects as well.

As per the General Guidelines on Internal Auditing issued by The Institute of Chartered Accountants of
India, “auditing is a systematic and independent examination of data, statement, records, operation
and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing
situation, the auditor perceives and recognizes the proposition before him for examination, collects
evidence, evaluates the same and on this basis formulates his judgment which is communicated
through his audit report’’. According to them, “…auditing is the accumulation and evaluation of
evidence about information to determine and report on the degree of correspondence between the
information and established criteria”.

Thus, in the broader perspective, auditing is a holistic appraisal of all the relevant aspects (be it financial or
otherwise) of an enquiry sought after a stated purpose.

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According to SA 200, Basic Principles Governing an Audit, “an audit is independent examination of financial
information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such
examination is conducted with a view to expressing an opinion thereon”.

Essential Features of Auditing

(i) It involves evaluation & verification of the relevance, reliability and adequacy of evidence in
support of verifiable information such as vouchers, documents, explanations.
(ii) It is analytical, critical and investigative review of systems of Accounting & Internal Controls.
(iii) The information audited may be financial or non-financial.
(iv) There should be standards or criteria for evaluation of the information in a systematic & scientific
manner.
(v) The auditor should be competent and independent, qualified & possessing prescribed qualification
& certificate of practice.
(vi) It ensures reliability of information and authenticity of assertions made in the financial statements
relating to enterprises, whether profit-oriented or not and whether it is required by law or not, to
enable the auditor to form his opinion on these statements with regard to true and fair view of
state of affairs of Business and of profit or loss made during financial period disclosed therein.

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Relationship between Accounting and Auditing

The basic objective of accounting is to record all the economic events that change the financial position of the
entity and to prepare a statement of performance and a statement of affairs for each accounting period. On
the other hand, auditing and more specifically financial auditing is undertaken to appraise the authenticity and
reliability of the of the accounting records and other relevant documents in order to arrive at a conclusive
opinion as to whether the financial statements exhibit a true and fair view of the financial performance and
state of affairs of the organisation. Thus auditing, in its conduct, aims to detect all material misstatements and
frauds and thereby put a check on the accountants and management. In other words, auditing is the critical
aspect of accounting. In this context, the following differences between accounting and auditing can be
mentioned.

SN ACCOUNTING AUDITING
1 It is the collection, classification and Auditing is an analytical and critical
summarization of data for preparation of examination of books of accounts, financial
books of accounts, and to make financial records and the financial statements
statements. prepared thereon
2 It is the recording of transactions at the It is the post mortem examination of
time of occurrence. recorded transactions.
3 It measures the business events in Auditing reviews financial records to form an
monetary terms, records them, and opinion on the authenticity of Financial
communicates the financial results through Statements.
Financial Statements.
4 Its primary responsibility is of the The auditor is an independent person
management towards the shareholders or appointed by the business entity to review
owners, to maintain the financial records in the Financial Statements and to give his
such a manner that Financial Statements opinion thereon.
can be prepared from the records.
5 An accountant is not expected to review or An auditor is required to submit a report with
report on the Financial Statement but to his opinion on ‘true and fair’ assertions made
report the compilation of records to the in the Financial Statements to the owners
management.
6 An accountant works for the management. The auditor is an independent person
accountable to the owners or shareholders
and not to the management
7 No such liability is there in accounting. In certain circumstances, the auditor could be
held liable to third parties also.
8 Maintenance of accounts may not be Audit could be exempt for various individuals
mandatory for small individuals or or small partnerships, e. g. under section
partnership firms, e. g. under section 44AA 44AB of the Income tax Act, and even in case
of the Income Tax Act, but could be where maintaining books of accounts is a
mandatory under other laws, e.g., for statutory requirement under section 44AA,
companies under the Companies Act. but may be mandatory under other laws e. g.
for Companies under the companies Act.
9 Accounting is done as per the principles set Auditing is done as per the principal set in
by Indian Accounting standards (Ind AS) standards on auditing

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Audit and Investigation

It is to be noted that both Auditing and Investigation have a fact-finding character. Both involve a systematic
and critic al examination of the available evidence, yet these are quite distinct from each other as follows:

SN BASIS AUDIT INVESTIGATION

1 Meaning Auditing is an independent and An investigation may be defined as an
systematic examination of the examination of accounts and records
evidence underlying the accounting with a view to ascertain any fact for
or other data in accordance with the some special purpose which varies
generally accepted auditing practices from assignment to assignment.
to ascertain the true and fair view of
the financial statements of an
enterprise.
2 Scope The audit has a wide scope. In The scope of investigations, on the
statutory audit, the scope is other hand, is limited as regards the
determined by the relevant law and period or areas to be covered.
in case of a private audit (e.g.,
management audit) by a client.
3 Objective ln audit, the accounts and records Investigation is for special purpose
are verified as to their truth and (e.g., investigation on the behalf of
fairness. incoming partner)
4 Audit The audit is conducted in accordance Investigations involve an extended
Procedure with the generally accepted auditing auditing procedure.
principle.
5 Evidence An auditor will evaluate the An investigator can draw his
accounting records predominantly conclusions only on the basis of
based on persuasive evidence. substantial or sometimes conclusive
evidence.
6 Approach An investigator can draw his Whereas an investigator starts with
conclusions only on the basis of suspicion and collects evidence to
substantial or sometimes conclusive either confirm or dispel that suspicion.
evidence.
7 Periodicity Auditing is a routine exercise Investigation may spread over a period
(normally conducted annually). longer than one year.

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SA-200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with
Standards on Auditing.

According to SA 200, Basic Principles Governing an Audit, “an audit is independent examination of financial
information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such
examination is conducted with a view to expressing an opinion thereon”.

SCOPE OF AUDIT

the scope of audit should cover the following aspects:

(a) The auditor shall assess the reliability and sufficiency of the information contained in the underlying
accounting records and shall undertake appropriate audit procedures for this purpose. Appropriate audit
procedure may include either Compliance Procedures (i.e., study of accounting system and internal control) or
Substantive Procedures (i.e., testing the authenticity, accuracy and completeness of information in accounting
records).

(b) The auditor has to determine whether the relevant information is properly disclosed in the financial
statements in conformity with the applicable generally accepted accounting principles and statutory
requirements (i.e., requirements as per Accounting Standards and Companies Act).

(c) The auditor’s work shall involve an exercise of judgement. He shall be principally concerned with items that
either individually or as a group are material in relation to the affairs of an organisation.

Thus, the duty of the auditor shall not be limited to mere verification of accounting entries based on the available
vouchers and other documents, but he shall evaluate the authenticity of the transaction, appropriate recoding
of the same in the books of accounts as well as compliance of the accounting and reporting process with
prevalent statutes in this respect.

BASIC PRINCIPLES GOVERNING AN AUDIT

(i) Integrity, objectivity and independence: The auditor should be straight-forward, honest, sincere
and free form any influence on his audit work. He should maintain impartiality and be free of any
interest.
(ii) Confidentiality: He should not disclose the client’s information to anybody without the client’s
permission or under any regulatory requirement.
(iii) Skills and competence: The audit should be performed and audit report be prepared by adequately
trained, experienced and competent person.
(iv) Work performed by others: The auditor should carefully supervise the work performed by others
(such as his subordinates, other auditors, experts etc.) as remains responsible for the work
delegated by him to his assistants, other auditors or experts.
(v) Documentation: Proper working papers should be maintained by the auditor to evidence the audit
work. Working paper which is maintained is to demonstrate that the audit is in adherence to the
basic principles.
(vi) Planning: The auditor should obtain the knowledge about client’s business to determine the
nature, timing and the extent of the audit procedures.
(vii) Audit evidence: The auditor should obtain sufficient appropriate audit evidence through
performing the compliance and substantive procedures.

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(viii) Accounting system and internal controls: An understanding of the accounting system and the
related internal controls help in determining the nature, timing and extent of other audit
procedures.
(ix) Audit conclusions and reporting: On the basis of conclusions drawn from the audit evidence
obtained the auditor should give unqualified report or qualified report or adverse report or the
disclaimer report.

OBJECTIVES OF AUDITING

the overall objectives of the auditor are:

(i) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error, thereby enabling the auditor to express an
opinion on whether the financial statements are prepared, in all material respects, in accordance
with an applicable financial reporting framework; and
(ii) To report on the financial statements, and communicates as required by the SAs, in accordance
with the auditor’s findings’’.

An audit is conducted with two main objectives:

(i) Primary Objective: The main objective of an audit is to determine whether the financial
statements present a ‘’ true & fair view’’ of the financial position and financial performance of a
business during the period. The Balance Sheet shows the financial position on a particular date
(say, the last day of the financial year), and the profit & loss Accounts shows the financial
performance of the business over that period (income and expenditure during the whole financial
year). Section 143 of the companies Act, 2013 requires the auditor of the company to state if in
his opinion the financial statements present “true and fair view’’ of the state of the company’s
affairs at the end of its financial year, and of the profit and loss for its financial year. Such an
opinion by the auditor increases the reliability of the Company’s financial statements.
(ii) Secondary Objective: The auditor is also responsible for detecting frauds and errors in the books
of accounts and financial records of the client’s business. Such detection of frauds and errors is
called the secondary objective of audit because the primary responsibility for safeguarding the
business assets rests with the management. If the auditor suspects the presence of material
misstatements or defalcations in the records of the business, he is expected to look into the
matter with greater detail by applying various audit procedures to satisfy himself about their
existence or non-existence. He is also to report on the existence of such misstatement and their
magnitude through his audit report.

In the process of adhering to the above objectives, an audit also attains certain social objectives as follows:

(i) To protect the shareholders’ interest of shareholders.

(ii) To stop evasion of taxes
(iii) To safeguard against capital erosion
(iv) To ensure fair return on investors
(v) To ensure reasonable price to customers
(vi) To ensure fair compensation to workers
(vii) Complying with polices regarding corporate social responsibilities

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SIGNIFICANCE OF AUDITING

🖸 From Legal Point of View:

(i) Filing of Income Tax Return — Income Tax authorities generally accept the profit and loss
account that has been prepared by a qualified auditor and they do not go into details of the
accounts.
(ii) Borrowing of Money from External Sources — Money can be borrowed easily on the basis
of audited balance sheet from the external sources. Most of the financial institution
sanctions various loans on the basis of audited financial statements.
(iii) Statement of Insurance Claim — In case of flood, fire, other natural calamities and the like
unexpected happenings the insurance company may settle the claim for loss or damages on
the basis of audited accounts of the previous year.
(iv) Sales Tax Payments — The audited books of accounts may generally be accepted by the
sales tax authorities.
(v) Action Against Bankruptcy — The audited accounts serve as a basis to determine action in
bankruptcy and insolvency cases.

🖸 From Internal Control Point of View

(i) Quick Discovery of Errors and Frauds — Errors and frauds are located at an early date, so
that in future no attempt is made to commit such frauds as one is rather careful not to
commit an error or a fraud as the accounts are subject to regular audit.
(ii) Moral Check on the Employees — The auditing of the accounts keeps the accounts clerks
and the accountants regular and vigilant as they know that the auditor would complain
against them if the accounts are not prepared up to date or if there is any irregularity.
(iii) Advice to the Management — It may happen that the management may consult the auditor
and seek advice on certain technic al points although it is not the duty of the auditor to give
advice.
(iv) Uniformity in Accounts — If the accounts have been prepared on a uniform basis, accounts
of one year can be compared with other years and if there is any discrepancy, the cause may
be enquired into.

🖸 From External Affairs Point of View

(i) Settlement of accounts — The audited accounts would facilitate the settlement of accounts
of a deceased partner.
(ii) Valuation of assets and goodwill — If the business is to be sold as a going concern basis,
there may not be much difficulty regarding the valuation of assets and goodwill as the
accounts have already been audited by an independent person.
(iii) Future trend of the business — From the audited books of accounts, the future trend of the
business can be assessed easily with certainty.

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ADVANTAGES OF AUDIT

The advantages of audit are as follows:

(i) Audit is a tool, which different stakeholders can use to protect their interests in the enterprise.
(ii) Audit is not only a corrective measure but has a deterrent effect. It serves as a moral check on
the employees from committing defalcations or embezzlements.
(iii) The employees of the organisation remain alert and vigilant as regards the updating of books of
accounts and other records.
(iv) Audited accounts are considered more reliable by different cadres of Government. For example,
the tax audit report filed with the taxation authorities.
(v) It facilitates detection of wastages and losses and helps in instituting corrective actions.
(vi) Audited accounts are taken to be more reliable and useful during corporate restructuring
exercises, valuations etc.
(vii) Banks, Financial Institutions and Government require audited accounts before granting any
financial assistance to the enterprise.
(viii) Audited accounts are taken to be more helpful in the settlement of accounts between the
partners and thus avoiding any dispute amongst them.

INHERENT LIMITATIONS OF AN AUDIT

(i) An audit does not guarantee that all the material misstatements will be detected because of the following
inherent limitations of audit:

a. Test nature of the audit;

b. The audit evidence available to the auditor is persuasive rather than conclusive in nature;

c. Inherent limitations of internal control, e.g., certain levels of management may be in a position to
override controls.

(ii) Professional scepticism — Professional scepticism means an approach that would ensure that if something
is wrong it is detected. This behaviour of auditor helps him in identifying and evaluating

(a) matters that increase the risk of material misstatements resulting from fraud or error,

(b) circumstances that make the auditor to suspect material misstatements,

(c) the question of reliability of management’s representations. The auditor is entitled to accept the
records and documents as genuine unless there is some evidence to the contrary.

(iii) Materiality is one of basic fundamental concepts in process of Auditing as well as Accounting. Auditor has
to constantly & continuously judge whether transaction is material or not. It is used by him in his Audit
Planning. Materiality means important cost wise, profit wise, effect wise, value wise; which influences
economic decision of user. What is material in one circumstance, may not be material in another
circumstances. Therefore, changes need to be done accordingly.

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Classification of Auditing

There are

(i) organisational structure-wise classification of audit,

(ii) objective-wise classification of audit,
(iii) periodicity-wise classification of audit, and
(iv) scope-wise classification of audit, and
(v) Subject matter -wise classification of audit.

I. Organisational Structure-wise Classification

a. Statutory Audit
Statutory audit is the checking of accounts as required by law. A statute or law may require
having an annual audit of financial records of a company or any other entity. The law may require
the audit to be conducted in the specified manner. The manner of reporting, contents of the
report and the authority to which the report of auditors should be presented are all specified by
the statute. Statutory audits are mandatory in nature. The statutory auditor is generally the
principal auditor in an organisation.
(i) In the case of companies, the Companies Act, 2013 governs the audit of accounts,
its reporting, and manner of preparing the audit report.
(ii) In the case of audit of a government body, the scope and audit programmes are
set by the Comptroller and Auditor General (CAG) of India and the Companies Act,
2013.
(iii) In the case of audit of an insurance company or a nationalized bank, the audit is
governed by specific statutes and IRDAI/RBI (Insurance regulatory & Development
Authority of India & Reserve Bank of India) guidelines. Co-operative banks are
also governed by the Co-operative Societies Act, 1912.

The statutory auditor of a company is appointed by the board /shareholders in the General
Meeting and shareholders cannot delegate this power to directors even by passing a
special resolution.

A statutory auditor can be appointed by the Central Government if shareholders fail to

appoint an auditor. A statutory audit should be performed by a qualified Chartered
Accountant holding a valid Certificate of Practice (COP) and not by any other person.

🖸 Advantages of Statutory Audit

(i) By the shareholders, for their economic decisions and for exercising their voting
rights.
(ii) For timely tax assessments.
(iii) For determining the purchase or sale consideration in case of ongoing concern.
(iv) Settlement of partners’ accounts in case of admission, retirement or death of
partner on account of goodwill or otherwise.
(v) Before the court, in case of settlement of disputes with employees, creditors or
debtors.
(vi) For determining the actual value of business or shares in case of merger,
acquisition, etc.
(vii) For getting financial assistance from financial institutions, banks or investors.

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(viii) In case of non-profit organisations, for getting government grants and availing tax
exemptions.
(ix) Evaluation of the internal control systems and strengthening it by removing the
inherent weaknesses, and checking the efficacy of the internal checks.
(x) For checking the integrity of the management which manages the funds and
affairs on behalf of the real owners or shareholders.
(xi) For other users of financial statements like creditors, investors and government
agencies, it ensures that any assertions in the Financial Statements are neither
overstated/understated nor misrepresented.
(xii) For the proper distribution of profits by way of payment of wages and other
benefits.
(xiii) For ensuring of proper distribution of profits as dividends.
(xiv) For ensuring that all legal requirements are fulfilled and statutory compliances are
adhered.
(xv) For settlement of insurance claims or other recoveries from government bodies
or otherwise.

🖸 Statutory Audit vs. Non-Statutory Audit

SN BASIS STATUTORY AUDIT NON-STATUTORY AUDIT

1 Legal compulsion It is compulsory. It is voluntary
2 Scope The relevant statute or law The employer or partners
determines the scope of work. determine the scope of work.
3 Qualification of The academic or professional The auditor need not possess any
auditor qualification is prescribed for the academic or professional
auditor. qualifications.
4 Powers, rights The statute dictates the powers, The agreement between an auditor
and duties of an rights and duties of an auditor. and firm decides these matters.
auditor
5 Independence The auditor has independence in The auditor does not enjoy such
status and in mental attitude. independence.
6 Auditor’s liability The auditor is liable for negligence The auditor isliable for negligence
under the Common Law and for only under the Common Law.
misfeasance under the relevant
statute governing the audit.
7 Publication of The audit report is published for The audit report is made known to
audit report the public. the employers or partners.

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b. Non-Statutory Audit
When audit is conducted without any legal requirement, it is called non-statutory audit or private
audit. This kind of audit is arranged purely voluntarily or sometimes as per internal rules of the
organisations. Here the auditor is appointed as per an agreement which determines the nature
and scope of audit to be conducted, the rights and duties of the auditor, requirement of
reporting etc. Sole-proprietors, partnership firms, non-profit seeking organisations such as clubs,
associations of persons, hospitals, etc, get their accounts audited to make them reliable and
acceptable to their stakeholders.
Some of these benefits are stated below:

🖸 Advantages of Auditing for Sole Proprietors

(i) It evaluates the internal control system and strengthens it by removing weaknesses, if
any.
(ii) It increases the reliability and authenticity of Financial Statements.
(iii) It helps in timely finalization of Annual Financial Statements and tax assessments.
(iv) It keeps a moral check on the working of employees.
(v) It helps them in obtaining funds easily from financial institutions, based on more reliable
Financial Statements available to the banks and financial institutions.
(vi) It helps in settling Trade disputes, Labour disputes and Insurance claims

🖸 Advantages of Auditing for Partnership Firms & Others The added advantages besides other
advantages are enumerated below;

(i) It helps in settlement of accounts among the partners on the basis of more reliable
accounting records.
(ii) It protects the interest of minors, sleeping partners/ partners who are not involved in day-to-
day operations, and keeps a check on persons who are working on behalf of others.
(iii) It helps in partnership firms for settlement of goodwill at the time of admission, retirement
and death of partners.
(iv) It enables firm to get loans from banks, financial institutions as they rely on audited accounts
of firm.
(v) Due to these advantages, even the entities which are not under any statutory obligation of
statutory audit get their accounts voluntarily audited to get the underlying benefits.

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II. Objective wise Classification of Audit

a. Internal Audit
The Institute of Chartered Accountants of India describes Internal Audit as “an independent
management function, which involves a continuous and critic al appraisal of the functioning of
entity with a view to suggest improvements thereto and to add value and strengthen the overall
governance mechanism of the entity, including the entity’s strategic risk management and
internal control system. Internal Audit, therefore, provides assurance that there is transparency
in reporting, a part of good governance”.
Internal Audit being an independent appraisal function ensures objectivity and consultation
which enhances the value and improves an organisation’s operations. It not only includes matters
related to finance but also critical appraisal of the policies and procedures of the company.
Internal Audit is based on principle of “early detection & prevention of further damage”. It points
out irregularities, non-compliances timely and not after year end as in case of Statutory Audit.

b. Independent Financial Audit

An independent financial audit may be conducted by a qualified auditor at the request of a client,
which may be a sole-proprietorship, partnership, non-profit organisation or any other entity. Its
objective is to comment on the truthfulness and fairness of the Financial Statements, and it may
be compulsory under some Acts which govern the entity.

III. Periodicity-wise Classification of Audit

a. Periodical or Final Audit
Final Audit is conducted at the end of the accounting year, after the books of accounts have been
closed. It does not interrupt with the regular functioning of the client’s accounting or operations
functions and ensures completion of work in one session due to continuity. The auditor may use
statistical sampling methods and techniques which lead to time effectiveness. The possibility of
tampering with the books of accounts during the audit is considerably reduced as the audit work
starts only after the books are closed.

🖸 Advantages and Limitations

Final audit is cost effective and ensures continued focus, planned approach to work and non-
interference with client’s accounting work being continued. However, a major disadvantage of
annual audit is that all the errors and frauds are found at the end of the accounting year, which
makes it very difficult to fix responsibility for defalcations. It delays the presentation of Audited
Financial Statements to the shareholders and to prevent the delay, the auditor uses sample
testing, which also reduces the possibility of detection of frauds and errors.

b. Interim Audit
Interim audit is the audit conducted between two annual audits. It may be conducted for a
specific period, such as a quarter or half year, with an interim object of declaration of interim
dividend or valuation of shares on a certain date, in case of mergers.
It is carried out by professionals, but has no legal status as the figures may be altered
subsequently.
It is useful for:
a. Ascertainment of interim profit and loss and declaration of interim dividend.
b. Change in the structure of a partnership firm.

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c. Determining goodwill and net worth of any business for acquisition purpose.
d. Investigation of any suspected fraud.
e. Obtaining loans from financial institutions.

c. Continuous Audit
According to the Institute of Internal Auditors, USA, continuous auditing is “a method used to
perform control and risk assessments automatic ally on a more frequent basis. Continuous
auditing changes the audit paradigm from periodic reviews of a sample of transactions to ongoing
audit testing of 100 percent of transactions. It becomes an integral part of modern auditing at
many levels. technology is a key to enabling such an approach.”
Continuous audit may be defined as the examination and verification of a firm’s financial
transactions and their supporting documents, continuously throughout the year, at regular or
irregular intervals.

🖸 Basic Features of Continuous Audit

a. It is a process conducted throughout the year.
b. It is conducted at regular or irregular intervals.
c. It focuses on testing 100% of transactions.
d. Technology is important to enable it.
e. It provides advance notice about errors and irregularities detected.
f. Surprise visits by the auditor are involved.

🖸 Necessary of Continuous Audit Continuous audit is necessary where:

a. Internal controls are inadequate.
b. The transactions run in large numbers.
c. The management is interested in getting statements of accounts audited periodic ally for
enabling better management of resources.

🖸 The Advantages of Continuous Audit

a. Early location of errors and frauds: It helps in detecting errors and frauds immediately on their
occurrence, and not at the year end when it would become difficult to install corrective control
mechanisms.
b. Quick rectification: rectification of errors at an early stage is possible.
c. Guidance: Continuous guidance to client.
d. Finalizations of accounts completion in time: Just at the end of the accounting period.
e. Moral check: Make employees of the client alert and more efficient in conducting their work.
f. Improves statutory auditor’s focus: It relieves statutory auditors of routine testing and allows
them to focus efforts on more valuable activities.

🖸 Demerits of Continuous Audit

a. The records and figures in the books of accounts, which have already been checked by the
auditor, may be altered after the audit is over.
b. Frequent visits made by the auditor may cause inconvenience at times inconvenient at work.
c. The client may suffer due to the clash of duties between his staff and that of the auditor clash
of work.
d. It is more expensive because the auditor has to devote more time to this audit.
e. The work of audit becomes too mechanical and repetitive work.

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d. Limited Review
As per Clause 33 of SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015, a
company shall submit its quarterly, year-to-date and annual financial results to the stock
exchange in the manner prescribed in this clause.
Accordingly, a company has an option to submit audited or unaudited quarterly and year to date
financial results to the stock exchange within forty-five days from the end of each quarter (other
than the last quarter). Under most of these circumstances the auditor finds little time to conduct
thorough examination of books and other supporting documents.
Moreover, it may also not be possible for the client to balance books and provide all
documentary evidences. So instead of conducting a full-fledged audit, the auditor has to make
restricted study of books and other documents. This system of review is called Limited Review.
It is to be noted that in case of Limited Review, generally accepted auditing standards are not
followed. So, the scope of Limited Review is substantially narrower as compared to an audit.

IV. Scopewise Classification of Audit

a. Complete Audit: A complete audit is an audit where the scope of audit is not confined to specific
limits, which may be set by the management or any other authority. The auditor is required to
check all the possible aspects of a business, including manufacturing operations, data flow
processes, accounting records and procedures, etc. In general, business practices, it is not
feasible to get a complete audit conducted.

b. Partial Audit: A partial audit is a non statutory audit, which restricts the scope of the auditor to
checking of certain specific aspects only. The auditor’s powers to enquiry are restricted by his
terms of engagement. He may not be allowed to obtain information which falls outside the
purview of the scope defined for him. E.g., an auditor may be appointed to check the accuracy of
recording of transactions relating to c ash sales, or he may be appointed to conduct an audit for
the month of Diwali only.

c. Detailed Audit: Detailed audit is also known as audit-in-depth. It involves checking of

transactions from the time of their recording till their final effect on the Financial Statements.
Every stage that a transaction goes through in the accounting processis closely examined by the
auditor using various audit evidences.

V. Subject Matter -wise Classification of Audit.

A. Cost Audit Cost Audit involves an examination of cost books, cost accounts, cost statements and
subsidiary and prime documents with a view to satisfying the auditor that these represent true
and fair view of the cost of production. This includes the examination of the appropriateness of
Cost Accounting system.
The Institute of Cost Accountants of India on the other hand, defines cost audit as “a system of
audit introduced by the Government of India for the review, examination and appraisal of the
cost accounting records and attendant information, required to be maintained by specified
industries.”
Cost Audit renders invaluable services to various parties connected with the business directly or
indirectly. It acts as a tool of control in the hands of management enabling it to identify the areas
of inefficiency and wastage.

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B. Management Audit Management audit is a comprehensive and critical review of each and every
aspect of the management process. It is basically a tool of management control. It covers all
areas of management like planning, organising, co-ordination and control. It assists managers at
all levels in the effective discharge of managerial functions.
Management audit is a forward-looking, independent and systematic evaluation of the activities
of the management for the improvement of the organisational profitability and attainment of
other predefined objectives of the organisation through well directed management function. It
acts as a guide, which helps in improving the efficiency of the management.

C. Operational Audit Operational Audit involves examination of all the operations and activities of
the entity under audit. The objective of operational audit includes the examination of the control
structure of the entity, the relation of department controls to general policies and its relation
with control of other departments. It provides an appraisal of whether the department is
operating in conformity with prescribed standards and procedures laid down by the
management.
It checks whether standards of efficiency and economy are maintained. It is concerned with
formulation of plans and checking of the implementation of systems and controls in respect of
other departments of the entity. It also checks whether capacity utilization in production
department and achievement of short-term targets in marketing departments and other
activities are so economically performed to achieve the predefined overall goals of the entity.
Operational audit, in its initial stages, was developed as a branch of internal auditing. Internal
audit focuses on accounting operations of the entity but operational audit has a wider scope of
working and covers all other operations, such as production and marketing too.
Operational audit is one of the management tools to get first-hand information. It is more useful
in an entity where the management is at a distance from actual operations. It is very useful in
large organisations where management cannot control the actual operations due to layers of
delegation of responsibility. The management information system has various tools like routine
performance report from department heads, internal audit reports, surprise checks, periodic
inspections and investigation to control the managers responsible for their departments. The
operational audit is also one of the tools used in large or geographically vast entities to control
the operation at first stage and to fill up the gaps of information provided by department heads
through periodic reports.

D. Tax Audit Tax audit can be defined as ‘an examination of financial records to assess correctness
of calculation of taxable profit, to ensure compliance with provisions of the Income Tax Act and
also ensure fulfilment of conditions for claiming deductions under Income Tax Act.’ Tax audit is
required in addition to the financial audit since taxable income largely differs from accounting
profit because of various allowances, disallowances, deductions and exemptions suggested under
tax laws.
In India, the Income Tax Act, 1961 contains a number of provisions requiring tax audit of an
entity. Section 44AB gives the provisions relating to the class of taxpayers who are required to get
their accounts audited from a chartered accountant. The audit under Section 44AB aims to
ascertain the compliance of various provisions of the Income-tax Law and the fulfilment of other
requirements of the Income-tax Law. The prime objective of tax audit is to stop tax evasion.

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E. Social Audit Business is a social institution and evolves out of social environment. In course of
earning profit business takes resources from society, so in return they should discharge certain
duties to society also for long term sustainability. In order to measure and examine how far the
business concerns have been able to discharge their social responsibility, that is, how much
contribution has been made by the concern towards social welfare, the concept of ‘social audit’
was introduced in business arena.
Social audit is defined as the system of independent evaluation of operations of an organisation,
examination of records relating to social responsibility accounting and critical appraisal of the
impact of organisations on the society.
Social audit is not mandatory in most of the countries including India. This exercise is often
undertaken by business houses voluntarily.

F. Propriety Audit Propriety audit is the independent and systematic evaluation of the
appropriateness of management decisions on the basis of public interest, financial discipline and
behavioural standards. In other words, it is an evaluation as to whether decisions have been
undertaken in tune with the accepted rules, standards, policy and delegated power. The objective
of propriety audit is to ensure safeguard of assets, check misappropriation of funds, misutilisation
of delegated authority and increase the productivity of management etc.

In India, propriety audit is not separately practiced. However, the Companies Act, CARO and
other legislations contain sufficient provisions that require performance of propriety audit in the
context of conventional statutory audit.

G. Forensic Audit Forensic audit involves examination of legalities by blending the techniques of
propriety audit, regularity, investigative and financial audits. The objective is to find out whether
or not true business value has been reflected in the Financial Statements and in the course of
examination to find whether any fraud has taken place.
Major accounting scandals involving Enron, World Tel, Parmalat and Satyam have been widely
reported. In all these cases, the methods and purpose of manipulations in the Financial
Statements were peculiar to the motives of such manipulations.
The Companies (Auditors’ Report) Order, 2016, requires auditors to report, amongst others,
“whether any fraud on or by the company has been noticed or reported during the year. If yes,
the nature and the amount involved are to be indicated”. In this background, the techniques of
forensic auditing have gained importance.

H. Performance Audit A performance audit is an independent assessment of an entity’s operations

to determine if specific programs or functions are working as intended to achieve stated goals.
Performance audits are typically associated with government agencies at all levels as most
government bodies receive federal funding.
Performance audits serve a fundamental purpose of government accountability. Through
performance audits government entities are held to objective standards of executing the
responsibilities that they are legally authorized and charged to carry out.

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I. Secretarial Audit Secretarial audit is also a relatively new concept and is coming to be recognized
with growing complexities the corporate laws. Compliance with the provisions of various
corporate laws is as important to be in the Any failure to comply with corporate laws may invite
heavy penalty and/or even imprisonment.
It is therefore imperative for corporate entities to ensure compliance with the applicable legal
requirements which are numerous. A secretarial audit assures the corporate body that the legal
requirements have been duly complied with and in time.

J. Human Resource Audit Human Resource Audit is a comprehensive method of objective and
systematic verification of current practices, documentation, policies and procedures prevalent in
the HR system of the organisation. An effective HR audit helps in identifying the need for
improvement and enhancement of the HR function. It also guides the organisation in maintaining
compliance with ever-changing rules and regulations. HR audit, thus, helps in analysing the gap
between ‘what is the current HR function’ and ‘what should be/could be the best possible HR
function’ in the organisation.

K. Information Systems Audit According to Ron Weber, “Information systems auditing is an

organisational function that evaluates asset safeguarding, data integrity, system effectiveness,
and system efficiency in computer-based information systems”. The effectiveness of an
information system’s controls is evaluated through an information systems audit. An audit aims
to establish whether information systems are safeguarding corporate assets, maintaining the
integrity of stored and communicated data, supporting corporate objectives effectively, and
operating efficiently. It is a part of a more general financial audit that verifies an organisation’s
accounting records and financial statements.
The factors that led to the development of Information System Audit are:
(i) The consequences of losing the data resource;
(ii) The possibility of misallocating resources because of decision based on incorrect
data or decision rules;
(iii) The possibility of computer abuse if computer systems are not controlled;
(iv) The high value of computer hardware, software, and personnel;
(v) The high costs of computer error;
(vi) The need to maintain the privacy of individual persons; and
(vii) The need to control the evolutionary use of computers.

L. Environmental Audit Environmental audit is an excellent management tool for relating

productivity to pollution. Environmental audit is the examination of the correctness of
environmental accounts. In broader sense, environmental auditing is the examination of accounts
of revenues and costs of environmental and natural resources, their estimate, depreciation and
values recorded in the books of accounts.
In India, recognising the importance of environmental audit, its procedure was first notified
under the Environment (Protection) Act, 1986 by the Ministry of Environment of Forests. Under
this Act, every person carrying operations of an industry, operation or process requiring consent
under Section 25 of the Water (Prevention & Control of Pollution) Act, 1974 or under Section 21
of the Air (Prevention & Control of Pollution) Act, 1981 or both or authorisation under the
Hazardous Wastes (Management and Handling) Rule of 1989 issued under the Hazardous
(Protection) Act, 1986 is required to submit an environmental audit report.

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CHAPTER – 2 Basic Concepts of Auditing

Brief Introduction to Auditing Standards

Auditing Standards

Standards on auditing are a set of well-defined guidelines which are followed by auditors in conducting audit of
the client’s accounts.

These are formulated by professional bodies of accountants based on the collective deliberations and
suggestions received from various interested groups or potential stakeholders including industry, academia and
regulators. The Standards provide principles and techniques expected to be followed by an auditor in order to
improve the quality of his audit work.

Purpose of Standards of Auditing

Standards of auditing serves a number of purposes as follows:

a. Standards act as a ready reference of the procedures to be followed by an auditor under a given
situation.
b. Adherence to Standards reduces audit risk considerably.
c. An auditor conducting the audit work based on the relevant standards can always defend himself
against possible allegations of negligence.
d. Standards improve the quality of audit work and thereby restore the public trust on the profession.

International Auditing and Assurance Standards Board (IAASB)

In 1977, the International Federation of Accountants (IFAC) was established with a view to bring harmony in the
profession of accountancy on an international scale.

In pursuing this objective, the IFAC Board established the International Auditing and Assurance Standards Board
(IAASB). The IAASB functions as an independent standard setting body under the auspices of IFAC. The objective
of the IAASB is to serve public interest by developing and issuing high quality auditing standards and by
facilitating the convergence of international and national standards, thereby enhancing the uniformity and
quality of audit practice throughout the world and strengthening public confidence on the audit profession
globally.

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Auditing and Assurance Standards Board (AASB)

The Institute of Chartered Accountants of India is one of the founder members of the International Federation
of Accountants (IFAC). Hence, it is one of the membership obligations of The Institute of Chartered Accountants
of India to actively propagate the pronouncements of International Auditing and Assurance Standards Board
(IAASB) of the IFAC to contribute towards the global harmonisation and acceptance of the Standards issued by
IAASB.

Accordingly, The Institute of Chartered Accountants of India constituted the Auditing Practices Committee (APC)
in 1982 to develop Statements on Standard Auditing Practices (SAPs).

In July 2002, the APC was converted into the Auditing and Assurance Standards Board (AASB).

The composition of the AASB is fairly broad-based and attempts to ensure participation of all interest groups in
the standard setting process. Apart from the elected members of the Council of The Institute of Chartered
Accountants of India, the Board includes members from profession, members from SEBI, RBI, IRDA, IIMs,
industry associations etc.

Objectives and functions of the Auditing and Assurance Standards Board:

a) To review the existing and emerging auditing practices worldwide and identify areas in which Standards
on Quality Control, Engagement Standards and Statements on Auditing need to be developed.

b) To formulate Engagement Standards, Standards on Quality Control and Statements on Auditing so that
these may be issued under the authority of the Council of the Institute.

c) To review the existing Standards and Statements on Auditing to assess their relevance in the changed
conditions and to undertake their revision, if necessary.

d) To develop Guidance Notes on issues arising out of any Standard, auditing issues pertaining to any
specific industry or on generic issues, so that those may be issued under the authority of the Council of
the Institute.

e) To review the existing Guidance Notes to assess their relevance in the changed circumstances and to
undertake their revision, if necessary.

f) To formulate General Clarifications, where necessary, on issues arising from Standards.

g) To formulate and issue Technical Guides, Practice Manuals, Studies and other papers under its own
authority for guidance of professional accountants in the cases felt appropriate by the Board.

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Structure of Pronouncements Issued by AASB

In order to facilitate understanding of the scope and authority of the pronouncements of the AASB issued under
the authority of the Council of The Institute of Chartered Accountants of India, a revised preface titled Preface
to the Standards on Quality Control, Auditing, Review, Other Assurance and Related Services has been issued
which has come into effect from April 1, 2008. Accordingly, the pronouncements by AASB are covered by the
following two broad categories of Standards:

A. Engagement Standards:
The following Standards issued by the Auditing and Assurance Standards Board under the authority of
the Council are collectively known as the Engagement Standards:
a. Standards on Auditing (SAs), to be applied in the audit of historical financial information.

b. Standards on Review Engagements (SREs), to be applied in the review of historical financial

information.

c. Standards on Assurance Engagements (SAEs), to be applied in assurance engagements, other

than audits and reviews of historical financial information.

d. Standards on Related Services (SRSs), to be applied to engagements involving application of

agreed- upon procedures to information, compilation engagements, and other related services
engagements, as may be specified by The Institute of Chartered Accountants of India.

B. Standards on Quality Control (SQCs):

These are issued by the AASB under the authority of the Council and are to be applied for all services
covered by the Engagement Standards as described above.
In addition to above, AASB issues the following:
a. Statements on Auditing: These are issued with a view to securing compliance by professional
accountants on matters which, in the opinion of the Council, are critical for the proper
discharge of their functions. Statements are, therefore, mandatory.

b. General Clarifications: These are issued by the Board under the authority of the Council of the
Institute with a view to clarify any issues arising from the Standards. General Clarifications are
mandatory in nature.

c. Guidance Notes: these are issued to assist professional accountants in implementing the
Engagement Standards and the Standards on Quality Control issued by the AASB under the
authority of the Council. Guidance Notes are also issued to provide guidance on other generic
or industry specific audit issues, not necessarily arising out of a Standard.

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Procedures for Issuing Standards on Auditing

Auditing and Assurance Standards Board (AASB) of the Institute formulates the auditing standards. Broadly, the
following procedure is adopted for the formulation of Standards on Auditing (SAs):

a) The Auditing and Assurance Standards Board identifies the areas where auditing standards need to be
formulated and the priority in regard to their selection.

b) In the preparation of Auditing Standards, AASB is assisted by study groups/task force constitute to
consider specific project. Study group comprising of a cross section of members of the Institute. The
study group/task force will consider the specific subject and prepare the primarily draft of Standards.

c) Based on the work of the study groups, an exposure draft of the proposed Standards is prepared by the
Committee and issued for comments by members of The Institute of Chartered Accountants of India

d) After taking the comments into consideration, AASB finalize the draft and submit to the Council of the
Institute.

e) The Council on its review of the draft, makes suitable modifications in consultations with the AASB and
then Standards/Statements is issued under the authority of the Council. While formulating the auditing
standards, the Board also takes into consideration International Standards on Auditing (ISA) issued by
the International Auditing Practices Committee (IAPC), applicable laws, customs, usages and business
environment in the India.

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List of Different Standards Issued by AASB in India

Standards on Quality Control (SQCs)

• SQC 1, Quality Control for Firms that Perform Audit and Reviews of Historical Financial Information, and
other Assurance and Related Services Engagements

New/Revised Standards (Auditing, Review and Others) under the Clarity Project

• 100-199 Introductory Matters

• 200-299 General Principles and Responsibilities
o SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing
o SA 210, Agreeing the Terms of Audit Engagements
o SA 220, Quality Control for an Audit of Financial Statements
o SA 230, Audit Documentation
o SA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
o SA 250, Consideration of Laws and Regulations in an Audit of Financial Statements
o SA 260, Communication with Those Charged with Governance
o SA 265, Communicating Deficiencies in Internal Control to Those Charged with Governance
and Management
o SA 299, Joint Audit of Financial Statements

• 300-499 Risk Assessment and Response to Assessed Risks

o SA 300, Planning an Audit of Financial Statements
o SA 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding
the Entity and Its Environment
o SA 320, Materiality in Planning and Performing an Audit
o SA 330, The Auditor’s Responses to Assessed Risks
o SA 402, Audit Considerations Relating to an Entity Using a Service Organisation
o SA 450, Evaluation of Misstatements Identified During the Audit

• 500-599 Audit Evidence

o SA 500, Audit Evidence
o SA 501, Audit Evidence-Specific Considerations for Selected Items
o SA 505, External Confirmations
o SA 510, Initial Audit Engagements – Opening Balances
o SA 520, Analytical Procedures
o SA 530, Audit Sampling
o SA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related
Disclosures
o SA 550, Related Parties
o SA 560, Subsequent Events
o SA 570, Going Concern
o SA 580, Written Representations

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• 600-699 Using Work of Others

o SA 600, Using the Work of Another Auditor
o SA 610, Using the Work of Internal Auditors
o SA 620, Using the Work of an Auditor’s Expert

• 700-799 Audit Conclusions and Reporting

o SA 700, Forming an Opinion and Reporting on Financial Statements
o SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report
o SA 705, Modifications to the Opinion in the Independent Auditor’s Report
o SA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent
Auditor’s Report
o SA 710, Comparative Information—Corresponding Figures and Comparative Financial
Statements
o SA 720, The Auditor’s Responsibilities Relating to Other Information

• 800-899 Specialized Areas

o SA 800, Special Considerations—Audits of Financial Statements Prepared in Accordance with
Special Purpose Frameworks
o SA 805, Special Considerations—Audits of Single Financial Statements and Specific Elements,
Accounts or Items of a Financial Statement
o SA 810, Engagements to Report on Summary Financial Statements

• 2000-2699 Standards on Review Engagements (SREs)

o SRE 2400, Engagements to Review Historical Financial Statements
o SRE 2410 Review of Interim Financial Information Performed by the Independent Auditor of
the Entity Assurance Engagements Other Than Audits or Reviews of Historical Financial
Information

• 3000-3699 Standards on Assurance Engagements (SAEs)

• 3000-3399 Applicable to All Assurance Engagements

• 3400-3699 Subject Specific Standards

o SAE 3400 The Examination of Prospective Financial Information
o SAE 3402, Assurance Reports on Controls at a Service Organisation
o SAE 3420, Assurance Engagements to Report on the Compilation of Pro Forma Financial
Information Included in a Prospectus Related Services

• 4000-4699 Standards on Related Services (SRSs)

o SRS 4400 “Engagements to Perform Agreed-upon Procedures Regarding Financial
Information”
o SRS 4410 (Revised), Compilation Engagements.

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CHAPTER – 3 Basic Concepts of Auditing

Audit Engagement, Program, Documentation and Evidence

SA 210 Agreeing the Terms of Audit Engagements

In case of statutory audit, the appointment of the auditor and his duties and responsibilities are governed by
the respective statutes. In all other organisations, however, these are decided by the agreement between the
auditor and the client. Such an agreement plays a significant role in the conduct of audit of the client because if
the auditor is held responsible for anything beyond the nature and scope of the current engagement, he can be
relieved without any doubt. In addition, existence of an agreement can easily avoid any misunderstanding or
ambiguity in future. Thus, it is desirable that before commencement of audit, the auditor and the client must
agree on the terms of engagement and the auditor should send an audit engagement letter in the interest of
both of them.

As per SA 210 an auditor and the client should agree to the terms of audit engagement prior to commencement
of the audit. The agreed terms should then be recorded by the auditor in an audit engagement letter or any
other suitable form of written agreement. However, if the law or regulation prescribes in sufficient detail the
terms of audit engagement, the auditor need not record them in written agreement.

Contents of Audit Engagement Letter

As per SA-210, Agreeing the Terms of Audit Engagements, every engagement letter as per should contain the
following:

a. Objective & scope of engagement

b. Management responsibility
c. Existence of inherent limitations
d. Need for use of Internal Auditor
e. Management confirmation letter
f. Restrictions & limitations of Auditor liabilities
g. Basis of computation of Audit fees
h. Billing arrangement
i. Form of report & Other communications of engagement
j. Validity of report
k. Limits on submission of report to other authorities

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SA 300, Planning an Audit of Financial Statements

Audit Programme

An audit programme is a detailed plan of the auditing work to be performed, specifying the procedures to be
followed in verification of each item and the financial statements and the estimated time required. To be more
comprehensive, an audit programme is written plan containing exact details with regard to the conduct of a
particular audit. It is a description or memorandum of the work to be done during an audit. Audit programme
serves as a guide in arranging and distributing the audit work as well as checking against the possibility of the
omissions.

As per SA 300, the auditor should prepare a written audit programme setting forth the procedures that are
needed to be implemented while carrying out the audit plan. He may take into account the reliance to be placed
on internal controls. The auditor has some flexibility in deciding when to perform audit procedures. But
sometimes he may have no discretion as to timing, such as, observing the stock taking by the client’s personnel.
The audit programme should consider previous year’s audit programmes and these may be modified, if
necessary.

An audit programme may be classified into two categories:

(i) Programme common to all types of audits - For example, checking of books of accounts; and
(ii) Special programme containing the work relating to a particular audit. For example, the audit
programme for a partnership firm would be different from that of a company.

Advantages of Audit Programme

(i) It serves as a ready check list of audit procedures to be performed.

(ii) The audit work can be properly allocated to the audit assistants or the article clerks.
(iii) The auditor may easily know the extent of work done at any point of time. Thus, the progress of work
done can be under the supervision and control of the auditor.
(iv) Audit programme would not only be useful for the audit assistants in carrying the audit work but for
the principal too as he would be in a position to account for the individual responsibilities.
(v) A uniformity of the work can be attained as the same programme would be followed from time to time.
(vi) It is a useful basis for planning the programme for the following year it is useful in selection of team
members & delegation of responsibilities to them.
(vii) It may be used as evidence by the auditor in the event when any charge is brought against him.
(viii) It is useful in selection of Team members and delegation of responsibilities to them.
(ix) He can prove that there has no negligence on his part and he exercised reasonable care and skill while
performing the task.

Disadvantages of Audit Programme

(i) The auditor’s task becomes mechanical and the auditors may lose interest and initiative.
(ii) Drawing up of an audit programme may be unnecessary for a small concern.
(iii) Though audit programme helps in fixing responsibilities but inefficient staff may defend themselves by
stating that the matter was not contained in the audit programme.
(iv) Rigid programmes cannot be laid down for each type of business.

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SA-230, ‘Audit Documentation’

In course of audit of an organisation, an auditor adopts various methods and procedures to accumulate and
thereafter analyse audit evidences and other important documents to reach at some meaningful conclusion
regarding his engagement. Audit working papers include all such records kept by an auditor in relation to the
evidences accumulated, methods and procedures adopted and conclusions reached during the course of the
audit.

As per SA-230, audit working papers (also called audit documentation) refer to the record of audit procedures
performed, relevant audit evidences obtained and conclusions the auditor reached.

Such records can be kept either in physical form or in an electronic form.

Purpose of Audit Working Papers

According to SA-230, ‘Audit Documentation’, audit working papers or audit documentation serves a number of
purposes as follows:

a. Providing evidence of auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor.
b. Providing evidence that audit was planned and performed in accordance with Standards of Audit
(SAs) and applicable legal and regulatory requirements.
c. Assisting the engagement team to plan and perform the audit.
d. Assisting members of the engagement team responsible for the supervision to direct and supervise
the audit work, and to discharge their review responsibilities in accordance with SA220, ‘Quality
Control for an Audit of Financial Statements’.
e. Enabling the engagement team to be accountable for its work.
f. Retaining a record of matters of continuing significance to future audits.
g. Enabling the conduct of quality control reviews and inspections in accordance with SQC 1.
h. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other
requirements.

Contents of Audit Working Papers

As per SA-230, ‘Audit Documentation’, an auditor should follow the guidelines mentioned below to decide on
the form, content and extent of audit documentation (or working papers).

(i) The auditor shall prepare audit working papers on a timely basis. They should be prepared while
performing the task itself rather than after the audit work is performed.
(ii) The auditor shall prepare audit working papers that is sufficient to enable an experienced auditor,
having no previous connection with the audit, to understand:
a. the nature, timing and extent of audit procedures performed to comply with the SAs and
applicable legal and regulatory requirements;
b. the results of the audit procedures performed and the audit evidence obtained; and
c. significant matters arising during the audit, the conclusion reached thereon and significant
professional judgments made in reaching those conclusions.
(iii) In documenting the nature, timing and extent of audit procedures performed, the auditor shall
record:
a. the identifying characteristics of the specific items or matters tested;
b. who performed the audit work and the date such work was performed; and

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c. who reviewed the audit work performed and the date and extent of such review.
(iv) The auditor shall document discussions of significant matters with management, those charged with
governance and others, including the nature of the significant matters discussed and when and with
whom the discussions took place.
(v) If the auditor identified information that is inconsistent with the auditor’s final conclusion regarding a
significant matter, the auditor shall document how the auditor addressed the inconsistency.
(vi) If, in exceptional circumstances, the auditor judges it necessary to depart from a relevant
requirement in a SA, the auditor shall document how the alternative audit procedures performed
achieved the aim of that requirement, and the reasons for the departure.

Types of Working Paper Files

In case of recurring audits, some working papers files may be classified into permanent audit files and current
audit files: while the former is updated with the information of continuing importance, the latter contains
information relating to audit of a single period. The contents of these files are given below:

Permanent Audit File Current Audit File

a. Legal and organisational structure of the a. Correspondence relating to
entity, e.g., Memorandum of Association acceptance of annual reappointment.
and Article of Association in case of a
company.
b. Extracts or copies of legal documents, b. Extracts of important matters in the
agreements and minutes relevant to the minutes of Board Meetings and
audit. General Meetings relevant to the
audit.
c. A record of study and evaluation of c. Copies of management letters.
internal controls.
d. Analysis of significant ratios & trends. d. Analysis of transactions and balances.
e. Copies of the audited financial e. Copies of communication with other
statements of previous year(s). auditors, experts and third parties
f. Notes regarding signific ant accounting f. Audit programme.
policies.
g. Significant audit observations of the g. Conclusions reached on significant
earlier years. aspects of audit.

Ownership and Custody of Audit Working Papers

Working papers are the property of the auditor, the portions or extracts of which can be had at his discretion.
These working papers should be kept in safe custody and in confidential manner for such time as is sufficient
to meet the requirements of his practice or to satisfy any related legal or professional requirement of record
retention. However, if required by some legislation, the auditor has to make working papers available to the
regulatory authority(s).

In case of Chantery Martin & Co, it was held that the audit working papers are the property of the auditor and
he is entitled to retain them.

The Institute of Chartered Accountants of India has prescribed that the members have to retain the working
papers for a period of 7 years (as per SQC 1), otherwise, the member is guilty of professional misconduct.

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SA-500, ‘Audit Evidence’

As per SA-500, the term ‘audit evidence’ includes information used by the auditor in arriving at the conclusions
on which the auditor’s opinion is based. Audit evidence includes both information contained in the accounting
records underlying the financial statements and other information.

In short, substantive evidence collected by an auditor from various sources to base his opinion on the financial
statements of the organisation is called audit evidence.

Need for Audit Evidence

Audit evidence is an important element of audit process. In order to form his unbiased opinion on the
reliability and fairness of the financial performance and financial state of affairs, an auditor needs to
objectively examine the financial statements based on sufficient and appropriate evidence. Opinion based on
casual and subjective evaluation may leave material misstatements or frauds undetected and as a result the
auditor may be held guilty of professional negligence. The auditor, therefore, should always try to obtain
sufficient and appropriate audit evidence and analyse them thoroughly before arriving at any opinion. Only by
doing so, the auditor can keep the audit risk to a substantially low level. In SA-200, it is recognised that
reasonable assurance is obtained when the auditor has obtained sufficient appropriate audit evidence to
reduce audit risk to an acceptably low level. Here, sufficiency refers to the quantity and appropriateness refers
to the quality of audit evidence.

Auditor’s Judgement while Obtaining Audit Evidence

The auditor should evaluate whether he has obtained sufficient appropriate audit evidence so that reasonable
conclusions can be drawn therefrom. It is to be noted that sufficiency and appropriateness are interrelated
and apply to evidence obtained from both substantive and compliance procedures.

Sufficiency refers to the quantum of audit evidence obtained and appropriateness relates to its relevance and
reliability.

The following factors influence auditor’s judgement while obtaining audit evidence:

a. the nature of the item;

b. the adequacy of internal controls;
c. the nature and size of the business carried on by the entity;
d. Situations which may exert an unusual influence on the management;
e. The financial position of the entity;
f. The materiality of the item;
g. The experience gained during the previous audits;
h. The results of auditing procedures, including fraud or error which may have been found;
i. The type of information available;
j. The trend indicated by accounting ratios and analysis.

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Types of Audit Evidence

Depending upon the source, audit evidences may be of two types—internal evidences and external evidences.
These are discussed below:

a. Internal Evidences
These are evidences collected from within the organisation. For example, sales invoices, counterfoils
of cash memos, goods received notes, credit notes and debit notes, etc.
b. External Evidences
These are evidences collected from outside sources. For example, quotations, confirmation from
debtors and creditors, etc.

Relevance and Reliability of Audit Evidence

In order to arrive at an appropriate conclusion regarding the truthfulness and fairness of financial statements,
the audit evidences under examination must be relevant and reliable.

As per SA-500, relevance of audit evidence deals with the logical connection with the purpose of audit
procedure and is therefore affected by the direction of testing. On the other hand, the reliability of audit
evidence depends on its source - internal or external and on its nature - visual, documentary or oral. While the
reliability of audit evidence is dependent on the circumstances under which it is obtained, the following
generalizations may be useful in assessing the reliability of audit evidence:

a. External evidence (e.g., confirmation received from a third party) is generally more reliable than
internal evidence;
b. Internal evidence is more reliable when related internal control is satisfactory;
c. Evidence in the form of documents and written representation is usually more reliable than oral
representations;
d. Evidence obtained by the auditor himself is more reliable than that obtained through the entity.

Methods to Obtain Audit Evidence

Auditor obtains evidence in performing compliance and substantive procedures by any one or more of the
following methods –

a. Inspection
It consists of examining records, documents, or tangible assets. Inspection of records and documents
provides evidence of varying degrees of reliability depending on their nature, source and the
effectiveness of internal controls over their processing.
b. Observation
It consists of witnessing a process or procedure being performed by others.
c. Inquiry and Confirmation
Inquiry consists of seeking appropriate information from a knowledgeable person inside or outside
the entity, Confirmation consists of the response to an inquiry to corroborate information contained
in the accounting records.
d. Computation
It consists of checking the arithmetic al accuracy of source documents and accounting records or
performing independent calculations.
e. Analytical Review
It consists of studying signific ant ratios and trends and investigating unusual fluctuations and items.

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Audit Procedure to Obtain Audit Evidence

As per SA-315 and SA-330, audit evidence to draw reasonable conclusions on which to base the auditor’s
opinion is obtained by performing:

I. Risk assessment procedures; and

II. Further audit procedures, which comprise:
a. Test of control or Compliance Procedure, and
b. Test of details and analytical procedures known as Substantive Procedure.

Risk assessment procedures are the audit procedures performed to obtain an understanding of the entity and
its environment, including the entity’s internal control, to identify and assess the risks of material
misstatement, whether due to fraud or error, at the financial statement and assertion level (assertions are
management representations, explicit or otherwise, that are embodied in the financial statements).

Compliance procedures or Tests of controls are those activities performed by the auditor during the control
testing stage that gather evidence as to the operational effectiveness of internal control procedures upon
which the auditor has planned reliance.

Management impliedly asserts that internal control procedures are effective as to both their design and
operation. If controls are effective, then the auditor can plan reliance on the controls and reduce the time
spent in gathering audit evidence. This is because the objective of an audit is similar in many respects to the
objectives of internal control procedures. One of the primary objectives of a financial statement audit is to
gather evidence as to whether account balances and classes of transaction are materially complete, valid and
accurate. This is very similar to the primary objective of internal control procedures - to provide management
with assurance that account balances and classes of transaction are complete, valid and accurate. Thus, if
controls are effective, the auditor can plan reliance on the controls and reduce the amount of evidence that he
would otherwise gather as to the completeness, validity and accuracy of account balances and classes of
transaction.

In the audit planning stage, the auditor gathers evidence as to the effectiveness of design of control
procedures and decides which control procedure, if any, upon which he will plan reliance. In the control
testing stage, the auditor gathers evidence as to the effectiveness of operation of those controls upon which
the auditor has planned reliance. The activities that the auditor employs to gather this evidence are referred to
collectively as tests of control (sometimes referred to as compliance tests or compliance procedures).

Tests of control include observation of an internal control procedure being performed, inspection of evidence
that the control procedure was performed (and performed at the appropriate time), and inquiry about how
and when the procedure was performed. Where the information system is computerized, evidence may also
be gathered using CAATs (Computer Assisted Audit Technique) such as a generalized audit software or an
embedded audit module.

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Substantive procedures (or substantive tests) are those activities which are performed by the auditor during
the substantive testing stage of the audit that gather evidence as to the completeness, validity and / or
accuracy of account balances and underlying classes of transactions. Management impliedly asserts that
account balances and underlying classes of transaction do not contain any material misstatements. In other
words, that they are materially complete, valid and accurate. Auditors gather evidence about these assertions
by undertaking activities referred to as substantive procedures.

For example, an auditor may

a. physically examine inventory on balance date as evidence that inventory shown in the accounting
records actually exists (validity assertion);
b. arrange for suppliers to confirm in writing the details of the amount owing at balance date as
evidence that accounts payable is complete (completeness assertion); and
c. make inquires of management about the collectability of customers’ accounts as evidence that trade
debtors are accurate as to its valuation (accuracy assertion).

Evidence that an account balance or class of transaction is not complete, valid or accurate is evidence of a
substantive misstatement.

There are two categories of substantive procedures - analytical procedures and tests of detail. Analytical
procedures generally provide less reliable evidence than the tests of detail. It may be noted that analytical
procedures are applied in several different audit stages, whereas tests of detail are only applied in the
substantive testing stage.

Audit Note Book

In the course of conducting audit of an organisation, the audit staff may come across various misstatements,
frauds or any other issues which need further clarification from the management or investigation and in-depth
observation later on. In order to avoid any chance of such issues being unanswered, the audit staff generally
records the same in a separate note book and raises the issue in future. Such a record is known as Audit Note
Book.

Generally separate note books are prepared for each client.

Contents of Audit Note Book

a. Name of the business enterprise.

b. Organisation structure.
c. Important provisions of Memorandum of Association (MOA) and Articles of Association (AOA).
d. Communication with the previous auditor, if any.
e. Management representations and instructions.
f. List of books of accounts maintained by the enterprise.
g. Accounting methods, internal control systems followed by the enterprise, applicable laws etc.
h. Key managerial personnel.
i. Errors and fraud discovered.
j. Matters requiring explanations or clarifications.
k. Special points that need attention in the audit report.

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CHAPTER – 4 Basic Concepts of Auditing

AUDIT RISK

Concept of Audit Risk

A statutory auditor is required to express an opinion as to whether the financial statements prepared by the
entity exhibit a true and fair view of the financial performance and financial position of the entity. However, in
spite of his sincere efforts, it may not be possible for an auditor to guarantee that the audited accounts are free
from all sorts of material misstatements; rather, there is every possibility that an auditor expresses an incorrect
opinion in his report.

Audit risk refers to the risk that an auditor gives an inappropriate opinion when the financial statements are
materially misstated. In other words, it is the risk that an auditor fails to express an appropriate opinion on the
financial statements of the entity.

Consider the following example. A Ltd. spent `50 lakh to repair a machinery. The repair was likely to improve the
capacity of the existing machine by 30%. Accordingly, the cost of repair should be capitalised and not to be
treated as a revenue expenditure. Unfortunately, the accountant debited the amount in the Repairs and
Maintenance A/C and changed the same as a revenue expenditure in the Statement of Profit and Loss instead
of debiting the Machinery A/c. The auditor, while auditing the accounts of the company overlook the same and
did not report anything regarding the error. In this situation, the auditor’s opinion is inappropriate resulting into
audit risk

What is Not Audit Risk?

The following two, however, does not come under the purview of audit risk.

a. Audit risk does not include the risk that the auditor may express an opinion that the financial statements
are materially misstated when actually they are not so.
b. Audit risk also doesn’t include the business risk of the auditor such as loss due to litigation, negative
publicity, etc. It is something very technical and related to the audit of the financial statement of the
client.

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Types of Audit Risk

Audit risk can broadly be classified into – Risk of Material Restatement and Detection Risk.

A. Risk of Material Misstatement

It may be defined as the risk that the financial statements are materially misstated prior to the audit
exercise either due to any unintentional error or any organised fraud.
This risk may exist at two levels:
I. At Overall Financial Statement Level:
It refers to the possibility that material misstatement relates pervasively to the financial
statements as a whole and may potentially affect multiple assertions.
II. At Assertion (it refers to some implicit or explicit claims) Level:
It refers to the possibility that material misstatement may exist while classifying the
transactions, calculating the balances or disclosing some material information. The risk of
material misstatement at the assertion level has two components as follows:

a. Inherent Risk: This refers to the possibility of material misstatement due to complex
transactions or even due to organised fraud. Accordingly, this risk may be higher for some
classes of transactions, account balances and disclosures. For example, transactions such
as fire damage or acquiring another company are non-recurring and hence the auditor
runs the risk of focusing too much or too little on the unique event.

b. Control Risk: This refers to the possibility of material misstatement due to ineffective
design, implementation and maintenance of internal control system. Thus, a sound
internal control system significantly reduces this risk. However, internal control can
reduce but cannot eliminate the risk completely because of its inherent limitations. For
example, due to inefficient internal control system in the organisations, there may be a
risk that bank reconciliations have not been prepared for any month or not appropriately
reviewed, resulting in misstatement of bank balance.

B. Detection Risk
This refers to the possibility that the audit procedures applied by the auditor to reduce the audit risk to
an acceptably low level will not be able to detect a misstatement which, either individually or in
aggregate, may be material. For example, if the auditor applies a testing method that checks the
accuracy of the invoice rather than the occurrence of the particular sale, he may run into a detection
risk.
As audit risk comprises risk of material misstatement and detection risk, it may be said that,

Audit risk = Risk of material misstatement × Detection risk.

Again, Risk of material misstatement (at the assertion level) = Inherent Risk × Control Risk.

Therefore,
Audit risk = Inherent Risk (I) × Control Risk (C) × Detection Risk (D).

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Solved Case 1 J Mart Ltd. is a multi-brand retailer and operates though in multiple locations across the nation.
It sells products of thousands of categories from food to consumer durables. Each individual product item has
a price tag with barcode. In addition, there is another security tag which is removed only after the billing is
done. Inventory records are physically verified on a fortnightly basis by the auditor of J Mart. Identify the risk
associated with the audit of inventory in J Mart. Solution: The auditor may perceive the following risks:

a. Inherent Risk: It is possible that the employees might have misappropriated the inventory by
manipulating the inventory records. So, inventory records may not be accurate. This leads to a risk of
material misstatement.
b. Control Risk: Here each item of inventory carries a price tag with bar code as well as a security code
(which is removed only after the billing). Additionally, physical verification of inventory is done on a
fortnightly basis. Thus, the internal control appears to be quite satisfactory. However, collusion
among employees at multiple layers can evade the control implemented at any time. Hence, an
element of control risk is present.
c. Detection Risk: It is expected that the auditor will apply appropriate procedures to judge the
efficiency of the control system before deciding on the extent of test checking. However, there may
still be possibilities of material misstatements and the same may not be detected due to adoption of
test checking. Hence, an element of detection risk can also exist.

SA 315 Identifying and Assessing the Risk of Material Misstatement through understanding the Entity and its
Environment

Assessment of Audit Risk

As per SA 315, the auditor shall perform risk assessment procedures to provide a basis for the identification and
assessment of risks of material misstatement at the financial statement and assertion levels. Risk assessment
procedures by themselves, however, do not provide sufficient appropriate audit evidence on which to base the
audit opinion.

The risk assessment procedures shall include the following:

a. Inquiries of management and of others within the entity who in the auditor’s judgment may have
information that is likely to assist in identifying risks of material misstatement due to fraud or error.
b. Analytical procedures.
c. Observation and inspection.

These are discussed below.

a. Inquiries of Management and Others Within the Entity:

Much of the information obtained by the auditor’s inquiries is obtained from management and those
responsible for financial reporting. However, the auditor may also obtain information, or a different
perspective in identifying risks of material misstatement, through inquiries of others within the entity
and other employees with different levels of authority. For example,
■ inquiries directed towards those charged with governance may help the auditor understand the
environment in which the financial statements are prepared;

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■ inquiries of employees involved in initiating, processing or recording complex or unusual transactions

may help the auditor to evaluate the appropriateness of the selection and application of certain
accounting policies.
■ inquiries directed towards marketing or sales personnel may provide information about changes in
the entity’s marketing strategies, sales trends, or contractual arrangements with its customers.

b. Analytical Procedure: This means evaluations of financial information through analysis of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass such
investigation as is necessary of identified fluctuations or relationships that are inconsistent with other
relevant information or that differ from expected values by a significant amount. Analytical procedures
performed as risk assessment procedures may identify aspects of the entity of which the auditor was
unaware and may assist in assessing the risks of material misstatement in order to provide a basis for
designing and implementing responses to the assessed risks.

Analytical procedures performed as risk assessment procedures may include both financial and non-
financial information, for example, the relationship between sales and square footage of selling space
or volume of goods sold. Analytical procedures may help identify the existence of unusual transactions
or events, and amounts, ratios, and trends that might indicate matters that have audit implications.
Unusual or unexpected relationships that are identified may assist the auditor in identifying risks of
material misstatement, especially risks of material misstatement due to fraud.

However, when such analytical procedures use data aggregated at a high level, the results of those
analytical procedures only provide a broad initial indication about whether a material misstatement
may exist.

c. Observation and Inspection:

Observation and inspection may support inquiries of management and others, and may also provide
information about the entity and its environment. Examples of such audit procedures include
observation or inspection of the following:
■ The entity’s operations.
■ Documents (such as business plans and strategies), records, and internal control manuals.
■ Reports prepared by management (such as quarterly management reports and interim financial
statements) and those charged with governance (such as minutes of board of directors’ meetings).
■ The entity’s premises and plant facilities.

Some other relevant factors are as follows:

• Information Obtained in Prior Periods: The auditor’s previous experience with the entity and
audit procedures performed in previous audits may provide the auditor with information
about such matters as past misstatements and whether they were corrected on a timely basis,
the nature of the entity and its environment, and the entity’s internal control, significant
changes that the entity or its operations. This information may assist the auditor in gaining a
sufficient understanding of the entity to identify and assess risks of material misstatement.
• Discussion among the Engagement Team: The discussion among the engagement team about
the susceptibility of the entity’s financial statements to material misstatement provides an
opportunity for experienced team members to share their insights based on their knowledge
of the entity, allows the team members to exchange information about the business risks,
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material misstatement of the financial statements in the specific areas assigned to them, and
provides a basis upon which engagement team members communicate and share new
information obtained throughout the audit that may affect the assessment of risks of material
misstatement or the audit procedures performed to address these risks.
• The Required Understanding of the Entity and Its Environment, Including the Entity’s
Internal Control: An understanding of the entity and its environment helps the auditor a lot in
assessing the risk of material misstatements. Factors such as industry, and regulations have
significant bearing on an entity. The industry in which the entity operates may give rise to
specific risks of material misstatement arising from the nature of the business or the degree
of regulation. For example, long-term contracts may involve significant estimates of revenues
and expenses that give rise to risks of material misstatement. Similarly, relevant regulatory
issues such as applicable financial reporting framework, taxation, government policies,
regulatory framework for a regulated industry can well be the potential source of the risk of
material misstatements. In addition, the nature and structure of the entity (complex or
simple), ownership and relation between the owner and stakeholders may also give rise to
audit risk.

An understanding of internal control assists the auditor in identifying types of potential

misstatements and factors that affect the risks of material misstatement, and in designing the
nature, timing, and extent of further audit procedures. However, internal control, no matter
how effective, can provide an entity with only reasonable assurance about achieving the
entity’s financial reporting objectives. The likelihood of their achievement is affected by
inherent limitations of internal control. Obtaining an understanding of the entity and its
environment, including the entity’s internal control, is a continuous, dynamic process of
gathering, updating and analysing information throughout the audit. The understanding
establishes a frame of reference within which the auditor plans the audit and exercises
professional judgment throughout the audit.

Information obtained by performing risk assessment procedures and related activities may be
used by the auditor as audit evidence to support assessments of the risks of material
misstatement. In addition, the auditor may obtain audit evidence about classes of
transactions, account balances, or disclosures and related assertions and about the operating
effectiveness of controls, even though such procedures were not specifically planned as
substantive procedures3 or as tests of controls. During the audit, information may come to
the auditor’s attention that differs significantly from the information on which the risk
assessment was based. For example, the risk assessment may be based on an expectation that
certain controls are operating effectively. In performing tests of those controls, the auditor
may obtain audit evidence that they were not operating effectively at relevant times during
the audit. Similarly, in performing substantive procedures the auditor may detect
misstatements in amounts or frequency greater than is consistent with the auditor’s risk
assessments. In such circumstances, the risk assessment may not appropriately reflect the true
circumstances of the entity and the further planned audit procedures may not be effective in
detecting material misstatements.

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SA 265 Communicating Deficiencies in Internal Control to those Charged with Governance and Management

SA-315, Risk Assessment and Internal Control

Internal Control

Internal control is the process, effected by an entity’s Board, management, and other personnel, designed to
provide reasonable assurance regarding achievement of the objectives in the following categories:

i. Reliability of financial reporting,

ii. Effectiveness and efficiency of operations, and
iii. Compliance with applicable laws and regulations.

SA 265 defines the system of internal control as “all the policies and procedures (internal controls) adopted by
the management of an entity to assist in achieving management’s objective of ensuring, as far as practicable,
the orderly and efficient conduct of its business, including adherence to management policies, the safeguarding
of assets, the prevention and detection of fraud and error, the accuracy and completeness of the accounting
records, and the timely preparation of reliable financial information”.

Therefore, internal control system is the total system of control established by the management of an
organisation so as to ensure achievement of organisational objective effectively and efficiently.

Scope of Internal Control

Internal control comprises both administrative control and accounting control.

a. Administrative Control: It ensures adherence to management’s plans and procedures. Therefore,

administrative control relates to the production process, quality control, pricing strategies etc.
b. Accounting Control: It refers to the control system which ensures recording of transactions in the books
of accounts adhering to the established accounting policies and principles. Accounting control relates
to maintaining proper books of accounts, recording transactions timely, checking arithmetical accuracy
of books of accounts, rotation of duties of staffs, etc. Accounting control is again divided into two sub-
sections namely (a) Internal Check and (b) Internal Audit.

Basic Elements of Internal Control

An effective system of internal control should have the following basic elements:

i. Financial and Other Organisation Plans: This may take the form of manual suitably classified by flow
charts. It should specify the various duties and responsibilities of both management and staff, stating
the powers of authorisation that reside with various members.
ii. Competent Personnel: In any internal control system, personnel are the most important element.
When the employees are competent and efficient in their assigned work, the internal control system
can be operated efficiently and effectively.
iii. Division of Work: In any internal control system, each and every work of the organisation should be
divided in different stages and should be allocated to the employees in accordance with quality and
skill.
iv. Separation of Operational Responsibility from Record Keeping: In order to ensure reliable records and
information, record-keeping function must be separated from the operational responsibility of the
concerned department.

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v. Separation of the Custody of Assets from Accounting: To protect assets from misuse and
misappropriation, it is required that the custody of assets and their accounting should be done by
separate persons.
vi. Authorization: In an internal control system, all the activities must be authorized by a proper authority.
vii. Managerial Supervision and Review: The internal control system should be implemented and
maintained in conformity with the environmental and elemental changes of the concern. There must
be regular supervision and review of the effectiveness of the internal control system of the
organisation.

Objectives of Internal Control

Each organisation must have a system of internal control in place for achieving the predetermined goals. In
addition to accomplishing the desired goals and objectives of the organisation, this system plays a very important
role in any organisation in several other ways.

The main objectives of internal control are:

a. To ensure that the business transactions take place as per the general and specific authorisation of the
management.
b. To make sure that there is a sequential and systematic recording of every transaction, with the accurate
amount in their respective account and in the accounting period in which they take place.
c. To ensures that all recorded transactions fairly represent the economic events that actually occurred,
are lawful in nature, and have been executed in accordance with management’s general authorisation.
d. To ensure that all valid transactions are accurately recorded as per the accounting policies and
standards.
e. To provide security to the company’s assets from unauthorised use.
f. To review the working of the business, locate weak points in operations and to take corrective measures
for proper working.
g. To ensure there is the optimum utilization of the firm’s resources.

In this respect, SA-315, Risk Assessment and Internal Control, advocates the following objectives of internal
control:

i. To ensure that transactions are executed as per management’s authorisation

ii. To ensure that transactions are recorded in proper way to facilitate preparation of financial
information for maintaining record of assets.
iii. To ensure that assets are protected from unauthorised use, sale, etc.
iv. To ensure that assets are verified at frequent intervals.

Advantages of Internal Controls

i. Efficiency, effectiveness and economy: A good internal control system ensures that the resources are
utilized only for their intended purposes and helps to overcome the risk associated with the misuse of
organisation’s funds and other resources.
ii. Prevention of errors and irregularities: It prevents errors and irregularities by detecting them in a
timely manner, thereby promoting reliable and accurate accounting records.
iii. Safeguard from irregularities or misappropriations: A good internal control system ensures the
protection of organisation resources from misappropriation.

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iv. Employees’ satisfaction and productivity: It enhances employee satisfaction and productivity by
segregation of duties and delegation of responsibilities.

Types of Internal Control

The type of internal control system to be employed in an organisation depends upon the requirements and
nature of the business. Generally, there are two types of Internal Control in an Organisation: preventive and
detective controls. Both types of controls are essential to an effective internal control system. From a quality
standpoint, preventive controls are essential because they are proactive and emphasize quality. However,
detective controls play a critical role by providing evidence that the preventive controls are functioning as
intended.

A. Preventive Control:
Preventive Controls are designed to discourage errors or irregularities from occurring. They are
proactive controls that help to ensure achievement of departmental.
Examples of preventive controls are:

i. Segregation of Duties: Duties are segregated among different people to reduce the risk of error or
inappropriate action. Normally, responsibilities for authorizing transactions (approval), recording
transactions (accounting) and handling the related asset (custody) are divided.

ii. Approvals, Authorizations, and Verifications: Management authorizes employees to perform

certain activities and to execute certain transactions within limited parameters. In addition,
management specifies those activities or transactions that need supervisory approval before they
are performed or executed by employees. A supervisor’s approval (manual or electronic) implies
that he or she has verified and validated that the activity or transaction conforms to established
policies and procedures.

iii. Security of Assets (Preventive and Detective): Access to equipment, inventories, securities, cash
and other assets is restricted; assets are periodically counted and compared to amounts shown on
control records.

B. Detective control
Detective Controls are designed to find errors or irregularities after they have occurred.
Examples of detective controls are:

i. Reviews of Performance: Management compares information about current performance to

budgets, forecasts, prior periods, or other benchmarks to measure the extent to which goals
and objectives are being achieved and to identify unexpected results or unusual conditions
that require follow-up.

ii. Reconciliations: An employee relates different sets of data to one another, identifies and
investigates differences, and takes corrective action, when necessary.

iii. Physical Verification of Inventories: The auditor may conduct physical verification of
inventory to detect any misappropriation.

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Techniques for Evaluation of Internal Control System

The following methods are generally suggested for evaluation of internal control system:

1. Narrative Record:
It is a complete and exhaustive description of the system. It is appropriate in circumstances where a
formal control system is lacking, like in the case of small businesses. Gaps in the control system are
difficult to identify using a narrative record.

2. Check List: The Internal Control Checklist is a tool to help evaluate and strengthen internal controls,
promote effective and efficient business practices, and improve compliance in a department or
functional unit. The checklist is not meant to be absolute but informative when reviewing controls in
a given area. In fact, checklist is a series of instructions and/or questions which the auditor or the
audit staff must follow and answer. When he completes the instructions, he initials the space against
the instruction. Answers to the checklist instructions are usually ‘Yes’, ‘No’ or ‘Not Applicable’.

3. Flow Chart: It is a pictorial representation of the internal control system depicting its various
elements such as operations, processes and controls, which help in giving a concise and
comprehensive view of the organisation’s working to the auditor. A complete flow chart would depict
the process of raising documents, personnel involved in doing so, the flow of documents through
various departments, maintenance of records, flow of goods and consideration, and dealing with
results. The internal control evaluation process becomes easier through a flow chart as a broad
picture of all the controls involved can be gauged in a glimpse.

4. Internal Control Questionnaire: This is the most widely used method for collecting information
regarding the internal control system and involves asking questions to various people at different
levels in the organisation. The questionnaire is in a pre-designed format to ensure collection of
complete and all relevant information. The questions are formed in a manner that would facilitate
obtaining full information through answers in ‘Yes’ or ‘No’, whereby the answer ‘Yes’ is satisfactory,
whereas the answers ‘No’ appear to indicate a weakness. However, not always the questionnaire is
designed to receive responses in ‘Yes-No’ format as the same may not provide adequate information.
Hence, questionnaire may receive descriptive responses also.

S.N. Basis Check List Questionnaire

i. Point of It is issued at the commencement of It can be issued at any point of time
time audit and reported back after and reported back immediately.
completion of audit
ii. Issued to To audit staff to be followed by them To various people at different levels
during audit and reported back at in the organisation
completion
iii. Contents Instructions to be followed by audit Questions to be answered by the
assistants employee of the organisation
iv. Objective It works as a guideline for audit staff This is used to collect the
so that no major issue remains information to know about the
unchecked internal control system and to
evaluate the weakness therein.

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Inherent Limitations of Internal Control System

Internal controls can provide only a reasonable assurance that objectives have been achieved. This is because,
some limitations are inherent in all internal control systems. These are as follows:

i. Breakdowns: Even well-designed internal controls can break down. Employees may misunderstand
instructions or commit mistakes. Errors may also result from application of new technology.
ii. Judgment: The effectiveness of internal controls is highly impaired when decisions are made with
human judgment under pressure.
iii. Management Override: High level personnel may be able to override prescribed policies and
procedures for personal gain or advantage.
iv. Collusion: Internal control systems may become ineffective due to collusion among employees. Several
individuals may act collectively to alter financial data or other management information in a manner
that cannot be identified by control systems.
v. Control Over Common Business Activities: Internal control system is suitable for common and
reparative business activities only.
vi. Costly System: Operating an internal control system often turns up to be very costly. If the losses
incurred on account of errors and frauds exceed the benefits of internal control system, then the system
becomes completely redundant for the entity.

Internal Check

Internal Check is an integral part of the internal control system. It is a process in which the duties of various staff
of a business are arranged in such way that work performed by one is automatically checked by the next staff
while performing his duties. As a consequence, any error or fraud committed by the previous staff is
automatically detected and corrected by the next one and thus misstatements are easily prevented.

According to The Institute of Chartered Accountant of England and Wales, London, “Internal Check System is a
system of instituting checks on the day-to-day transactions which operate continuously as part of the routine
system whereby the work of one person is proved independently or is complementary to the work of another,
the object being the prevention or early detection of errors and frauds”.

Thus, internal check or internal check system may be defined as a system of allocation of duties among the staff
of the entity in such a manner that the chances of any duplicity of work are eliminated and at the same time
work done by the previous employee is automatically checked by the next one.

Objectives of Internal Check

The objectives of internal check are as follows:

a. Lessen the possibility of fraud and error.

b. Identify fraud and error at an early stage due to independent checking.
c. Improve the efficiency of the workforce, by implementing division of labor.
d. Allocate the duties and responsibilities of each worker in a way that they can be easily identified and held
responsible for the actions performed.
e. Receive confirmation of facts and entries both physical as well as financial by way of presentation and
necessary maintenance of records.
f. Exercise moral pressure on the workforce with the implementation of a continuous receive process.
g. Reduce the workload of independent auditors by adopting an internal check system.

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Essential Characteristics of Internal Check System

Following are the essential characteristics or principles of a good internal check system.

a. Division of work: The entire task should be divided among the staff in such a way that no single person is
allowed to complete the work solely by himself from the beginning to the end.

b. Provision of check: There must be clear instruction that the work performed by any staff must be checked
by the next staff.

c. Responsibility: Responsibility of each individual must be properly defined and fixed.

d. Use of technology: As far as possible, various technology enabled devices should be used to minimise
human error.

e. Rotation of employees: A system of transfer or rotation of employees from one responsibility to another
must be followed by the business.

f. Control over employees: Generally, chances of frauds are high in case there is direct contact between staff
and the customers. So, a manager can keep eyes in those areas to make internal check system more
effective.

g. Supervision: A strict supervision should be exercised to ensure that the prescribed internal checks and
procedures are fully operative.

h. Periodical review: The system of internal check is reviewed from time to time to introduce improvements.

Advantages of Internal Check System

A good system of internal check offers many benefits as follows:

To the auditor

a. It saves time and cost of checking all records. Auditor may apply test checking approach
b. Auditor devotes more time to appraise critical areas. This improves quality of audit work

To the Client

a. It reduces chances of errors and frauds.

b. As work is distributed among the employees based on their skill the entire work process gets completed
smoothly.
c. A moral pressure can be built on the employees. So, they remain reasonably honest.
d. Final accounts are prepared promptly.

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Auditor’s Liability for Relying on the Internal Check System

Reliance on an effective internal check system and thereby streamlining the audit process enables the auditor
to devote more time in examining the critical areas of accounting including valuation of closing stock, valuation
of assets and liabilities, determining the reasonableness of provisions etc. However, such reliance
simultaneously increases the risk of the auditor. This is because, even a sound internal check system cannot
guarantee the elimination of all errors and frauds in the accounts. Hence, if the auditor relies on the internal
check system and performs test checking rather than a detail checking, he cannot escape his responsibility of
any such error or fraud remaining undetected. This was also held in the famous case law of Mc. Bride Ltd vs.
Rooke and Thomas, Canada (1941). Thus, the auditor should always keep in mind that resorting to test checking
by relying on internal check system of the organisation no way reduces the liability of the statutory auditor.

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SA 610, Using the Work of Internal Auditor

Internal Audit

Internal audit is a part of the internal control system of an organisation. Traditionally internal audit was seen as
a continuous evaluation appraisal of financial operations within a given organisational framework. However,
today it is recognised as an independent appraisal of various operating activities of the entity. Thus, an internal
auditor is not only to see that a purchase transaction has been appropriately recorded in the books of accounts
but also to see that there was a valid purchase requisition, the order was placed to the vendor who was in the
approved list of the entity, the terms were reasonable and the goods was duly received and included in the
stock.

As per the Committee of Internal Audit, formed by The Institute of Chartered Accountants of India, internal audit
is, “An independent management function, which involves a continuous and critical appraisal of the functioning
of an entity with a view to suggesting improvements thereto and add value to and strengthen overall governance
mechanism of the entity, including the entity’s risk management and internal control system.”

As per SA 610, Using the Work of Internal Auditor, internal audit is a function of an entity that performs
assurance and consulting activities designed to evaluate and improve the effectiveness of the entity’s
governance, risk management and internal control process.

Thus, internal audit is a continuous appraisal of the different operational activities of the entity, including
verification of the books of accounts, by a competent employee of the organisation, with an objective to report
on the effectiveness of operations so that governance, risk management and internal control process can be
improved further.

Scope and Objectives of the Internal Audit Function

The objectives of internal audit functions vary widely and depend on the size and structure of the entity and the
requirements of management and, where applicable, those charged with governance. The activities of the
internal audit function may include one or more of the following:

a. Monitoring of internal control: The internal audit function may be assigned specific responsibility for
reviewing controls, monitoring their operation and recommending improvements thereto.

b. Examination of financial and operating information: The internal audit function may be assigned to review
the means used to identify, measure, classify and report financial and operating information, and to make
specific inquiry into individual items, including detailed testing of transactions, balances and procedures.

c. Review of operating activities: The internal audit function may be assigned to review the economy,
efficiency and effectiveness of operating activities, including non- financial activities of an entity.

d. Review of compliance with laws and regulations: The internal audit function may be assigned to review
compliance with laws, regulations and other external requirements, and with management policies and
directives and other internal requirements.

e. Risk management: The internal audit function may assist the organisation by identifying and evaluating
significant exposures to risk and contributing to the improvement of risk management and control systems.

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f. Governance: The internal audit function may assess the governance process in its accomplishment of
objectives on ethics and values, performance management and accountability, communicating risk and
control information to appropriate areas of the organisation and effectiveness of communication among
those charged with governance, external and internal auditors, and management.

Advantages of Internal Audit

Internal audit offers a number of advantages as follows:

a. Assistance to Management: Internal audit helps management in executing various plans and policies
effectively and efficiently.

b. Detection Errors and Frauds: Through internal audit, frauds and errors can be detected easily.

c. Prevention of Errors and Frauds: By ensuring continuous evaluation, it contributes a lot in preventing the
errors and frauds.

d. Reduction in Wastage: Internal audit identifies the weaknesses and deficiencies of the organisation and
thereby helps in reducing wastages.

e. Safeguarding Assets: Internal audit ensures that proper measures are in place to safeguard the assets.

f. Increased Efficiency: It helps in improving the effectiveness of the internal control system and thereby
improves the overall efficiency of the entity.

Internal Audit in India

Section 138 of the Companies Act, 2013 read with Rule 13 of Companies (Accounts) Rules, 2014, specifies certain
classes of companies which are required to appoint Internal Auditors who shall either be a Chartered
Accountant, Cost Accountant or such other professional as may be decided by the Board to conduct internal
audit of the functions and activities of the company. The following class of companies shall be required to
appoint an internal auditor or a firm of internal auditors, namely:

(a) every listed company;

(b) every unlisted public company having-

(i) paid up share capital of fifty crore rupees or more during the preceding financial year; or

(ii) turnover of two hundred crore rupees or more during the preceding financial year; or

(iii) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred
crore rupees or more at any point of time during the preceding financial year; or

(iv) outstanding deposits of twenty-five crore rupees or more at any point of time during the preceding
financial year; and

(c) every private company having-

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(i) turnover of two hundred crore rupees or more during the preceding financial year; or

(ii) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred

crore rupees or more at any point of time during the preceding financial year.

The internal auditor may be an employee of the company. The scope, functioning, periodicity and methodology
for conducting the internal audit shall be finalised by the Audit Committee of the company or the Board in
consultation with the Internal Auditor.

Interplay between Internal Audit and Statutory Audit – Statutory Auditor’s Reliance on the Work of Internal
Auditor

As per SA 610, Using the Work of Internal Auditor, the external auditor can use the work of an internal auditor
after conducting an evaluation of internal audit functions.

Accordingly, the external auditor shall consider the following factors to determine the extent to which he can
rely on the work of an internal auditor:

I. whether internal audit is undertaken by an outside agency or by a separate audit department within the
entity.
II. the scope of internal audit, management action and the internal audit report.
III. experience and qualification of internal auditor.
IV. the technical compliance by internal auditor.
V. authority vested on internal auditor and level of management to whom he is accountable.
VI. whether professional care has been taken by the internal auditor in conducting audit work.

After the evaluation, if the external auditor is satisfied with all the above criteria and if the law doesn’t prohibit,
he can decide to rely upon the work of an internal auditor.

The external auditor, in such a case, shall discuss his plans to use direct assistance of the internal audit function
with the internal auditor. He shall carefully undergo the reports of internal audit function and obtain an
understanding of the nature and extent of the audit procedures that has been applied and the related findings.
In addition, the external auditor shall also perform sufficient and appropriate audit procedure on the body of
work of the internal audit function as a whole to determine its adequacy for purposes of the statutory audit. He
shall also inform the management about his decision to rely on the internal audit function. Additionally, the
external auditor shall obtain a written agreement from an authorized representative of the entity that the
internal auditors will be allowed to follow the external auditor’s instructions without their intervention. A
written agreement from the internal auditors shall also be obtained that they will keep confidential specific
matters as instructed by the external auditor. Moreover, the external auditor also needs to document
adequately the basis of his decision to use the work of internal auditor in an appropriate manner.

Whatever is the nature and extent of use of direct assistance from an internal auditor, an external auditor cannot
escape his liability for his opinion in the audit report. His reliance on the work of the internal auditor can, in no
way, reduce his responsibility and he will be held responsible for all damages arising out of any material
misstatement in the accounts remaining undetected because of his reliance on the work of the internal auditor.
An external auditor cannot be relieved by the law under the plea that he relied upon the work of an internal
auditor.

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Internal Control VS Internal Check VS Internal Audit

SN BASIS INTERNAL INTENAL CONTROL INTERNAL CHECK

AUDIT
1. Mode of Each component Work of one person is It operates in routine to double
checking of work is automatically checked by check every part of a transaction
checked another. at the time of occurrence and
recording of the same
2. Objective To evaluate To ensure adherence to To ensure that no one employee
internal control management policies, has exclusive control over any
system and safeguarding of assets, transaction or group of
detect frauds prevention and detection transactions and their recording in
and errors of errors and frauds, the books
accuracy and
completeness of
accounting records
3. Point of Work is checked Checking is done Methods of recording
time after it is done simultaneously with the transactions are devised where
conduct of work. work of an employee is checked
continuously by correlating it with
the work of others.
4 Thrust of To detect error To prevent errors Fixing responsibility and division
system and frauds of work to avoid duplication
5. Cost Cost is involved It is costly It does not add cost, as it is part of
involvement in addition to internal control
accounting
6. Report Auditor submits It provides for built in MIS The summary of day-to-day
report to report transactions work as report for
management the senior

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