If it is impracticable to quantify the amount, this fact should be disclosed. A change in Accounting Policies - As per AS-1, consistency is one of the fundamental accounting assumptions. Moreover, users should be able to compare the financial statements of an enterprise over a period of time in order to identify trends in its financial position, performance and cash flows. Therefore, the same accounting policies are normally adopted for similar events or transactions in each period. A change in an accounting policy should be made only if the adoption of a different accounting policy is required by status or for compliance with an accounting standard or if it is considered. That the change would result in a more appropriate presentation of the financial statements of the enterprise. Any change in an accounting policy which has a material effect should be disclosed. The impact of and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made, to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted. 5.6AUDIT DOCUMENTATION “The skill of an accountant can always be ascertained by an inspection of his working papers”. - Robert H. Montgomery A written or printed document that bears the original, official, or legal type of something and can be used to provide decisive evidence or facts is referred to as a \"document.\" The act or instance of providing information, supporting references, or records is referred to as \"documentation.\" “Audit Documentation” refers to the working papers prepared or obtained by the auditor and retained by him, in connection with the performance of the audit. Form and Content Of Audit Documentation Permanent and Current Audit Files 151 CU IDOL SELF LEARNING MATERIAL (SLM)
Any working paper files can be known as permanent audit files in the case of recurring audits, as they are updated with information that is still relevant to future audits. Current audit files, on the other hand, are mainly concerned with the audit of a particular era. Contents of Permanent Audit Files • If the commitment is recurring, a copy of the original appointment letter. • Any contact with the retiring auditor prior to accepting the appointment as auditor, if any. • A letter of authorization from the previous auditor. • Information about the entity's legal and organisational structure. IN the case of a company, this includes the Memorandum and Articles of Association. In case of partnerships- Partnership deed. In case of trusts- Trust deed. In case of societies- Certificate of registration/ Rules and Bye-laws. • The client's organisational framework. • A list of the governing body's members, including their names, addresses, and phone numbers. For example, in the case of a corporation, the list of directors, the list of partners in a partnership, and the list of trustees in a trust. • Copies of previous year's audited financial statements • Details about the sister's interests • Contact information for bankers, registrars, lawyers, and other professionals Contents of Current Audit File The current file normally includes: • Correspondence related to annual reappointment approval. • Extracts from the minutes of significant Board and General Meetings that are applicable to the audit. • Documentation of the audit and audit program's preparation process. • Transactions and balances analysis 152 CU IDOL SELF LEARNING MATERIAL (SLM)
• A log of the types, dates, and scope of auditing procedures conducted, as well as the outcomes of such procedures. • Documentation that assistants' work was supervised and checked. • Copies of correspondence with other auditors, experts, and third parties • Copies of letters or reports sent to or addressed with the client about audit matters, such as the terms of the engagement and material shortcomings in applicable internal controls. • Representation letters or approval letters from the agency. • The auditor's conclusions about important aspects of the audit, such as how exceptions and irregular issues, if any, revealed by the auditor's procedures were resolved or dealt with. • Copies of the financial data being reported on, as well as the audit reports that go with it. • Conduct an audit and highlight key points. • Internal regulation is a major flaw. 5.7AUDIT PROCEDURE Audit procedures are the systems, strategies, and methods used by auditors to obtain audit proof that allows them to reach a decision and express their opinion on the audit objective. The audit techniques or procedures used to obtain evidence inspection are mentioned below. It entails reviewing records or documents that include varying degrees of Audit Proof. Inspection of documents/assets will reveal who owns them, how much they are worth, and how reliable they are in terms of their life. Request for information Inquiry is the process of posing questions to management with the aim of receiving an answer. The aim of the investigation is to gain a clear understanding of the evidence gathered. External Reassurance 153 CU IDOL SELF LEARNING MATERIAL (SLM)
Obtaining written responses from third parties, either in tangible or electronic form, is referred to as external confirmation. Observer ship Observation is the act of watching someone else conducts a process or procedure. It offers audit information regarding the process or procedure's results. Analytical Techniques Analytical procedures are financial information analyses based on a study of possible relationships between financial and non-financial data. Analytical procedures also include the analysis of known fluctuations and relationships that contradict other related data or deviate significantly from expected numbers in relation to results The auditor's independent implementation of procedures or controls that were initially conducted as part of the entity's internal control is known as reperformance. Recalculation The term \"recalculation\" refers to the process of double-checking the mathematical accuracy of documents or records. Recalculation can be done manually or automatically. Evaluating Audit Evidence Methodologies 1. Controllability test 2. Procedure of substance Internal control is evaluated to see if it exists, if it functions correctly, if it is efficient, and if it functions reliably. It consists of substantive procedures that deal with transaction assessment. Analytical methods and transactional details testing 154 CU IDOL SELF LEARNING MATERIAL (SLM)
The test of transaction information is nothing more than vouching for and verifying financial assertions such as existence, ownership, rights, valuation, disclosure, and obligation. Existence—As of the balance sheet date, do assets exist? Ownership: Is the client the owner of the Assts in question? If the client has complete control over the assets. Whether the assets are appropriately priced is a question of valuation. Whether or not assets and liabilities have been properly disclosed Completeness—whether all aspects of assets and liabilities are properly registered. Analytical methods The term \"analytical procedures\" is described in the Standard on Auditing (SA) 520 \"Analytical Procedures\" as \"evaluations of financial information by analysis of plausible relationships among both financial and non-financial data.\" Analytical procedures also include any necessary analysis of known fluctuations or relationships that are inconsistent with other related data or with other procedures that are significantly different from expected values Analytical Procedures that take into account comparisons of the entity's financial details with include: 1. Data from previous periods that can be compared. 2 The entity's expected performance, such as budgets or projections, or the auditor's expectations, such as a depreciation estimate. 3. Similar market data, such as a measure of the entity's sales-to-accounts-due ratio to industry averages or other similar-sized businesses in the same industry. Example Explaining Analytical Procedures PARTICULARS X LTD INDUSTRY 19-20 20-21 19-20 20-21 GROSS PROFIT 27% 22.5% 31% 21.35% 155 CU IDOL SELF LEARNING MATERIAL (SLM)
RATIO 3.076:1 3.123:1 3.6726:1 DEBT EQUITY RATIO 2.67:1 Examples of Analytical Procedures-Ratio Analysis, Comparison Method, Trend Analysis etc. 5.8 SUMMARY An audit plan is a methodical, step-by-step process that allows auditors to concentrate on the most critical aspects of the audit. Steps in audit planning range from engagement planning and staffing to checking financial statements and internal processes. The audit programme consists of step-by-step guidelines for team members to follow, i.e. a list of audit procedures to be completed by team members. Vouching is the process of examining documentary documentation to verify the arithmetic accuracy of entries. Verification is a method in which an auditor inspects the documentary evidence available to satisfy himself regarding the authenticity of the assets and liabilities appearing in the Balance Sheet. The term \"verification\" refers to proving or confirming the accuracy of the assets and liabilities listed on the Balance Sheet. The words verification and vouching are not interchangeable. Vouching is used to verify information. As a result, verification is a component of vouching. The auditor's working papers, which he prepares or obtains and keeps in conjunction with the audit, are referred to as documentation. In the case of recurring audits, certain working paper files can be known as permanent audit files, which are updated on a regular basis with details that will be useful in future audits. Current audit files, on the other hand, are mainly concerned with the audit of a particular era. 5.9 KEYWORDS Audit Evidence- Documentary and other evidence used by the Auditor in arriving at conclusion 156 CU IDOL SELF LEARNING MATERIAL (SLM)
Plausible relationship- Reasonable or probable relationship 5.10 LEARNING ACTIVITY 1. Prepare an overall Audit plan to conduct Audit of a bottling plant ______________________________________________________________________________ ______________________________________________________________________________ 5.11UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. Define Audit Plan. What are the two stages involved in an Audit plan? 2. Benefits of developing Audit plan 3. Briefly explain Audit Program. 4. Define the term Vouching. 5. What are the objectives of Vouching? 6. Advantages / Importance of Vouching 7. What are the factors to be kept in mind during Vouching? 8. Define the term Verification. 9. What are the objectives of Verification? 10. List the Advantages / Importance of verification 11. State whether the following are True or False with reasons (a) The establishment of overall audit strategy and detailed audit plan are not necessarily discrete or sequential process, but are closely interrelated since changes in one may result in consequential changes to the other (b) Establishment of overall audit strategy that sets the scope, timing etc and guides the development of detailed audit plan is prerogative of the management. (c) Planning is discrete phase of an audit. (d) A detailed audit programme once prepared for a business can be used for all business under all circumstances. (e) The audit plan is more detailed than overall audit strategy. 157 CU IDOL SELF LEARNING MATERIAL (SLM)
(True: a & e ; False: b, c & d) Long Questions 1. Explain in detail about Audit Procedures in obtaining Audit Evidence 2. Explain in detail about Vouching and verification along with the differences 3. Discuss the general considerations in valuation of Assets 4. How to Vouch or verify (i) Debentures (ii) Investment in Subsidiary 5. Explain the process of verification of prior period items B. Multiple Choice Questions 1. Purchase invoice is an example of ____________. a. External Evidence/confirmation. b. Internal Evidence c. Both a and b d. None of these 2. What are analytical procedures? a. Substantive tests designed to assess control risk b. Substantive tests designed to evaluate the validity of management representation letter c. Substantive tests designed to study relationships between financial and non-financial d. All of these 3.Auditor can depend on routine checks to disclose all the mistakes or manipulation that may exist in accounts. a. True b. False c. Partly True 158 CU IDOL SELF LEARNING MATERIAL (SLM)
d. None of these 4. SA -530 Deals with ________ a. Going concern b. Overall objectives of an Independent Audit c. Sampling d. Audit report 5.SA -570 Deals with ________ a. Going concern b. Overall objectives of an Independent Audit c. Sampling d. Audit report Answers 1-a 2-c 3-b 4-c 5-a 5.12 REFERENCES Textbook: T1 ArunaJha, Auditing, Taxmann’s Publications, University Edition T2 Ravinder Kumar, Auditing: Principles and Practice :PHI Learning Pvt. Ltd Reference Books: R1 N.D Kapoor, Auditing, Sultan Chand & Sons R2 Gupta; Contemporary Auditing, Tata McGraw Hill Website: www.icai.org 159 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 6 – COMPANY AUDITOR 160 Structure 6.0 Learning Objectives 6.1Introduction 6.2 Appointment of Auditor 6.3Filling of Casual Vacancy 6.4 Rotation of Auditor 6.5 Audit Committee 6.6 Powers/Duties of Auditors 6.7Punishment for Non compliance 6.8 Summary 6.9 Keywords 6.10 Learning activity 6.11 Unit End Questions 6.12 Refrences 6.0 LEARNING OBJECTIVES After studying this unit students will be able to, Explain about the provisions of Companies Act 2013 Learn provisions relating to Filling of Casual vacancy Describe about Audit Committee Learn about Powers and Duties of Auditor Describe about Punishment for non-compliance 6.1INTRODUCTION CU IDOL SELF LEARNING MATERIAL (SLM)
Companies Act, 2013 is rule based Act. Sections 139 to 148 of the Companies Act, 2013 (hereinafter referred to as the Act unless otherwise mentioned) deal with provisions relating to audit of companiesFollowing are the sections covered in this chapter 139. Appointment of auditors. 140. Removal, resignation of auditor and giving of special notice. 141. Eligibility, qualifications and disqualifications of auditors. 142. Remuneration of auditors. 143. Powers and duties of auditors and auditing standards. 144. Auditor not to render certain services. 145. Auditors to sign audit reports, etc. 146. Auditors to attend general meeting. 147. Punishment for contravention. 6.2 APPOINTMENT OF AN AUDITOR Section 139 of the Companies Act, 2013 contains provisions regarding Appointment of Auditors. It can be categorized into a. Appointment of First Auditors b. Appointment of Subsequent Auditors Government Company A “Government business” is one in which the Central Government or any State Government or Governments owns at least 51 percent of the paid-up share capital, or partly by the Central Government and partly by one or more State Governments and involves a subsidiary company of such a Government company. Appointment of First Auditors- Government Company Section 139(7) states that the first auditor shall be appointed by the Comptroller and Auditor- General of India within 60 days of the date of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State 161 CU IDOL SELF LEARNING MATERIAL (SLM)
Government, or Governments, or partly by the Central Government and partly by one or more State Governments. If the Comptroller and Auditor-General of India fail to nominate such auditor within the above-mentioned time frame, the company's Board of Directors must do so within the next 30 days. Furthermore, if the Board fails to select such auditor within the next 30 days, it shall notify the company's shareholders, who shall appoint such auditor at an extraordinary general meeting within 60 days. Auditors will serve until the end of the first annual general meeting. Appointment of First Auditors- Non-Government Company The first auditor of a corporation, other than a government company, must be named by the Board of Directors within 30 days of the company's registration date, according to Section 139(6). In the event that the Board fails to select an auditor, the company's representatives will be notified. An extraordinary general meeting of the company's shareholders must select the auditor within 90 days. The appointed auditor will serve until the end of the first annual general meeting. Appointment of Subsequent Auditors in case of Non-Government Company According to Section 139(1) of the Companies Act of 2013, every company must nominate an auditor at its first annual general meeting, who will serve from the end of that meeting until the conclusion of its sixth annual general meeting, and thereafter until the conclusion of every sixth meeting. In this regard, the following points should be taken into consideration: 1. The auditor's written consent to such appointment, as well as a certificate from him or her that the appointment, if made, would be in compliance with the conditions as may be required, must be obtained before such appointment is made. 2. The said certificate shall state the following, in accordance with Rule 4 of The Companies (Audit and Auditors) Rules, 2014: (a) the person or firm, as the case may be, is eligible for appointment and is not disqualified for appointment under the Act, the Chartered Accountants Act, 1949, and the rules or regulations made thereunder; (b) the proposed appointment is for the term provided by the Act; (c) the proposed appointment is within the limits set out by or under the authority of the Act; (d) the lis is valid; 162 CU IDOL SELF LEARNING MATERIAL (SLM)
3. Within 15 days of the meeting at which the auditor is named, the corporation must notify the auditor concerned of his or her appointment and file a notice of such appointment with the Registrar. Appointment of Subsequent Auditors in case of Government Companies According to section 139(5), the Comptroller and Auditor-General of India shall appoint an auditor duly qualified to be an auditor 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, for a financial year. As a result, it is important to understand that in the case of government companies or companies regulated by the government, an auditor is appointed by the Comptroller and Auditor General of India in accordance with Sections 139(5) and 139(6) of the Companies Act, 1956. (7). It is important to note that the Comptroller and Auditor General of India is an autonomous statutory authority that audits all receipts and expenditures of the Indian government and state governments, as well as those of bodies and companies funded by the government. 6.3 FILLING OF A CASUAL VACANCY As per Section 139(8), any casual vacancy in the office of an auditor shall- • Be filled by the Board of Directors within 30 days in the case of a corporation other than one whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor General of India. If the casual vacancy arises as a result of an auditor's resignation, the corporation must accept the appointment at a general meeting held within three months of the Board's recommendation, and he must serve until the end of the next annual general meeting. • Be filled by the Comptroller and Auditor-General of India within 30 days in the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India. It should be noted that if the Comptroller and Auditor-General of India does not fill the vacancy within the specified time frame, the Board of Directors will do so within the next 30 days. Casual Vacancy by Resignation: 163 CU IDOL SELF LEARNING MATERIAL (SLM)
According to section 140(2) of the Act, an auditor who has resigned from the company must file a statement in the prescribed Form ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar within 30 days of the date of resignation. The auditor, along with the company and the Registrar, must file such a statement with the CAG in the case of the companies referred to in section 139(5), i.e. Government companies. The auditor must state the reasons for his resignation, as well as any other relevant information. Figure 6.1 Filling of casual vacancy Source: Institute of Chartered Accountants of India In the event of a loss, the auditor is liable to a liability of fifty thousand rupees or the auditor's remuneration, whichever less is, and a further penalty of five hundred rupees for each day after the first during which the failure continues, up to a limit of five lakh rupees under section 140. (3). Other Important Provisions About Auditors' Appointment 1. At an annual general meeting, a retiring auditor can be re-appointed. Assuming- (a) He is not ineligible to be re-appointed. (b) He has not given the company written notice that he does not want to be re-appointed; and (c) At that meeting, no special resolution was passed naming a new auditor or specifically stating that he would not be reappointed. 164 CU IDOL SELF LEARNING MATERIAL (SLM)
2. If no auditor is appointed or re-appointed at the annual general meeting, the current auditor will continue to be the company's auditor. 6.4APPLICABILITY OF SECTION 139(2) ROTATION OF AUDITOR: As per rules prescribed in Companies (Audit and Auditors) Rules, 2014, for applicability of section 139(2) the class of companies shall mean the following classes of companies excluding one person companies and small companies- 1. All unlisted public companies with a paid-up share capital of rupees ten crore or more; 2. All private limited companies with a paid-up share capital of rupees fifty crore or more; 3. All companies with a paid-up share capital of rupees fifty crore or more but public borrowings from financial institutions, banks, or public deposits of rupees fifty crore or more As per section 139(2), no listed company or a company belonging to such class or classes of companies as mentioned above, shall appoint or re-appoint- (a) a person serving as auditor for more than one five-year term; and (b) an audit company serving as auditor for more than two five-year terms. (i)An individual auditor who has finished his term under clause (a) is not qualified for re- appointment as an auditor in the same company for a period of five years after his term has ended; (ii) An audit firm that has finished its term under clause (b) is not available for re-appointment as auditor in the same business for a period of five years after the term has ended. On the expiration of their term, companies rotate their auditors in the following manner: Rule 6 of the Companies (Audit and Auditors) Rules, 2014 specifies the procedure for rotating auditors when their term expires, as follows: (1) When the incumbent auditor's term expires, the Audit Committee shall recommend to the Board the name of an individual auditor or an audit firm to replace him or her. 165 CU IDOL SELF LEARNING MATERIAL (SLM)
(2) If a corporation is required to form an Audit Committee, the Board shall consider the committee's recommendation, and in other situations, the Board shall consider the issue of auditor rotation and make a recommendation to the members at the annual general meeting for the selection of the next auditor. (3) For the purpose of auditing rotation- (i) In the case of an auditor (whether a person or an audit company), the time in which the individual or firm served as auditor prior to the Act's enactment shall be taken into consideration when measuring the period of five or ten years, as the case may be; (ii) If the incoming auditor or audit firm is affiliated with the outgoing auditor or audit firm via the same network of audit firms, the incoming auditor or audit firm is not eligible. Explanation I - For the purposes of these regulations, the term \"same network\" refers to companies that have operated or will operate under the same brand name, trade name, or common control in the past or in the future. Explanation II - In order to ensure that auditors rotate, (a) A break in the term for a continuous span of five years is considered to satisfy the rotation criterion. (b) If a partner in charge of an accounting firm that also certifies the company's financial statements retires from the firm and joins another firm of chartered accountants, the firm may be ineligible to be appointed for a period of five years. (4) When a company appoints two or more individuals or firms as joint auditors, the company may obey the auditor rotation in such a way that both or all of the joint auditors, as the case may be, do not complete their term in the same year. 6.5 PROVISIONS RELATING TO AUDIT COMMITTEE Applicability of section 177 i.e. Constitution of Audit Committee: 166 CU IDOL SELF LEARNING MATERIAL (SLM)
When a corporation is required to form an Audit Committee under section 177, all appointments, including the filling of a casual vacancy of an auditor, must be made after the committee's recommendations have been considered. According to Section 177 of the Companies Act, the audit committee has many responsibilities, including recommending the selection, remuneration, and terms of appointment of the company's auditor, evaluating and controlling the auditor's independence, results, and effectiveness of the audit process, and examining financial statements and the auditor's report thereon. It is important to note that the audit committee is made up of the company's executives. It has a minimum of three directors, with independent directors constituting the rest. Aside from that, the audit committee has other relevant responsibilities. The audit committee contributes to higher corporate governance standards. It's important to note that, in addition to listed public companies, the following types of companies must have an Audit Committee: (i) All public companies with a paid-up capital of ten crore rupees or more; (ii) All public companies with a turnover of one hundred crore rupees or more; and (iii) All public companies with outstanding loans, borrowings, debentures, or deposits in aggregate. Explanation: For the purposes of this provision, the paid-up share capital, turnover, unpaid loans, borrowings, debentures, or deposits, as applicable, as of the date of the most recent audited Financial Statements shall be taken into account. Selection and appointment of auditors: method and process The following method and process for selecting and appointing auditors is prescribed by Rule 3 of CAAR, 2014: (1) In the case of a company that is required to form an Audit Committee under section 177, the committee, and in the absence of such a committee, the Board, shall consider the qualifications and experience of the individual or firm proposed for appointment as auditor, as well as whether such qualifications and experience are commensurate with the position. It should be noted that the Audit Committee or the Board, as the case may be, will consider any order or pending action relating to professional matters of conduct against the proposed auditor before the Institute of 167 CU IDOL SELF LEARNING MATERIAL (SLM)
Chartered Accountants of India, any competent authority, or any Court while making their decision. (2) The Audit Committee or the Board, depending on the situation, can request additional information from the proposed auditor. (3) Where a corporation is required to form an Audit Committee, the committee shall recommend the name of a person or a firm as auditor to the Board for consideration, and in other situations, the Board shall consider and recommend an individual or a firm as auditor to the members in the annual general meeting for appointment, subject to the provisions of sub-rule (1). (4) If the Board agrees with the Audit Committee's recommendation, it may also recommend to the members at the annual general meeting the appointment of a person or a firm as auditor. (5) If the Board disagrees with the recommendation of the Audit Committee, it shall refer back the recommendation to the committee for reconsideration citing reasons for such disagreement. (6) If the Audit Committee, after considering the reasons given by the Board, decides not to reconsider its original recommendation, the Board shall record reasons for its disagreement with the committee and send its own recommendation for consideration of the members in the annual general meeting; and if the Board agrees with the recommendations of the Audit Committee, it shall place the matter for consideration by members in the annual general meeting. (7) The auditor appointed in the annual general meeting shall hold office from the conclusion of that meeting till the conclusion of the sixth annual general meeting, with the meeting wherein such appointment has been made being counted as the first meeting. 6.6 POWERS/RIGHTS OF AUDITORS During an audit, the auditor has the following powers and rights: (a) Right of access to books, etc. – Section 143(1) of the Act states that the auditor of a company has a right of access to the company's books of account and vouchers at all times, whether kept at the company's registered office or elsewhere, and that he is entitled to demand from the company's officers such information and explanation as he deems necessary. 168 CU IDOL SELF LEARNING MATERIAL (SLM)
It's worth noting that the word \"officer\" is described in section 2(59) of the Act as \"any director, manager, or key managerial staff, or any person in whose direction or orders the Board of Directors or any one or more of the directors is or is accustomed to act.\" Both documents that have or are likely to have some effect on the accounts are included in the term \"books, accounts, and vouchers,\" whether they are the ordinary financial books or the legislative or statistical books; memoranda books, such as inventory books, costing records, and the like, may also be reviewed by the auditor. Similarly, the word \"voucher\" refers to any and all correspondence that can be used to vouch for the authenticity of the accounts in any way. As a result, the right to access is not limited to books of account, and it is up to the auditor to decide which records or documents are required for the audit. The right of access does not apply only to books and documents kept at the registered or head office; for example, if a business has branches, the right of access also applies to branch records if the auditor believes it is appropriate to have access to them under Section143 (8). (b) Right to obtain information and explanation from officers - The auditor's right to obtain from the company's officers whatever information and explanations he deems appropriate for the performance of his duties as auditor is a broad and powerful one. Without such authority, the auditor would be unable to obtain information about the sum obtained by the directors, etc. from any other entity, corporation, or individual, as well as any benefits in kind received by the directors from the company, which would not be apparent from a review of the books. It is up to the auditor to determine which matters require additional details and explanations. When the auditor is refused access to books or documents that he requires, his only recourse is to advise the members that he was unable to obtain all of the information and explanations he needed or found essential for the performance of his duties as auditors. (c) Right to receive notices and to attend general meeting – The auditors of a company have the right to attend every general meeting of the company (not only those where the audited accounts will be discussed); to receive all notices and other communications relating to the general meetings that members are entitled to receive; and to be heard at any general meeting in any part of the meeting's business which concerns them as auditors The right and responsibility of the auditor was discussed in Section 146 of the Companies Act of 2013. “All notices of, and other communications relating to, any general meeting shall be 169 CU IDOL SELF LEARNING MATERIAL (SLM)
forwarded to the auditor of the company, and the auditor shall, unless otherwise exempted by the company, attend any general meeting either by himself or by his authorised representative, who shall also be qualified to be an auditor, and shall have right to be heard at such meeting, unless otherwise exempted by the company.” Thus, the auditor has the right to obtain notifications and other correspondence relating to any general meeting, as well as the right to be heard at such meetings, relating to the matter of his concern; moreover, it is the auditor's responsibility to attend such meetings, either personally or through his appointed representative, unless otherwise exempted. (d) Right to report to the members of the company on the accounts examined by him – 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 to be laid before the company in general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made there under or under any order made under this section and 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 and such other matters as may be prescribed. (e) Right to Lien – In terms of the general principles of law, any person having the lawful possession of somebody else’s property, on which he has worked, may retain the property for non-payment of his dues on account of the work done on the property. On this premise, auditor can exercise lien on books and documents placed at his possession by the client for non-payment of fees, for work done on the books and documents. The Institute of Chartered Accountants in England and Wales has expressed a similar view on the following conditions: (i) Documents retained must belong to the client who owes the money. (ii) Documents must have come into possession of the auditor on the authority of the client. They must not have been received through irregular or illegal means. In case of a company client, they must be received on the authority of the Board of Directors. 170 CU IDOL SELF LEARNING MATERIAL (SLM)
(iii) The auditor can retain the documents only if he has done work on the documents assigned to him. (iv) Such of the documents can be retained which are connected with the work on which fees have not been paid. Duties of Auditors Sections 143 of the Companies Act, 2013 specifies the duties of an auditor of a company in a quite comprehensive manner. It is noteworthy that scope of duties of an auditor has generally been extending over all these years. (1) Duty of Auditor to Inquire on certain matters: Under provisions of section 143(1), it is the duty of 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. where the company not being 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. The opinion of the Research Committee of the Institute of Chartered Accountants of India on section 143(1) is reproduced below: “The auditor is not required to report on the matters specified in sub-section (1) unless he has any special comments to make on any of the items referred to therein. If he is satisfied as a result of the inquiries, he has no further duty to report 171 CU IDOL SELF LEARNING MATERIAL (SLM)
that he is so satisfied. In such a case, the content of the Auditor’s Report will remain exactly the same as the auditor has to inquire and apply his mind to the information elicited by the enquiry, in deciding whether or not any reference needs to be made in his report. In our opinion, it is in this light that the auditor has to consider his duties under section 143(1).” Duty to report: Under provisions of 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 to be laid before the company in general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made thereunder or under any order made under subsection (11). Further, auditor has to report whether to 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 and following matters as prescribed under relevant rules:- (a) Whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement. (b) 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; (c) Whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company. As per section 143(3), the auditor’s report shall also 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. 172 CU IDOL SELF LEARNING MATERIAL (SLM)
(b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books 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 under sub- section (8) by a person other than the company’s auditors has been sent to him under the proviso to that sub-section 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 sub- section (2) of the 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; However, it may be noted that the reporting requirement on adequacy of internal financial controls (IFCs) with reference to financial statements shall not be applicable to a private company which is a– (i) One person company; or (ii) Small company; or (iii) Company having turnover less than ` 50 crore as per latest audited financial statement and having aggregate borrowings from banks or financial institutions or anybody corporate at any point of time during the financial year less than ` 25 crore. (j) Such other matters as may be prescribed. Rule 11 of the Companies (Audit and Auditors) Rules, 2014 prescribes the other matters to be included in auditor’s report. The auditor’s report shall also include their 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. 173 CU IDOL SELF LEARNING MATERIAL (SLM)
(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) Whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund (IEPF) by the company. Further, in case of government companies and companies controlled by government, the Comptroller and auditor general of India shall direct the auditor of such companies the manner in which accounts of such companies are required to be audited. The copy of such report shall be submitted to the Comptroller and auditor general of India. It is to be further noted that Comptroller and auditor general of India has a right to conduct supplementary audit of financial statements of such companies within 60 days of receipt of audit report. Duty to Sign the Audit Report: As per section 145 of the Companies Act, 2013, the person appointed as an auditor of the company shall sign the auditor's report or sign or certify any other document of the company, in accordance with the provisions of section 141(2). Section 141(2) of the Companies Act, 2013 states that 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. The qualifications, observations or comments on financial transactions or matters, 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. Duty to comply with Auditing Standards: As per section 143(9) of the Companies Act, 2013, every auditor shall comply with the auditing standards. Further, as per section 143(10) of the Act, the Central Government may prescribe the standards of auditing as recommended by the Institute of Chartered Accountants of India, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority. (5) Duty to report on frauds: A. Reporting to the Central Government- As per section 143(12) of the Companies Act, 2013 read with Rule 13 of the Companies (Audit and Auditors) Rules, 2014, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ` 1 crore or 174 CU IDOL SELF LEARNING MATERIAL (SLM)
above, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as prescribed B. Reporting to the Audit Committee or Board- In case of a fraud involving lesser than the specified amount [i.e. less than Rs.1 crore], the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as prescribed. C. Disclosure in the Board's Report: The companies, whose auditors have reported frauds under this sub-section (12) to the audit committee or the Board, but not reported to the Central Government, shall disclose the details about such frauds in the Board's report in such manner as prescribed. Sub-section (13) of section 143 of the Companies Act, 2013 safeguards the act of fraud reporting by the auditor if it is done in good faith. It states that no duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reason of his reporting the matter above if it is done in good faith. It is very important to note that the provisions regarding fraud reporting shall also apply, mutatis mutandis, to a cost auditor and a secretarial auditor during the performance of his duties under section 148 and section 204 respectively. If any auditor, cost accountant or company secretary in practice do not comply with the provisions of sub-section (12) of section 143, he shall be punishable with fine which shall not be less than ` 1 lakh but which may extend to ` 25 lakh. Besides, auditor has also to report matters pertaining to fraud at point (xi) of paragraph 3 of CARO,2020 which is discussed subsequently. (6)Duty to report on any other matter specified by Central Government: The Central Government may, in consultation with the National Financial Reporting Authority (NFRA), by general or special order, direct, in respect of such class or description of companies, as may be specified in the order, that the auditor's report shall also include a statement on such matters as may be specified therein. However, as per the notification dated 29.03.2016, till the time NFRA is constituted, the Central Government may hold consultation required under this sub-section with the Committee chaired by an officer of the rank of Joint Secretary or equivalent in the MCA and the Committee shall have the representatives from the ICAI and Industry Chambers and also 175 CU IDOL SELF LEARNING MATERIAL (SLM)
special invitees from the National Advisory Committee on Accounting Standards (NACAS) and the office of the C&AG. (7) Duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor are discussed separately in the chapter under heading 13 branch audit. (8) Duty to state the reason for qualification or negative report: As per section 143(4), where any of the matters required to be included in the audit report is answered in the negative or with a qualification, the report shall state the reasons there for 6.7 PUNISHMENT FOR NON-COMPLIANCE Section 147 of the Companies Act, 2013 prescribes following punishments for contravention: (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 imprisonment for a term which may extend to one year or with fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees, or with both. (2) If an auditor of a company contravenes any of the provisions of section 139 section 143, 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. It may be noted 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- (i) refund the remuneration received by him to the company; (ii) 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. 176 CU IDOL SELF LEARNING MATERIAL (SLM)
(4) The Central Government shall, by notification, specify any statutory body or authority of 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 the 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 an 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. It may be noted that in case of criminal liability of an audit firm, in respect of liability other than fine, the concerned partner(s), who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud shall only be liable. 6.8 SUMMARY 139(1) 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 6th annual general meeting and thereafter till the conclusion of every 6th meeting and the manner and procedure of selection of auditors by the members of the company at such meeting shall be such as may be prescribed: Provided further that 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 may be prescribed, shall be obtained from the auditor: Provided also that the certificate shall also indicate whether the auditor satisfies the criteria provided in section 141 Provided also that the company shall, inform the auditor concerned of his or its appointment, and also file a notice of such appointment with the Registrar within 15 days of the meeting in which the auditor is appointed. Explanation: For the purposes of this Chapter, “appointment” includes reappointment. 177 CU IDOL SELF LEARNING MATERIAL (SLM)
(2) No listed company or a company belonging to such class or classes of companies as may be prescribed shall appoint or re-appoint: (a) An individual as auditor for more than one term of 5 consecutive years; and (b) An audit firm as auditor for more than two terms of 5 consecutive years: Provided that: (i) An individual auditor who has completed his term under 139(2)(a) shall not be eligible for re- appointment as auditor in the same company for 5 years from the completion of his term. (ii) An audit firm which has completed its term under 139(2)(b), shall not be eligible for re- appointment as auditor in the same company for 5 years from the completion of such term: Provided further that as 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 5 years: Provided also that every company, existing on or before the commencement of this Act which is required to comply with the provisions of this sub-section, shall comply with requirements of this section 139(2) within a period which shall not be later than the date of the first annual general meeting of the company held, within the period specified under section 139(1) of section 96, after 3 years from the date of commencement of this Act. Provided also that, nothing contained in this sub-section shall prejudice the right of the company to remove an auditor or the right of the auditor to resign from such office of the company (3) Subject to the provisions of this Act, members of a company may resolve to provide that: (a) 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 (b) The audit shall be conducted by more than one auditor. (4) The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors in pursuance of section 139(2). Explanation: For the purposes of this Chapter, the word “firm” shall include a limited liability partnership incorporated under the Limited Liability Partnership Act, 2008. 178 CU IDOL SELF LEARNING MATERIAL (SLM)
(5) Notwithstanding anything contained in section 139(1), 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 CAG 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, who shall hold office till the conclusion of the annual general meeting. (6) Notwithstanding anything contained in section 139(1), the first auditor of a company, other than a Government company, shall be appointed by the Board of Directors within 30 days from the date of registration of the company and in the case of failure of the Board to appoint such auditor, it shall inform the members of the company, who shall within 90 days at an extraordinary general meeting appoint such auditor and such auditor shall hold office till the conclusion of the first annual general meeting. (7) Notwithstanding anything contained in section 139(1) or (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 first auditor shall be appointed by the CAG of India within 60 days from the date of registration of the company and in case the CAG of India does not appoint such auditor within the said period, the Board of Directors of the company shall appoint such auditor within the next 30 days; and in the case of failure of the Board to appoint such auditor within the next 30 days, it shall inform the members of the company who shall appoint such auditor within the sixty days at an egm, who shall hold office till the conclusion of the 1st annual general meeting. (8) Any casual vacancy in the office of an auditor shall: (i) in the case of a company other than a company whose accounts are subject to audit by an auditor appointed by the CAG of India, be filled by the Board of Directors within 30 days, but 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 3 months of the 179 CU IDOL SELF LEARNING MATERIAL (SLM)
recommendation of the Board and he shall hold the office till the conclusion of the next annual general meeting. (ii) In the case of a company whose accounts are subject to audit by an auditor appointed by the CAG of India, be filled by the CAG of India within 30 days: Provided that in case the CAG of India does not fill the vacancy within the said period, the Board of Directors shall fill the vacancy within next 30 days. (9) Subject to the provisions of section 139(1) and the rules made thereunder, 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) 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) 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. 6.9 KEYWORDS CAG-Comptroller and Auditor General IEPF-Investor Education and protection Fund NFRA- National Financial Reporting Authority EGM- Extraordinary general meeting 6.10 LEARNING ACTIVITY 1. Can more than one Auditor or Audit Firm be appointed as Auditor of a company? ______________________________________________________________________________ ______________________________________________________________________________ 180 CU IDOL SELF LEARNING MATERIAL (SLM)
6.11 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. Mr.X who was the Auditor of X Ltd. resigns after 2 months owing to ill health, State how the new Auditor is to be appointed for XLtd 2. List out the Duties of Auditor as mentioned in companies Act 2013 3. Define the term “Government Company” as mentioned in Companies Act 2013 4. Describe the steps for Appointment of First Auditor in case of a Government Company 5. The First Auditor of XYZ ltd a Government company was appointed by board of directors. Comment Long Questions 1. Explain in detail about Appointment of an Auditor of a company 2. Explain the provisions of Sec 143(1) of Companies Act 2013 3. Explain in detail the rights of an Auditor as given in companies Act 2013 4. Explain about Auditor’s duty to report on Fraud. 5. Discuss provisions relating to Rotation of Auditors. B. Multiple Choice Questions 1. The Auditor is duty bound to report on fraud to Central Governmentif amount of fraud exceeds a. 1 crore b. 50 Lakhs c. 25 Lakhs d. None of these 181 CU IDOL SELF LEARNING MATERIAL (SLM)
2. An individual cannot be appointed as an Auditor for a period of more than ___________ a. 5 years b. 10 years c. 12 years d. None of these 3. Who appoints the Auditor of a Government company in case C&AG fails to appoint? a. Share Holders b. Central Government c. Board of Directors d. None of these 4. In case of resignation of existing Auditor who appoints the Auditor in case of a Government Company? a. Share Holder b. Board of Directors c. Central Government d. None of these 5.IEPF stands for 182 a. Investor Education and Protection Fund b. Internal Education and policy Fund c. Both a and b d. None of these Answers 1-a 2-a 3-c 4-b 5-a 6.12REFERENCES CU IDOL SELF LEARNING MATERIAL (SLM)
Textbook: T1 ArunaJha, Auditing, Taxmann’s Publications, University Edition T2 Ravinder Kumar, Auditing: Principles and Practice :PHI Learning Pvt. Ltd Reference Books: R1 N.D Kapoor, Auditing, Sultan Chand & Sons R2 Gupta; Contemporary Auditing, Tata McGraw Hill Website: www.icai.org 183 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 7 – DIVISIBLE PROFITS AND DIVIDEND 184 Structure 7.0 Learning Objectives 7.1 Introduction 7.2 Concept of Profit 7.3 Difficulties in determination of Profit 7.4 Difference between business profit and capital profit 7.5 Consequences of Incorrect determination of profit 7.6 Importance of proper ascertainment of profits 7.7 Concept of divisible profit 7.8 Dividend equalisation reserve 7.9 Auditors’ duties regarding divisible profit 7.10Difference between interim dividend and dividend 7.11Summary 7.12 Keywords 7.13 Learning activity 7.14 Unit end questions 7.15 References 7.0LEARNING OBJECTIVES After studying this unit students will be able to State the meaning of the term profit Analyse difficulty in determination of profit Explain difference between business profit and capital profit State the term interim dividend 7.1INTRODUCTION CU IDOL SELF LEARNING MATERIAL (SLM)
Meaning of Profit What exactly do you mean when you say \"profit\"? It is common knowledge that the primary goal of any business concern is to make a profit. Benefit determination is critical since a company's true profits influence not only its assets but also the income tax authorities, as well as the managers, executives, and shareholders who are paying a percentage of the net profit. But, what exactly is profit? This is a difficult question to address. Since various people, governments, and courts have described benefit in different ways: There are the following: “Generally speaking, the benefit of a company over a given period is the excess of profits over expenditure for the period,” according to some authors. “It is the excess of assets over liabilities and resources between the two periods,” according to others. Lord Herschel in Gresham was the subject of another case decision in 1892. 1892, Life Assurance Culture vs. Types. “Profits are calculated by subtracting the cost of receiving revenue from the income earned.” “Profits means profits realised,” said the Union Bank of Allahabad in 1925. Following the preceding discussion, it is clear that profit is defined as the difference between total expenditures and total revenue. 7.2 THE CONCEPT OFTHE PROFIT The issue of benefit calculation is extremely important. Its outcome has an effect on a variety of people from various walks of life, including business owners, tax officials, shareholders, and executives. As a result, it is a critical component in assessing a company's correct benefit. The term \"benefit\" has been described in a variety of ways by experts in the field. (1) In general, the profit of a company over a given period is the surplus over the period's expenditure. (2) that is the difference in assets and liabilities, as well as capital, between the two periods. 7.3DIFFICULTIES IN THE DETERMINATION OF PROFITS The following are some of the most common problems that arise when determining profit: (1) How should the assets be valued at the end of the period? (2) What method should be used to value the liabilities? (3) Is it necessary to write off previous losses? 185 CU IDOL SELF LEARNING MATERIAL (SLM)
(4) Is it appropriate to have such reserves, special arrangements for depreciation, and so on? (5) The issue of whether capital expenditures should be viewed as income expenditures or vice versa should be carefully considered. (6) Costs from which a profit may be obtained in a subsequent accounting period should be carefully considered. What is the difference between company benefit and sales profit? Company or sales benefit is a daily profit from day-to-day operations after deducting current expenses and depreciation of existing assets. Capital benefit, on the other hand, is an erratic profit derived from capital transactions such as the sale of capital assets, the forfeiture of bonds, the redemption of debentures, and so on. 7.4DIFFERENCES BETWEEN BUSINESS PROFIT AND CAPITAL PROFIT: • Nature: Business profit is the profit generated by a company's regular operations. Capital benefit, on the other hand, is the profit gained from a capital purchase. • Dividends: Profits from the company can be paid to shareholders as a dividend. However, from a corporate perspective, capital profit cannot be allocated as a dividend. • Application: In some situations, a company's benefit may be used as a reserve. Capital gains, on the other hand, can be used to fund business growth and meet contingent liabilities. • Determination: The income involved account or profit and loss account is used to calculate business profit. Capital benefit, on the other hand, is obtained from various accounts. • Trading concern: Profit from a business is profit from trading. Capital profit, on the other hand, is not the same as trading profit. • Recurrence: Benefit in business happens regularly. Capital benefit, on the other hand, is not recurring. 7.5CONSEQUENCES OF INCORRECT DETERMINATION OF PROFIT If the benefit is not calculated correctly, the following will happen: 186 CU IDOL SELF LEARNING MATERIAL (SLM)
(1) Benefit understatement can result in the following disadvantages: (a) Decreasing the market's value. (b) Refusing to pay dividends to shareholders who are entitled to them. (c) Reducing the manager's profit-sharing commission. (2) Benefit overstatement can result in the following: (a) Capital distribution in the form of a dividend. (b) Managing agents are paid a percentage of profits over the entitlement. (3) Misrepresentation of the balance sheet would arise from overvaluation or undervaluation of assets and liabilities. 7.6 IMPORTANCE OF PROPER ASCERTAINMENT OF PROFITS Since other parties are uninterested in the profits of businesses owned by individuals and associates, the proprietors are free to determine their profits in any way they see fit. The situation with limited companies, on the other hand, is very different. Other people who are involved in this benefit include prospective shareholders, debenture holders, creditors, staff, and others. As a result, it is critical that the company's profit be accurately determined, failing which the following parties would be affected: (1) If earnings are understated, current owners would be deprived of dividends to which they are entitled. Furthermore, the stock's market value is decreasing. (2) An overstatement of profits can result in an incorrect dividend payment. (3) Dividends can be paid out as a result of a benefit overstatement. As a result, dividends may be paid from the company's capital, and the company may become insolvent and eventually liquidate. (4) An overstatement of profits could result in higher remuneration for managing agents, resulting in a corresponding loss for the company. 7.7CONCEPT OF DIVISIBLE PROFIT 187 CU IDOL SELF LEARNING MATERIAL (SLM)
All profits that can be lawfully allocated to the company's shareholders are referred to as \"divisible benefit.\" According to Section 123 (1) of the Companies Act, 2013, no dividend should be declared or paid by a company for any financial year unless: (a) it is paid out of the profits of the company for that financial year after depreciation is taken into account in accordance with Section 123(2), or (b) it is paid out of the profits of the company for that financial year after depreciation is taken into account in accordance with Section 123(3). (b) From income from previous financial years, after depreciation has been taken into account in compliance with the terms of that subsection and the profits have remained undistributed; or (c) A combination of the two. (d) From funds provided by the Central Government or any State Government for the payment of dividends by the Company in accordance with any guarantee given by that government; provided, however, that no dividend should be declared or paid from a company's reserves other than free reserves. In the event of inadequacy or absence of profits in any year, a company may declare dividend out of the accumulated profits earned in previous years and transferred to the reserves for the purposes of the second proviso to sub-section (1) of section 123, subject to the fulfilment of the following conditions as per the Companies (Declaration and Payment of Dividend) Rules, 2014. (1) The dividend rate declared does not exceed the average of the dividend rates declared by the company in the three years immediately preceding that year: given, however, that this sub-rule does not apply to a company that has not declared any dividend in each of the three preceding financial years. (2) The gross amount to be drawn from such cumulative earnings should not be more than one- tenth of the balance of the company's paid-up share capital and free reserves as shown in the most recent audited financial statement. (3) Before any dividend in respect of equity shares is declared, the sum so drawn should be used to offset losses incurred in the financial year in which the dividend is declared. 188 CU IDOL SELF LEARNING MATERIAL (SLM)
(4) The reserve balance after such withdrawal should not be less than 15% of the paid-up share capital as shown in the most recent audited financial statement. (5) No company should declare a dividend unless carried over previous losses and depreciation not provided in the previous year are set off against the profit of the current year, or the loss or depreciation, whichever is less, in previous years is set off against the profit of the current year, or the loss or depreciation, whichever is less, in previous years is set off against the profit of the company for the year for which dividend is declared or charged. I Move to the Reserves As per section 123 (1) of the Companies Act, 2013, the Board of Directors are free to appropriate a portion of the income to the credit of a reserve or reserves. No dividends shall be declared or paid by a company for any financial year from profits derived from the sale or disposal of any immovable property or capital assets comprised in the undertaking or any of the undertakings of the company, unless the company's business consists, wholly or partly, of selling and purchasing any such property or assets, except a company's own property or assets. The method by which the company's profit is determined is not specified in the company law. It also doesn't specify how much benefit should be paid as dividends. The question then becomes: What are the guiding criteria to be used in deciding whether or not a benefit is eligible for dividend distribution? The following guiding principles must be remembered at all times: (1) A dividend cannot be paid out of the money in any conditions. (2) The provisions of the company's memorandum and articles of association must be faithfully followed in all cases. Dividends would be deemed to have been paid out of earnings in the following cases: (a) If any revenue-related expenditure is unfairly charged to capital in order to inflate the company's profit. (b) If a company paid a dividend despite the fact that the profit and loss account shows a loss and there are no other income that have not been allocated. If a business distributes the proceeds of the sale of one of its fixed assets. 189 CU IDOL SELF LEARNING MATERIAL (SLM)
The following are the reasons why the company law forbids the payment of dividends from the capital: (i) The payment of a dividend from the capital constitutes a voluntary reduction of capital without the Court's approval. (ii) It is unconstitutional, since it is ultra quires the Ordinance, to pay a dividend out of capital unless the memorandum or articles of association allow it. An important factor to consider when calculating divisible benefit. Some considerations must be considered when calculating divisible benefit. Transfer to Reserves I As per section 123 (1) of the Companies Act, 2013, the Board of Directors are free to appropriate a portion of the income to the credit of a reserve or reserves. II A legal appropriation of a portion of benefit is often made. (a) For example, under the Banking Regulation Act, a certain amount of a bank's earnings must be transferred to the General Reserve before a dividend can be paid out. (b) A transfer of a portion of profit to a reserve is also required where the corporation agreed, at the time of loan raising, that until any part of its profit is allocated, a certain percentage of the profit should be credited to a reserve for loan repayment every year, and the balance should remain invested in a specified manner until the time for repayment arrives. III (b) Apart from the above appropriations, it may also be important to account for losses and depreciation arrears, as well as to exclude capital profit, as previously stated, in order to arrive at the sum of divisible profit. Dividend Declaration According to Section 123 of the Companies Act, 2013, a company's Board of Directors may declare dividends, including interim dividends, out of the profit and loss account surplus and income of the financial year in which such interim dividend is sought to be declared: If the company has incurred a loss during the current financial year up to the end of the quarter immediately preceding the date of interim dividend declaration, such interim dividend should not be declared at a rate higher than the company's average dividends declared during the previous three financial years. Within five days of the date of declaration of the dividend, including interim dividends, the balance of the dividend should be deposited in a scheduled bank in a separate account. A business should not pay a dividend in 190 CU IDOL SELF LEARNING MATERIAL (SLM)
respect of any of its shares to someone other than the registered shareholder, his order, or his banker, and it should not be paid in cash: Provided, however, that nothing in Section 123 should be construed as prohibiting a company from capitalising its income or assets for the purpose of offering fully paid-up bonus shares or paying up any unpaid sum on any shares owned by its members: Furthermore, any dividend payable in cash can be paid to the shareholder entitled to the dividend by check, warrant, or by other electronic means. Preference share dividend (a) Before any dividend is declared on equity shares, holders of preference shares are entitled to a fixed rate dividend. (b) However, such a right should only be exercised if there are earnings, and the Board of Directors recommends that the dividend be paid. 7.8DIVIDEND EQUALIZATION RESERVE The company's earnings will fluctuate dramatically from year to year. To preserve uniformity in dividend declarations, it is preferable to monster a portion of earnings until declaring dividends to the dividend equalisation reserve. 3. Funding Requirements: If working capital is just about adequate, it is not advisable to declare a dividend; if one is announced, it must be paid to shareholders within 42 days, reducing working capital. Regulation in the past: The directors should follow a clear policy when announcing dividends. The market value of shares would be greatly influenced by changes in dividend rates. Preference shares: Dividends must be paid to preference shareholders before dividends are declared to equity shareholders. -Judicial decision: The following benefit sharing principles have been established by legal decisions:- (a) The money of the shareholders cannot be used to pay dividends; (b) Only a genuine surplus can be used to pay a dividend. 7.9AUDITORS’ DUTIES REGARDING DIVISIBLE PROFIT. When deciding divisible benefit, the directors must obey the provisions of law and G.A.A.P. There are enough or necessary duties of a company appointed auditor about company divisible 191 CU IDOL SELF LEARNING MATERIAL (SLM)
profit. As a result, in the case of a company's divisible benefit, the auditor must explain or review clauses of the articles of association, as well as legal provisions. Case law rulings, for example. The responsibilities of auditors in relation to divisible benefit are addressed further down. 1. Verification of sources: Profits received from regular business operations must be checked to see whether they are allocated to shareholders as divisible profits. 2. Verification of divisible profit: When calculating a company's divisible profit, the auditor must verify whether proper depreciation of depreciable assets is paid and whether proper rules and procedures are followed or not. 3. Verification of legal decisions: In general, if a dividend from capital gains is announced, it must be determined whether or not various legal decisions are followed in this situation. 4. To Examine Money: In no circumstances will the dividend be paid from capital based on his own expertise, ability, or experience. The auditor must be debt-free or certain that capital has not been harmed and that there is no capital beyond divisible profit. 5. To review the reserve account: Before the directors of the company declare a dividend, it must be determined if a certain portion of the current year's profit is allocated to the reserve account. 6. Verification of past losses: It must be determined if the divisible benefit is determined or not after past compensation. 7. Verification of Articles of Association: The auditor should check the articles of association for any clauses relating to divisible profit. 8. Examine the meeting's decisions: How many decisions of the company's shareholders and directors must be justified at the meeting? 9. Taxation Verification: It is essential to check whether income tax and other taxes on a company's divisible profit are handled efficiently. After thorough verification of the above- mentioned contents, the auditor will be secure. In this case, if the auditor is found to be negligent, the auditor will be held liable. THE DIVIDEND is a portion of earnings that goes to the shareholders' credit after fulfilling obligations to various parties. The roles and obligations of auditors in relation to dividend payment are as follows: 192 CU IDOL SELF LEARNING MATERIAL (SLM)
• To think about the articles of association. • To investigate the Act's portion. • To look at the minutes book. • To look at the register and register book. • To look at the dividend that has been measured. • To investigate the bank account. • Responsibilities for Dividend Payment • Responsibilities in relation to unclaimed dividends • To look at the bonus shares that were given out. • To look at the dividends that have been paid out and those that have yet to be claimed. Interim Dividend is a term used to describe a payment made over a period of time The most powerful motivator is the interim dividend. Interim dividend is when an organisation declares a dividend before the close of the accounting period. If the article of association allows it, the board of directors may announce an interim dividend after confirming the company's likely profit before the end of the accounting period. Until announcing an interim dividend, an interim sum is calculated to assess the interim benefit. Interim dividend payment: The auditor should perform the following tasks in order to verify dividend payment. Interim accounting must be prepared: The company's earnings must be meticulously calculated. It is recommended that interim accounts for the half-year be prepared for this reason. However, if the structure of the company is such that the amount of gross profit on sales remains relatively stable year over year and there are no irregular variables during the current year that could change the profit figure, it could be possible to avoid taking stock and preparing interim accounts. 2. Expected conditions for the rest of the year: It's likely that the profit generated in the first half of the year will be wiped out by a loss in the second. 193 CU IDOL SELF LEARNING MATERIAL (SLM)
3. Cash Position to Monitor: The company's cash position should be reviewed because paying an interim dividend, even though there are earnings, would be inadvisable if such payment would deplete the company's working capital. 4. Rate to be lower than final dividends: If an interim dividend is declared, the rate should ideally be lower than the estimated rate for the whole year, since it is preferable for the final dividend to be higher than the interim. The auditor must complete the above task in order to verify dividend payment.. 7.10DIFFERENCE BETWEEN INTERIM DIVIDEND AND DIVIDEND 1. Definition: Interim dividend: When the dividend of a company is declared before at the end of the accounting period, it is called interim dividend. Dividend: The part of the profits of the company which is distributed to the shareholders at the end of period, it is called dividend. 2. Timely payment: Interim dividend: An interim dividend is received during the accounting period. Dividend: At the end of the accounting period, a dividend is paid. 3. Amount: Interim dividend: The interim dividend amount is smaller than the dividend amount. Dividend: The dividend sum is greater than the interim dividend. 4. Cost: Interim dividend: Interim dividends are usually paid at a lower rate than dividends. Dividend: the dividend rate is higher than the interim dividend rate. These are the main distinctions between interim and dividend dividends. Prior to incorporation, benefit The shareholders have no legal right to share profits made by the company since it was established. As a result, dividends paid out of earnings prior to incorporation are illegal. Profits prior to incorporation, on the other hand, are distributed in the form of incentive shares. The remaining benefit received prior to incorporation can be used to write off goodwill or, if no goodwill exists, fictitious expenses such as preliminary expenses, lender writing commissions, brokerage on shares, discount on shares and debentures, or carried forward as capital Reserve not eligible for dividend. 7.11 SUMMARY 194 CU IDOL SELF LEARNING MATERIAL (SLM)
Benefit relates to the difference between expenditure and revenue, or Assets less Liabilities and Opening Money Profit determination affects each stakeholder differently • Business profits are profits earned through the ordinary course of business, while capital profits are profits earned from capital transactions. Business profits are eligible for dividend distribution, while capital profits are not available for dividend distribution. In the case of corporations, executive remuneration is calculated in accordance with sections 197 and 198 of the Companies Act 2013. In the case of corporations, dividends cannot be paid out of something other than earnings, and capital cannot be allocated as a dividend. Companies are required to pay dividend distribution tax at the time of dividend payment. A dividend equalisation reserve is necessary to ensure that dividends are paid consistently. An interim dividend is a dividend paid in the interim of two annual general meetings. 7.12KEYWORDS Managerial remuneration - Remuneration paid to key managerial personnel DER- Dividend equalisation reserve 7.13LEARNING ACTIVITY 1. Learn about the provisions relating to declaration and payment of dividend as per companies Act 2013 ______________________________________________________________________________ ______________________________________________________________________________ 7.14UNIT END QUESTIONS A.Descriptive Questions Short Questions 195 CU IDOL SELF LEARNING MATERIAL (SLM)
1. Write a short note about dividend equalizer equalisation reserve 196 2. List out the difficulties in determination of profits 3. What is meant by the term interim dividend? 4. What is the difference between business profit and capital profit? 5. What is meant by the term divisible profit Long Questions 1. Explain in detail auditors duties regarding divisible profit 2. Explain the provisions given in Companies Act 2013 with regards to dividend 3. What are capital and revenue items, explain how they affect profit determination. 4. Explain the duties of Auditor with respect to Audit of dividend B. Multiple Choice Questions 1. Treatment of revenue expenditure as capital expenditure leads to a. understatement of profits b. overstatement of profits c. has no effect on profits d. None of these 2. Net profit and divisible profit are one and the same a. True b. False c. partly true d. None of these 3. Gain arising from forfeiture of shares is an example of a. capital profit CU IDOL SELF LEARNING MATERIAL (SLM)
b. revenue profit c. both a and b d. None of these 4. Loss arising from sale of Fixed Assets is an example of _________ a. capital loss b. revenue loss c. both a and b d. None of these 5. If a capital expenditure is treated as an expense it _______ a. Increases profit b. Decreases profit c. No effect d. Increases G.p Answers 1-b 2-b 3-a 4-a 5-b 7.15REFERENCES Textbook: T1 ArunaJha, Auditing, Taxmann’s Publications, University Edition T2 Ravinder Kumar, Auditing: Principles and Practice :PHI Learning Pvt. Ltd Reference Books: R1 N.D Kapoor, Auditing, Sultan Chand & Sons R2 Gupta; Contemporary Auditing, Tata McGraw Hill 197 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 8 – AUDITOR’S REPORT Structure 8.0Learning Objective 8.1 Introduction 8.2 Forming an opinion 8.3 Auditor’s report 8.4 SA 705 8.5 Summary 8.6 Keywords 8.7 Learning activity 8.8 Unit End Questions 8.9 References 8.0 LEARNING OBJECTIVES After studying this unit students will be able to State the meaning of Audit report Analyze the process of forming an opinion Describe in detail about Auditor’s report Learn about Modified opinion and its types 8.1 INTRODUCTION The basic principles that govern the auditor's professional duties are defined in SA 200, \"Basic Principles Governing an Audit,\" and should be followed anywhere an audit is conducted. The final area of concern, according to the same, is audit conclusion and reporting. He must express an opinion on the following based on the audit evidence gathered during the audit: Whether 198 CU IDOL SELF LEARNING MATERIAL (SLM)
accounting procedures have been consistently applied; Whether financial information complies with regulations and legislative requirements; and There is sufficient disclosure of material facts relating to the presentation of financial data in accordance with legislative requirements. The financial information should be the subject of a straightforward written opinion in the auditor's report. A clean audit report implies that the auditor is satisfied in all areas, and when a competent, adverse, or disclaimer of opinion is to be issued, or when a reservation of opinion is to be made on any matter, the audit report should state the reasons. SA 700 – Forming an Opinion and Reporting On Financial Statements The auditor's duty to form an opinion on the financial statements is addressed in this Standard on Auditing (SA). It also covers the format and substance of the auditor's report released following a financial statement audit. This SA is written in the form of an audit of a full collection of general-purpose financial statements. When financial statements are prepared in compliance with a special purpose system, SA 800 addresses special concerns. Special considerations for an audit of a single financial statement or a particular feature, account, or item of a financial statement are addressed in SA 8055. This SA also refers to audits that are covered by SA 800 or SA 805. This SA applies to financial statement audits for fiscal years starting on or after April 1, 2018. Objectives The auditor's goals are to: • Shape an opinion on the financial statements based on an assessment of the conclusions derived from the audit evidence obtained; and • express that opinion clearly in writing. Definitions For purposes of the SAs, the following terms have the meanings attributed below: General purpose financial statements – Financial statements prepared in accordance with a general-purpose framework. 199 CU IDOL SELF LEARNING MATERIAL (SLM)
General purpose framework – A financial reporting framework designed to meet the common financial information needs of a wide range of users. The financial reporting framework may be a fair presentation framework or a compliance framework The term “fair presentation framework” is used to refer to a financial reporting framework that requires compliance with the requirements of the framework and: (i) Acknowledges explicitly or implicitly that, to achieve fair presentation of the financial statements, it may be necessary for management to provide disclosures beyond those specifically required by the framework; or (ii) Acknowledges explicitly that it may be necessary for management to depart from a requirement of the framework to achieve fair presentation of the financial statements. Such departures are expected to be necessary only in extremely rare circumstances. The term “compliance framework” is used to refer to a financial reporting framework that requires compliance with the requirements of the framework, but does not contain the acknowledgements in (i) or (ii) above Unmodified opinion – The opinion expressed by the auditor when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework Reference to “financial statements” in this SA means “a complete set of general purpose financial statements, including the related notes”. Reference to “Accounting Standards” in this SA includes The Accounting Standards issued by the ICAI (or) The Standards of Accounting notified by the Central Government in pursuance of section 133 of the Companies Act, 2013 and the Rules thereunder (or) The International Financial Reporting Standards (IFRSs) (or) The International Public Sector Accounting Standards (IPSASs) issued by the International Public Sector Accounting Standards Board; as may be applicable to the entity. 8.2 FORMING AN OPINION The auditor must express an opinion on whether the financial statements are prepared in compliance with the relevant financial reporting framework in all material respects. 200 CU IDOL SELF LEARNING MATERIAL (SLM)
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