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Thread: CA Final Notes - Advanced Auditing And Professional Ethics.

  1. #1

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    1. What is meant by True and Fair Cost of Production?


    True and Fair Cost of Production: The concept of “True and Fair Cost of Production” is used in the context of cost audit wherein the cost auditor has to state whether in his opinion the company‟s cost accounting records have been kept so as to give a true and fair view of the cost of production, processing and marketing of the product. A cost auditor checks the cost accounting records to verify that the cost statements are properly drawn up as per the records and that they present a true and fair view of the cost of production and marketing of various products dealt with by the undertaking. The following are the relevant considerations in determining whether the cost of production determined by the cost auditor is true and fair:

    1) Determination of cost following the generally accepted cost accounting principles
    2) Application of the costing system appropriate to the product
    3) Materiality
    4) Consistency in the application of costing system and cost accounting principles
    5) Maintenance of cost records and preparation of cost statements in the prescribed form and having the prescribed contents
    6) Elimination of material prior-period adjustments
    7) Abnormal wastage‟s and losses and other unusual transactions being ignored in determination of cost.

    It as a result of the examination of the books of account, the cost auditor desires to give a qualified report he shall indicate the extent to which he has to qualify the report and the reasons therefor.
    Last edited by arisha; 25-11-2011 at 03:50 PM.

  2. #2

    Thumbs up CA Final Notes - Advanced Auditing And Professional Ethics.

    Question: 2.

    Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The Bank follows financial year as accounting year. State your views on the following issues which were brought to your notice by your Audit Manager:

    (a) In computing the aggregate of funded and non-funded exposure of a constituent for purpose of assigning risk weight in regard to capital adequacy, the bank "Netted off' the credit balance of Rs.10 lakhs in their Current Account against the total exposure of Rs.1 crore.

    (b) The bank has recognised on accrual basis income from dividends on securities and Units of Mutual Funds held by it as at the end of financial year. The dividends on securities and Units of Mutual Funds were declared after the end offinancial year.

    (c) The bank is a consortium member of Cash Credit Facilities of Rs.50 crores to X Ltd Bank's own share is Rs.10 crores only. During the last two quarters against a debit of Rs.1.75 crores towards interest the credits in X Ltd's account are to the tune of Rs.1.25 crores only. Based on the certificate of lead bank, the bank has classified the account of X Ltd as performing.

    (d) In case of all such advances which have been classified as non-performing for the first time during the current financial year, only the last date of the financial year has been reckoned as the date of account becoming non-performing.


    (a) The RBI requires banks to adhere to certain capital adequacy norms to ensure that they have adequate capital in relation to the credit and other risks undertaken by them. In accordance with the circular issued by the RBI, while computing risk adjusted value of assets netting may be done only for advances collateralised by cash margins or deposits and in respect of assets where provision for doubtful debts have been made. The circular further states that in calculating the aggregate of funded and non-funded exposure of a borrower for the purpose of assignment of risk weight, banks may "net off' against the total outstanding exposure of the borrower, credit balance in current account which are free from any lien.

    Accordingly the treatment of netting off followed by the bank is in order.

    (b) It is not a prudent practice to treat dividend on shares of corporate bodies and units of mutual funds as income unless these are actually received. Accordingly, income from dividend on shares of corporate bodies and units of mutual funds should be booked on cash basis. In respect of income from government securities and bonds and debentures of corporate bodies, where interest rates on these instruments are pre-determined, income could be booked on accrual basis, provided interest is serviced regularly and as such is not in arrears. It was further, however, clarified that banks may book income on accrual basis on secure ties of corporate bodies/public sector undertakings in respect of which the payment of interest and repayment of principal have been guaranteed by the central government or a state government. Banks may book income from dividend on shares of corporate bodies on accrual basis, provided dividend on the shares has been declared by the corporate body in its annual general meeting and the owner's right to receive payment is established. This is also in accordance with AS-9 as well. In the instant case, the recognition of income by the bank on accrual basis is not in order

    (c) The bank is a consortium member of cash credit facilities of Rs.50 crores to X Ltd. Bank's own share is Rs.10 crores only. During the last two quarters against a debit of Rs.l.75 crores towards interest, the credits in X Ltd's account are to the tune of Rs.1.25 crores only. Sometimes, several banks form a group (the 'consortium') under the leadership of a 'lead bank' to make advance to a large customer on same conditions and security with proportionate rights. In such cases, each bank may classify the advance given by it according to its own experience of recovery and other factors. Since in the last two quarters, the amount remains outstanding and, thus, interest amount should be reversed. This is despite the certificate of lead bank to classify that the account as performing. Accordingly, the amount should be shown as non-performing asset.

    (d) It is wrong to take the Balance Sheet date for purposes of classification. In this context, it is important to note the concept of past due. An amount should be considered as past due when it remains outstanding for 30 days beyond due date.

    For example, if any SSI loan amount, the repayment of term loan instalment falls due for payment on December 31 and is not paid; the amount would become past due if it remains unpaid for 30 days beyond that date. In case of terms loans, if interest or instalment of principal is in arrears for any two quarters out of four quarters although default may not be continuously for two quarters during the year by applying past due test, it should be classified as non-performing asset and from that date provision should be made. In the case of other advances, outstanding in the last two quarters would be enough to classify the amount as such nonperforming asset if no transaction appears in the last two quarters.

    As per RBI Circular dated January 29, 1997, if the account of the borrowers have been regularised before the balance sheet date by repayment of overdue amounts through genuine sources and not by sanction of additional facilities, the account need not be treated as NP A inspite of payment of interest and instalment were in arrear for two quarters. Bank should, however, ensure that the account remains in order subsequently and a solitary credit entry made in the account on or before the balance sheet date which extinguished the overdue amount of interest or instalment of principal is not reckoned as the sole criterion for treating the account as a standard asset.

    It has been further clarified that in respect of accounts where there are potential threats of recovery on account of erosion in the value of security or non-availability of security and existence of other factors such as frauds committed by borrowers, it will not be prudent for banks to classify them first as sub-standard and then as doubtful after expiry of two years from the state of account has became NPA. It should be straight way classified as doubtful asset or loss asset, as appropriate, irrespective of the period for which it has remained as NPA.
    Last edited by arisha; 25-11-2011 at 03:33 PM.

  3. #3

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    Question: 3

    As a statutory auditor for the year ended 31st March 2008, how would you deal with the following?

    (a) As on 31/3/2007, the equity share capital of Lini Ltd. is 10 crores divided into shares of Rs.10 each. During the financial year 2007/08, it has issued bonus shares in the ratio of 1:1. The net profit after tax for the years 31/3/2007and 31/3/2008 is Rs.8.50 crores and Rs.11.50 crores respectively. The Earnings per Share (EPS) disclosed in the accounts for two years is Rs.8.50 and Rs.5.75 respectively.

    (b) Simon Ltd., a listed company, was incurring heavy losses since the last several years and the industry in which it was functioning was not expected to perform better in the next few years. While finalising the accounts for the year ended 31st March 2008, the CFO of the company decided to create a Deferred Tax Asset for the tax benefits that would arise in future years from the earlier years losses that had remained unabsorbed in Income tax.

    (c) Reena Ltd., has borrowed Rs.25 crores from financial institutions during the financial year 2007/08. These borrowings are used to invest in shares of Ajit Ltd., a subsidiary company which is implementing a new project estimated to cost Rs.50 crores. As on 31st March 2008, since the said project was not yet complete, the directors of Reena Ltd. resolved to capitalize the interest on the borrowings amounting to Rs.3 crores and add it to the cost of investments.

    (d) “There should be sufficient liaison between a principal auditor and other auditors”.
    Discuss the above statement and state in this context the reporting considerations, when the auditor uses the work performed by other auditor.


    (a) Disclosure of Earnings Per Share: AS-20 on Earnings Per Share (EPS) prescribes principles for the determination and presentation of earnings per share.

    As per AS 20, the earnings per share have to be disclosed as basic and diluted earnings per share on the face of the statement of profit and loss for each class of equity shares that has a different right to share in the net profit for the period. In the instant case, both the basic as well as the diluted earnings per share would be the same since there are no dilutive instruments that have been issued by the company.

    As per the Standard, in the case of a bonus issue, equity shares are issued to existing shareholders for no additional consideration. Therefore, the number of equity shares outstanding is increased without an increase in resources. The Standard further requires that the number of equity shares outstanding before the event of a bonus issue have to be adjusted for the proportionate change in the number of equity shares outstanding as if the event had occurred at the beginning of the earliest period reported. The standard also explains how the earnings per share is to be calculated in the case of a bonus issue of shares.

    In view of the above, the earnings per share for both the years will have to be calculated taking the equity share capital after the bonus issue as the denominator.
    If the same is done the earnings per share for 31/3/2007 will be Rs.4.25 and that for 31/3/2008 will be Rs.5.75. Since the above figures of earnings per share have not been disclosed, the company has not complied with the provisions of the standard.
    If the same is not followed, he would then have to qualify his report in terms of Section 227 (3) (d) of the Companies Act, 1956.

    (b) Recognition of Deferred Tax Assets: Accounting Standard 22 on “Accounting for Taxes on Income”, requires that deferred tax should be recognised for all timing differences, subject to the considerations of prudence in respect of deferred tax assets. The standard further states that where an enterprise has unabsorbed depreciation or carry forward of losses under the tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised. In this context, virtual certainty supported by convincing evidence would mean that there is a reasonable certainty that the carry forward losses would be recouped in the future years. In the instant case, looking to the fact that the industry in which the company was functioning was not expected to perform well in the next few years, getting virtual certainty and convincing evidence for the same would be almost impossible. Hence, in the absence of virtual certainty for offset of the losses in future years, creating a deferred tax asset would not be possible for the company. The statutory auditor would therefore have to qualify his report by stating that deferred tax assets have been created though there is no virtual certainty for getting the said benefit in income tax. He would also have to mention the amount by which the loss for the year has been understated and the amount by which the reserves are overstated.

    (c) Capitalisation of Interest on Borrowings in respect of Investments: As per Accounting Standard 13 on “Accounting for Investments”, the cost of investment includes acquisition charges such as brokerage, fees and duties. In the instant
    case, Reena Ltd. has used borrowed funds for making investment in shares of a subsidiary company. For acquiring shares of a subsidiary company, apart from any fees, duties etc., there are no cost incurred for investing in shares. Hence, any borrowing costs incurred cannot be treated as part of cost of investments and cannot be added to the cost of investments. The Accounting Standard 16 on “Borrowing Costs” also does not consider investment in shares as qualifying assets that can enable a company to add the borrowing costs to investments. In the instant case therefore, the statutory auditor would qualify his report by stating that the borrowing costs have been wrongly added to the cost of investments rather than charging them to the profit and loss account. The effect of the same on the profit for the year would also have to be mentioned in the audit report.

    (d) AAS-10 (SA 600) on “Using the work of another auditor” lays down the procedure to be applied in situations where a principal auditor reporting on the financial statement of the entity uses the work of another independent auditor. AAS- 10 (SA 600) contemplates coordination between auditors and requires that there should be sufficient liaison between the principal auditor and the other auditor. For this purpose, the principal auditor may find it necessary to issue written communication(s) to the other auditor.

    The other auditor, knowing the context in which his work is to be used by the principal auditor, should coordinate with the principal auditor. For example, by bringing to the principal auditor‟s immediate attention any significant findings requiring to be dealt with at entity level, adhering to the time-table for audit of the component, etc. He should ensure compliance with the relevant statutory requirements. Similarly, the principal auditor should advice the other auditor on any matters that come to his attention that he thinks may have an important bearing on the other auditor‟s work.

    When considered necessary, the principal auditor may require the other auditor to answer a detailed questionnaire regarding matters on which the principal auditor requires information for discharging his duties. The other auditor should respond to such questionnaire on a timely basis.

    The reporting considerations laid down by AAS are as under:

    When the principal auditor concludes, based on his procedures, that the work of the other auditor can not be used and the principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component audited by the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

    In all circumstances, if the other auditor issues, or intends to issue, a qualified report, the principal auditor should consider whether the subject of the qualification is of such nature and significance, in relation to the financial information of the entity on which the principal auditor is reporting, that it requires a qualification in the principal auditor‟s report.

  4. #4

    Thumbs up CA Final Notes - Advanced Auditing And Professional Ethics.

    Question: 4

    State your views as an auditor on the following:

    (a) During the year under audit LMJ Ltd. credited to the Profit and Loss Account, the entire profit of Rs.20 lakhs on the sale of land not required for its use. You are informed that the directors would like to propose dividend out of the above profit.

    (b) Venkate Ltd. had announced a voluntary retirement plan for its employees on January 1, 2008. The scheme is scheduled to close on June 30, 2008. The scheme envisaged an initial lump sum payment of maximum of Rs. 2 lakhs and monthly payments over the balance period of service of employees coming under the plan. 200 employees opted for the scheme as on March 31, 2008. The total lump sum payment for these employees would be Rs. 250 lakhs and the aggregate of future payments to them would amount to Rs.1,500 lakhs. However, no payment had been made to the employees under the scheme up to March 31, 2008. Nor the company made any provision in its accounts towards any liability under the scheme.


    (a) Profit of Rs. 20 lakhs on the sale of land is a capital profit. It represents the excess of sale value over the original cost of the asset. The question whether such a profit can be distributed as dividend has been considered in two legal cases, viz.,
    Lubbock vs The British Bank of South America Ltd. and Foster vs The New Trinidad Lake Aspha/te Co. Ltd. Based on the Court judgements, it is argued that capital profits can be distributed by a company only if all the following conditions are fulfilled:

    (i) The articles of association should permit distribution of capital profits.
    (ii) The capital profit which is sought to be distributed should have actually been realised.

    Unrealised capital profits, e.g., those arising on a revaluation of fixed assets, cannot be distributed as dividends. However, if the assets so revalued are subsequently sold, the amount realised over and above. the original cost of such assets is a capital profit available for distribution as dividend (provided the other conditions are satisfied).

    (iii) The capital profit should remain after a proper valuation has been fairly taken of the whole of the assets and liabilities. In other words, any fall or deficiency in the value of other assets or appreciation in the amount of liabilities should be deducted from the amount of capital profits to ascertain the amount which can properly be regarded as distributable as dividend.

    However, Accounting Standard 10 on "Accounting for Fixed Assets" requires that any gain arising from disposal of a fixed asset should be recognised in the profit and loss account. Moreover, section 205 of the Companies Act, 1956 does not make any distinction between capital profit and other profit. Thus, all profits which can properly be taken to the profit and loss account are 'profits' for the purposes of section 205 and are, thus, distributable.

    (b) Accounting Standard (AS)- 4 (Revised) on 'Contingencies and Events Occurring After the Balance Sheet Date', states that events occurring after the 'balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and, by the corresponding approving authority in the case of any other entity.

    Two types of events can be identified as:

    (a) those which provide further evidence of conditions that existed at the balance sheet date; and
    (b) those which are indicative (of conditions that arose subsequent to the balance sheet date).
    It further states that assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern (i.e., the continuance of existence or substratum of the enterprise) is not appropriate.

    As per facts of the case, a condition existed on the balance sheet date (31st March, 2008) regarding the liability towards the Voluntary Retirement Plan (VRP) since the management started the VRP in the month of January, 2008 and 200 employees opted for the VRP as on March 31, 2008. Since it was probable that future events will confirm that a liability has been incurred on the balance sheet date and that the amount could be estimated on reasonable basis, a provision for payments under the VRP would be required to be made for an appropriate amount for the aforesaid number of employees.

  5. #5

    Thumbs up CA Final Notes - Advanced Auditing And Professional Ethics.

    Question: 5

    As a statutory auditor of a Public Limited Company, how would you deal with the following situations?

    (a) The company had subscribed to shares of associate companies amounting to Rs.5 crores. These associate companies have incurred substantial losses and have been referred to BIFR for being declared as sick companies. The company does not want to make any provision for the fall in the value of the investments.

    (b) As at the beginning of the year, the company has a capital of Rs.2.50 crores, free reserves of Rs.0.50 crores and Revaluation Reserve of Rs.4.50 crores. In the relevant year under audit the company has incurred a loss of Rs.4 crores.

    The company proposes to adjust the loss with the Revaluation Reserve.


    (a) Valuation of Investments: AS 13 on "Accounting for Investments" requires investments to be classified as long term and current investments distinctly in its financial statements. The investments in shares of associate companies can very well be considered as trade investments since they would not be intended to be liquidated within a period of one year from its acquisition. Hence they would be classified as long term investments.

    AS 13 states, "long-term investments should be carried in the financial statements at cost. However, provision for diminution shall be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually". In the instant case, these associate companies have incurred substantial losses and have been referred to BIFR for being declared as sick companies. The net worth of these companies would have been wiped out resulting in a fall in the value of the investments.

    Therefore, such fall cannot be merely temporary as the companies could take a long time to turn around (if at all) and again have a positive net worth. The auditor would therefore have to qualify his report by saying that no provision for diminution for fall in the value of investments as required by AS 13 has been made and to that extent the profits and reserves have been overstated

    (b) Adjustment of Loss against Revaluation Reserve: AS-10 on "Accounting for Fixed Assets" states that an increase in net book value of fixed assets is normally credited to owner's interest and under the heading Revaluation Reserves except that, to the extent that such increase is related to and not greater than a decrease arising on revaluation previously recorded as a charge to the profit and loss statement, it may be credited to the profit and loss statement. A decrease in net book value arising on revaluation of fixed asset should be charged directly to the profit and loss statement except that to the extent that such a decrease is related to an increase which was previously recorded as, credit to revaluation reserve and which has not been subsequently reversed or utilised, it may be charged directly to that account. The Guidance Note on Treatment of Reserve created on Revaluation of Fixed Assets states that where the value of fixed assets is written up in the books of account of a company, the corresponding credit appearing as revaluation reserve does not represent a realised gain and is, therefore, not available for distribution as dividend.

    Similarly, accumulated losses and the depreciation on the acquisition cost (including arrears of depreciation) should not be adjusted against revaluation reserve since this would amount to setting off actual losses against unrealised gains.

    The auditor should explain to the management that accumulated losses cannot be adjusted against the revaluation reserve created on revaluation of the fixed assets.

    In case the company in question does so, the balance sheet of the company will not reflect a true and fair view of the state of affairs of the company keeping in view the magnitude of the amounts involved, i.e., accumulated losses amount to Rs.4 crores and share capital and reserves amount to Rs.3 crores (excluding revaluation reserve). If the management does not agree with the opinion of the auditor, the auditor may even issue an adverse report.

  6. #6

    Thumbs up CA Final Notes - Advanced Auditing And Professional Ethics.

    Question: 6

    Write short notes on the following:
    (a) Evaluating inherent risk
    (b) Evaluating internal control


    (a) Evaluating Inherent Risk - To assess inherent risk, the auditor would use professional judgement to evaluate numerous factors, having regard to his experience of the entity from previous audit engagements of the entity, any controls established by management to compensate for a high level of inherent risk, and his knowledge of any significant changes which might have taken place since his last assessment. Examples of are such factors are:

    At the Level of Financial Statements:

    1) Management‟s experience and knowledge and changes in management during the period, for example, the inexperience of management may affect the preparation of the financial statements of the entity.

    2) Unusual pressures on management, for example, circumstances that might predispose management to misstate the financial statements, such as the industry experiencing a large number of business failures or an entity that lacks sufficient capital to continue operations.

    3) The nature of the entity‟s business, for example, the potential for technological obsolescence of its products and services, the complexity of its capital structure, the significance of related parties and the number of locations and geographical spread of its production facilities.

    4) Factors affecting the industry in which the entity operates, for example, economic and competitive conditions as indicated by financial trends and ratios, and changes in technology, consumer demand and accounting practices common to the industry.

    At the level of Account Balance and Class of Transactions:

    1. Quality of the accounting system.
    2. Financial statements are likely to be susceptible to misstatement, for example, accounts which required adjustment in the prior period or which involve a high degree of estimation.
    3. The complexity of underlying transactions and other events which might require using the work of an expert.
    4. The degree of judgement involved in determining account balances.
    5. Susceptibility of assets to loss or misappropriation, for example, assets which are highly desirable and movable such as cash.
    6. The completion of unusual and complex transactions, particularly at or near period end.
    7. Transactions not subjected to ordinary processing.

    (b) Evaluating Internal Control - The auditors‟ assessment of the control environment is crucial to the decision on whether to make an extended assessment of controls.

    This is because a good control environment is conducive to the maintenance of a reliable system of accounting and control procedures. For strategy purposes the auditor should obtain a sufficient understanding of the control environment. The auditor needs an understanding of the accounting systems, regardless of whether the audit strategy will involve an extended assessment of internal accounting controls. This should be done by:

    (a) documenting the extent to which the system is computerised; and
    (b) preparing or updating overview flowcharts to record the files and transactions relating to significant systems-derived account balances.

    If there are significant computer systems, the auditor should obtain an understanding or the IT controls so decide whether to make an extended assessment of monitoring controls. Whether it is necessary to carry out any preliminary work for strategy purposes to ascertain whether IT controls are likely to be satisfactory will depend on the auditor‟s previous knowledge about IT controls.

    For an existing audit, the objective will normally be to carry out the minimum work necessary to update this previous understanding. If more information is needed, or if the engagement is new or substantially changed, the auditor should carry out an overview assessment of IT controls. However, even if auditor has not carried out an overview assessment of the IT controls for strategy purposes, it may be necessary to do so later, to help design and perform substantive tests and draw conclusions on whether proper accounting records have been kept. Whether this work is done before determining the strategy or subsequently as part of the fieldwork is a matter of audit efficiency.

  7. #7

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    Question: 7

    Answer the following:

    (a) Mention the difference between „report‟ and „certificate.‟
    (b) What are the contents of reports and certificates for special purposes?
    (c) What are the reporting requirements for closing stocks in the Manufacturing and other Companies (Auditors Report) Order, 1988?


    (a) Difference Between Report and Certificate: A certificate is written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion. A report on the other hand, is a formal statement usually made after an enquiry, examination or review of specified matters under report and includes the reporting auditor‟s opinion thereon. These words are fundamentally distinct from each other. Etymologically, the word „certificate‟ is derived from Latin words certus (Certain) and facere (to make). So, the certificate connotes verification of certain and exact facts. However, the rendition of this type of statement is an impossible task and the auditor‟s duty indeed becomes onerous. The dictionary meaning of the word „report‟ refers to formal account of results after an enquiry, examination or review given by an authorised person or group of reasons.

    In other words, when a certificate is issued, the auditor is responsible for the factual accuracy of what is contained therein. However, when a report is given, the auditor is responsible for ensuring that the report is based on factual data, that his opinion is in due accordance with facts and that it is arrived at by the application of due care and skill.

    (b) Contents of Reports and Certificates for Special Purposes: The contents of reports and certificates for special purposes in many cases are specified by statute and cannot be changed. However, in cases where no format has been specified, the reporting auditor can choose the form and contents. In such cases, where a reporting auditor is free to draft his report or certificate, he should consider the following:

    (i) Specific elements, accounts or items covered by the report or certificate should be clearly identified and indicated.
    (ii) The report or certificate should indicate the manner in which the audit was conducted, e.g., by the application of generally accepted auditing practices, or any other specific tests.

    (iii) If the report or certificate is subject to any limitations in scope, such limitations should be clearly mentioned.

    (iv) Assumptions on which the special purpose statement is based should be clearly indicated if they are fundamental to the appreciation of the statement.

    (v) Reference to the information and explanations obtained should be included in the report or certificate. In certain cases apart from a general reference to information and explanations obtained, a reporting auditor may also find it necessary to refer in his report or certificate to specific information or explanations on which he has relied.

    (vi) The title of the report or certificate should clearly indicate its nature, i.e.,

    whether it is a report or a certificate. Similarly, the language should be unambiguous, i.e., it should clearly bring out whether the reporting auditor is expressing an opinion (as in the case of a report) or whether he is only confirming the accuracy of certain facts (as in the case of a certificate). For this, the choice of appropriate words and phrases is important.

    (vii) If the special purpose statement is based on general purpose financial statements, the report or certificate should contain a reference to such statements. However, the report or certificate should not contain a reference to any other statement unless the same is attached therewith. It should be clearly indicated whether or not the statutory audit of the general purpose financial statements has been completed and also, whether such audit has been conducted by the reporting auditor or by another auditor. In case the general purpose financial statements have been audited by another auditor, the reporting auditor should specify the extent to which he has relied on them. He may communicate with the statutory auditor for securing his cooperation and in appropriate circumstances, discuss relevant matters with him, if possible.

    (viii) Where a report requires the interpretation of a statute, the reporting auditor should clearly indicate the fact that he is merely expressing his opinion in the matter. He should take sufficient care to ensure that in respect of matters which are capable of more than one interpretation, his report is not misconstrued as representing a settled legal position.

    (ix) An audit report or certificate should ordinarily be a self-contained document. It should not confine itself to a mere reference to another report or certificate issued by the reporting auditor but should include all relevant information contained in such report or certificate.

    (x) The reporting auditor should clearly indicate in his report or certificate, the extent of responsibility which he assumes. Where the statement on which he is required to give his report or certificate, includes some information which has not been audited, he should clearly indicate in his report or certificate the particulars of such information.

    In certain cases, the form and/or contents of the report or certificate, as prescribed by a statute or a notification, may not be appropriate or adequate. In such situations, the reporting auditor may consider modifying the report or certificate on the basis of the aforesaid parameters, to the extent applicable. In case this is not possible, he should clearly indicate the limitations in his report or certificate itself.

    (c) Reporting Requirements for Closing Stocks Under MAOCARO, 1988: The auditor has to make four specific statements on verification and valuation of closing stocks under MAOCARO, 1988 issued under Section 227(4A) of the Companies Act, 1956. The Order requires the auditor to state “whether physical verification has been conducted by the management at reasonable intervals in respect of finished goods, stores, spare parts and raw materials”. Secondly, the auditor has to state, “Are the procedures of physical verification of stocks followed by the management reasonable and adequate in relation to the size of the company and the nature of its business? If not, the inadequacies in such procedures should be reported”. Further, “whether any material discrepancies have been noticed on such verification as compared to book records, and if so, whether the same have been properly, dealt with in the books of account”. Finally, “whether the auditor is satisfied on the basis of his examination of stocks that such valuation is fair and proper in accordance with the normally accepted accounting principles. Is the basis of valuation of stocks same as in the preceding year? If there is any deviation in the basis of valuation, the effect of such deviation, if material, should be reported”.

    The comment on the reasonableness and adequacy of the stock verification procedures requires that the auditor should examine the methods and procedures of such verification and may, if considered appropriate by him, be also present at the time of stock-taking. He should, in any case, examine the instructions given by the management to the stock-taking personnel (which should preferably be in writing).

    Where stocks are material and the auditor is placing reliance on the physical verification by the management, it may be appropriate for the auditor to attend stocktaking and perform test counts. He should ascertain whether the cut-off procedures are adequate. The original physical verification sheets should be reviewed and selected items traced into final inventories, which in turn should be compared with stock records and other evidence such as stock statements submitted to banks. The procedures for identifying damaged and obsolete items of inventory should be reviewed. While commenting on this clause, the auditor should point out the specific areas where the procedures are not reasonable or adequate.

    The auditor should look carefully into all material discrepancies between the book stocks and physical and physical inventories to examine whether the same have been properly adjusted in the books of account.

    The auditor has also state whether the valuation of stocks is fair and proper in accordance with the normally accepted accounting principles. To determine what constitute the normally accepted accounting principles regarding valuation of stock, one may refer to Accounting Standard 2. This standard provides that, in general, inventories should be valued at the lower of historical cost and net realisable value.

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