A HANDBOOK PRACTICAL AUDITING Ry Dr, B. N, TANDON” M.A, eon, LL, (Agra), Moa. Com, (Gab), B. Com, (fom.), Ph.D, Reon, (Munich), Dep srtrer of Gomoirece usiness Administration, Dull Polslezhesic, Dethi, Ferurly of Meerut College, Meerst. 1958 8 CHAND &CoO. DELI - JULLUNDUR - LUCKNOW5S. CHAND & Co., AsfAti Road —. NEW DELHI Fountain _ DELHI Mai Hiran Gate —~ JULLUNDUR Lal Bagh LUCKNOW Rs. 10f- hed by G, 5, Sharma, for 5, Chand & Co., Fountain, Dethi, and Printed by §. p, Dhawan at the Central Electric Pye , ic Press, 60-D, Kamla Nagar, Delaj. °PREFACE I think, I owe an explanation for bringing out yet another book on auditing when there are so many already in the market. I have taught this subject for many years and have always felt the need for a book which will not only be useful to the students for examination purposes but will also be useful from practical point of view. The book docs not claim any originality in regard to matter and facts since I had to depend for these on standard books published in India and outside on the subject. I have, however, tried to present the facts in such a way as to make it easy for the students to comprehend them. T have taken special care to incorporate the latest Companies and other Acts as they refer to auditors and auditing. Legal cases have also been discussed at Iength. At the end of cach chapter, questions set by Universities and Professional Bodies are given. I hope the book will prove to be useful not only to the students who are to take university examinations but also to candidates who take professional and competitive examinations in the subject. I take this opportunity to thank my esteemed colleague and friend Mr. A. Dasgupta, Head of the Commerce Department, Delhi Polytechnic and Professor of Business Administration, Delhi School of Economics, Delhi University, without whose encouragement it would not have been possible for me to bring out this book. Suggestions for the improvement of the book from practising accountants, teachers and students will be very much appreciated. Decur. B. N. Tanpon.CONTENTS Carrer I, Introduction. Origin of Audit—Definition of Audit—Difference be- tween Accountancy and Auditing— Qualities of an Auditor —Objects of an Audit—Advantanges of an Audit—Differ- ent classes of Audits and their relative advantages—Con- duct of an Audit—Continuons Audit--Periodical or Final Audit—Procedure. Typical Questions. Carrer II. Internal Check or Control. Meaning of Internal Check—Objects of Internal Check—Auditor’s duty in regard to Internal Check— Considerations at the commencement of a new Audit—~ Division of work between Senior and Junior Audit Clerks ~-Ticks—Audit Programme—Audit Note Book. Typical Questions. Cmartrr III. Vouching of Cash Transactions. Vouching—Its Meaning—Voucher—Points to be noted in a Voucher—Internal Check as regards cash— Vouching the debit and credit side of the Cash Book— Petty Cash Book. Typical Questions. CuapreR IV. Vouching of Trading Transactions, Purchases—Internal Check System as regards Pur- chases—Duty of an Auditor in connection with Credit Purchases—Purchases Returns—Credit Sales—Internal Check as regards Credit Sales—Duty of an Auditor in connection with Credit Sales—Sales Returns—Goods Sold on Sale or Return System—Goods sent on Consignment —Packages and Emptics—Journal—Bought Ledger— Sales Ledger—Total Accounts and Scctional Balancing, . Typical Questions. Cnapter V. The Audit of Impersonal Ledger, Outstanding Assets and Liabilities—Allocation of Expenditure between Capital and Revenue—Contingent Liabilities—Contingent Assets. Typical Questions. Craprer VI. Verification and Valuation of Assets and Liabili- ties, “ Meaning of Verification—~Valuetion of Assets — Fixed Assets—Modc of Valuation of Fixed Assets—Floatir Paces 119 20—27 28—50 5I1—65 66—8¢ 81-119 a Lee : \ ’(vi) © Current Assets—Mode of Valuation of Floating ‘Assots—Wasting Asseis~Valuation of Wasting Assets— Auditor’s position as regards the Valuation of Asscts— Verification and Valuation of different classes of Asscts-~ Stock in hand—Methods used in the Valuation of diffee- ent classes of goods—Duty of an Auditor in connection with Stock in trade ~Book Debts —Goodwill-—Verification of Liabilities~Share Capital~Trade Creditors—Bills Pay- able—Outstanding Expenses. ‘Yypical Questions. Guarrer VIL. Depreciation. General—Definition—Causes of Depreciation—Wear and tear-—EMuxion of time—Obsolescence—Exhaustion— Pifference between Depreciation and Fluctuation ~ Necessity for providing Depreciation—Measure of Depreci- ation—Plant Rewister—Principal methods of providing Depreciation—Fixed Instalment or Straight-line Mcthod— Reducing Instalment Method—Insurance Policy Method —Revaluation—Use or Mileage Method—Efficiency-hour Method—Global Mcthod—Depletion Unit Method or Production Unit Method—Auditor’s duty as regards De- preciation—Repairs and Renewals—Legal aspect of De- preciation—Legal decisions considered. Typical Questions. Cuaprer VIL Reserves, Meaning — General Reserve — Specific Reserve — DiFerence between Gencral and Specific Reserves—Re- serves for Bad Debts—Reserves for Discount on Debtors and Creditors—Sinking Tund—How is Sinking Fund crcated—Difference between Sinking Fund for the Re- demption of a Liability and Sinking Fund for the Re- placement ofan Asset—Duty of an Auditor as regards Sinking Fund— Reserve or Development Funds — Capital Reserve—Duties ofan Auditor in connection with the Capital Reserve—Secret Reserve—Definition—Objects of ~Secret Reserve ~How Secret Reserve is created ~—Dangers or Objections to Secret Reserve—Duty of an Auditor connection with the Secret Reserves. Typical Questions. /Cuarrer IX. The Audit of Limited Companies. Qualifications and Appointment of an itor— Remuneration ofan Auditor Different classes of Audion ~Auditors appointed on behalf of different classes of shareholders—Auditor’s Powers and Duties—Rights of an Auditor—Auditor’s Lien—His Duties—Status of an Au- ditor—Preliminaries to be gone through before the actual PAGES 120-41 142—157 158—229(vii) work is begun by the auditer—Whether his appointment is in order—Inspection of the books, documents ctc.—Memo- randum of Association—Articles of Association—Prospec- tus—Minute Books—Last Balance Sheet and the Auditor’s Report — List of Officers — Audit of Share Capital — Shares issued at a Premium—Duty of an Auditor—Shares issued at a Discount—Shares issued for consideration other than cash—Bonus Shares—Forfeited Shares—Audit of Share Transfer-—Brokerage and Underwriting Commis- sion~—Debentures—Debentures and Share Capital— Issue of Debentures—- Different Classes of Debentures—Different ancthods of the Issue of Debentures—Fixed and Floating Charge—Redemption of Debentures—Duty of an Auditor in case of Redemption of Debentures—-Mortgages—Preli- minary Expenses—Auditor’s Duty—~Interest paid out of Capital — Statutory Meeting, Report and Audit ~ Profits prior to Incorporation — Directors — Remuneration of Directors—Managing Directors—Loans to and from Directors—Managing Agents—Dividends—Interim and Final Dividends—Position of an Auditor in connection with the Payment of Dividends—Reorganisation of Capi- tal — Auditor’s Report — Qualified report ~ Private Limited Companies— ‘Their Privileges — Their, Audit — Holding Companies—Subsidiary Companies —Require- ments of the Companies Act regarding Holding and Subsidiary Companies -- Auditor of such, Companies— Audit of Banking Gompanies— Capital of a Banking Com- pany—Banking Companies Act, 1949—~Internal Check —Publication of Accounts — Audit of Insurance Com- panies, ee Typical Questions. Carter X. Audit of Partnership Accounts, Introduction—Procedure to be followed by a newly appointed auditor of a partnership—Audit on behalf of different classes of partners. Typical Questions, EuaprTer XI. Divisible Profits. What are Profits—Difficultics in the Determination of Profit—Who are affected if profit is not correctly deter- mined—Consequences of Incorrect Valuation of profits— Relevant clauses of Table A re Dividends—Whecher Capital Profits are available for Dividends—Whether all the surplus made by a company engaged in working a Wasting Assct is available for Dividends—Whether the loss of fixed asset must be made good before the distribution of the surplus —Whether profits made prior to incorporation are available PAGES 230—236 237-261for dividends—Loss prior to considered. 'ypical Questions. SuapTer XII. Investigation, Definition—Difference (uit) PAGES Inenrporation—Legal cases 262—2% between Investigation and Auditing—-Report of Investigator—Different classes of Tne vestigation—Investigation on behalf of a Purchascr to ascertain the carning capacity—Investigation on behalf of an incoming Partner—Investig: of. gar ih : ofa company—Valuat ion o| Companies Act, 1956. Typical Questions. ation on behalf of a Lender shen Fraud is suspected—Investi- who wishes to purchase shares {shares—Investigation under the _ Sp rrR XI. Liabilities of an Auditor. 217~298 Liability ofan Auditor appointed bya private concern —Liability of an Auditor under the Companies Act-~Civil Liability of an Auditor—Criminal Liability ofan Auditor —Liability of an Auditor to third parties—Liability of an Honorary Auditor—Dual Ar Liability of Auditor for libe” -*- Typical Questions, Guapter XIV. Typical Audi Preliminary Work—Cash Book—Petty Cash Book— Tr sal Auditor— « "considered. it Programmes. 299—319 Purchases and Sales Journals—~Purchases Returns—Sales Book—Sales Returns—~Wages Book—Bills Receivable and Payable Books —Journal —Purchases Ledger—Sales Ledger Nominal Ledger—Audit Programme for the Statutory Report—General Audit Programme for Limited Com- panies. Special Features of the Audit of Non-Trading Con- cerns:->Charitable Institutions—Clubs—Educational Insti- tutions—Hospitals. . Special Features of the Audit of Trading Concerns :- ‘ranches —~ Bus Companies — Cinemas, Theatres, Cir- cuses ctc,—Collieries—Contractors and Builders~Co- operative Societies — Electric and Gas Companies —Executors and Trustees—Finance and Trust Newspapers and Periodicals—Pub| nies—Retailers—Rubber, Typical Questions. Index st_ Companics~ Hotels— lishers—Railway Compa- Ss! Tea and Coffee Plantations— Shipping Companics—Solicitors. antations 321CHAPTER I INTRODUCTION Origin of Audit. — The origin of audit may be traced to middle ages but the audit in the present sense can be traced after the introduction of large-scale production in consequence of Industrial Revolution during the 18th century. Before this era, goods were produced by indivi- duals on small scale. There was not much capital, The individual who invested the capital, usually himself maintained the accounts and therefore there was no necessity of checking them. Again stabilised governments, expansion of banking facilities and new means of communication have widened the scope of investment and business. The investor would naturally like to see that his investment is safe. For this purpose the accounts must be checked and audited especially in case of joint-stack compa- nies, where the shareholders are drawn from far-off places, and who have no hand in the actual running of the business. It is but essential to get the accounts audited in order to assure them that their investment is safe and that the Directors and the Managing Agents etc., who handled the capital and accounts, presented true and correct accounts, Itis not possible for the shareholders to check the accounts of the company. ‘The shareholders appoint a person who would audit the accounts on their behalf. Formerly such a person used to be one of the shareholders who might not have technical knowledge of accountancy. To havean effective check, the custom to apoint professional auditors began to develop. Definition of Audit, — The word ‘‘audit” is derived from the Latin word “audire” which means to hear. In olden times, whenever the owners of a business suspected fraud, they appointed certain persons to check the accounts. Such persons sent for the accountants and “heard” whatever they had to say in connection with the accounts. It was an Italian, Luca Pacialo, who first published his treatise on double entry system of book-keeping for the first time in 1494. He mentioned and described the duties and responsibilities ofan auditor. Since then there have been lot of changes in the ‘scope and definition of audit and the duties and responsibilities of an auditor,« 2 A HANDBOOK OF PRACTICAL AUDITING ‘As has been indicated above, the original object of an aut was principally to sce whether the accounting party had propery accounted for the receipts and payments of cash. _Thus it wa : only a Cash Audit, but as will be seen later on, the principal objec of modern audit is to sce whether the Balance Sheet exhibits a truce and fair view of the state of affairs of a company. Since the Ba Sheet incorporates all personal and impersonal accounts and the palance of Profit and Loss Account, which in its turn incorporates fictitious transactions, we may safely say that the Balance Sheet for a particular period incorporates all the transcations which took place during the period for which the Balance Sheet is prepared. ; Spicer and Pegler have defined an Audit as “such an examuna~ tion of the books, accounts and vouchers of a business, a shall enable the auditor to satisfy himself whether or not the balance sheet is properly drawn up, so as to exhibit a true and correct view of the state of the affairs of the business, according to the best of his information and explanation given to him and as shown by the books ; and if not, in what respect it is untrue or incorrect.” Another writer has given the definition: “Auditing may be defined as careful searching of the books of accounts by comparing them with the documents and papers from which they have been written up; and thus trying to find out whether the profit or loss for a particular period and the financial position, as shown by the Final Account are correct and truc.” Yet another writer says : “Official examination and verification of accounts or claims; especially an examination of accounts by proper officers, or persons appointed for that purpose, whe compare the charges with the vouchers, cxamine witnesses, and state the result.” From the above definitions, it would be seen, that an auditor has not only to see the arithmetical accuracy of the books of accounts but has to go further and. find out whether the transactions entered ir \the books of original entry are correct or not. How is he to find it “1? The answer is by inspecting, comparing, checking, reviewing, satinising the vouchers supporting the transactions in the books of vunts and the correspondence, minutes books of the shareholders and directors, memorandum of association and articles of association et Difference between Accountancy and Auditing. jore ¥V it i ‘ De nee between Accountancy and _INTRODUCTION 3 1. Accountancy means keeping the books of accounts in such a way that one is in a position to know the state of affairs of the business, while auditing means the checking of such accounts to find out their accuracy. 2, The spade work is done by the accountant while the finishing touch is given by the auditor or, as has been said, that where the work cfan accountant ends, the work of an auditor begins. 3. Sometimes an auditor is asked to prepare from a set of books the trial balance, profit and loss account and balance sheet in which case he would be acting as an accountant and he would not be required to give his -certificates at the foot of the BS. He has simply to put his signature in token of his having prepared such a profit and loss account and balance sheet that the balance sheet exhibits a true and correct state of affairs. On the . other hand, an auditor has not to prepare the Trial Balance, P & L Account and Balance Sheet. He is to certify that the balance sheet as has been prepared by an accountant exhibits a true and correct state of affairs of the concern. 4. An accountant has to,record the transactions in the books of accounts while gfauditor has to check and verify such transactions an@“accounts prepared by an accountant. Investigation. Sometimes students get an impression that auditing and investigation mean the same thing. However, there is a lot of difference between the two. Investigating means a searching enquiry into the profit-earning capacity or the financial position of a con- cern or to find out the extent of the fraud if there is any suspicion about it. 1, Audit is carried out to find out whether the B.S. is properly drawn up and exhibits a true and correct state of affairs, while investigation is carried out with a certain end in view, ¢.g., the profit-earning capacity, or the financial position of a concern or to find out a fraud and the extent thereof. 2. Investigation covers several years, say 3, 5, or 7 years to find out the average earning capacity, financial position etc., while audit relates to one year only.3, A MABDEGOK OY PRACTICAL APOITRES Investigation mey he eared outon hehalt af asides while audit i conducted an behalf of dhe prnpricters ot However, investigation fs carried ait by propacins a in some eases where fraud of defateation is suspected, Qualities of an Auditor, 1 2. 3. 4. 3. &. 9. + , o in Acis very important for an auditor ta he well versed 5 the fundamental principles and theory of all ranches om acconnting, cy, Betieral accounting, Cost acenuntint income tax, ete. [tis not posible fara perioa to At at the acemants untess he himeelf knows fw fo prepate them. , He should not pass a transaction unless he knows thar it is correct. ‘This is posible only when one knows thoroughty well the principles of accounting, He should be able to gee “quickly technical details of the business whose accounts he fs auditing. If possible, he should pay a visit to the works before he undertakes the work of audit. trib ernnteen He should be prepared to seck elucidation on technical questions rather than show a false pride or fear of dis playing his own ignorance. He should be quite familiar with the Company Law and must be complete master of the principles of auditing. He must be tactfal and honest, as Lord Justice Lindley has said: ‘An auditor must he honest, ic. he must not certify what he docs not believe to he truc, and he must take reasonable care and skill before hic believes what he certifies is true.” (In re London and General Bank, 1895). He must not be influenced directly or indirectly by others in the discharge of his duties. Sometimes he is put in a very awkward position when his duties to his client is opposed to his own interests in which case he must have the courage to carry out his duties faithfully and honestly even if such a step harms him. In we Jong run this policy will be of immense value to him. He will acquire a rp, i i which will bring nore business te him. @ for Bis honesty emus Be Ne ines ene rather than signa balance h Rot exhibit i view of the state of affairs and thus gi false S Zive a false report.INTRODUCTION 3 10. He should not disclose the secrets of his clients. 11. He must have the tact to put intelligent questions to extract full information. 12. He must not adopt an attitude of suspicion. Lord Justice Lope has said : “An Auditor is not bound to be a detective or as was said, ‘approach his work with suspicion’, or with foregone conclusion that there is something wrong. He should behave like a ‘watch dog’ but should not adopt . the attitude and outlook of a ‘blood hound’.” 13, He must be prepared to hear argument and must be reasonable. 14, He must be vigilant, cautious, methodical and accurate. 15. He should have the ability to write clearly, forcibly, concisely and correctly. . 16, He should have an understanding of the general principles of economics. 17. He should have thorough training in business organisation, management and finance. 18. Heshould be able to write the report clearly, forcibily concisely, and correctly. ~ 19, Last but not the Ieast, he should have ‘Common Sense’. Objects of an Audit. The next point to be considered is the object and extent of an audit. The objects of an audit may be said to be :— I. Detection and prevention of errors ; and II. Detection and prevention of fraud. IL. Detection of Errors. “4 Errors are generally innocent but sometimes errors which might appear at first sight as innocent are ultimately found to be due to fraudulent manipulation and therefore an auditor must pay parti- cular attention to any error, howsoever innocent it may appear to be at first sight. Errors are of three kinds, viz. 1, Clerical crrors which can be sub-divided into (a) Errors of Omission ; and (b) Errors of Commission. 2. Errors of Principles. 3. Compensating Errors. Let us explain these separately in detail,6 A HANDBOOK OF PRACTICAL AUDITING (a) Errors ef Cmission. As the name indicates, the error of omission is one where a transaction has not leen recorded in the books of accounts chet wholly or partially. In the former case it will not be casy to detett the error and it will not affect the Trial Balance. But sometimes? js apparent from the balance of an account that an entry has beet omitted, ¢.g. the rent account may show that the rent has been nt for only 11 months and that the rent for the 12th month has not oe paid. But there are many other cases where it may not be poss to detect the omission, c.g. purchases or sales have entirely been omitted to be entered which error will not affect the Trial Balance and the omission will not be apparent even. But if one aspect of the purchase or sales has been entered in the books, it will affect the Trial Balance and the omission will be easily detectable. Tt may be due to the fact that the item has not been posted although entry has been made in the books of original entry. Ifa transaction has been omitted to be entered in the books of accounts intentionally, it will affect results shown by the accounts and affect the ultimate profit or loss. (b) Errors of Commission. When a transaction has been recorded but has been wrongly entered in the books of original cntry or posted in the ledger, error of commission is said to have been made, e. g. incorrect entries in the original records, wrong castings, calculations, postings, extensions and carry forwards. Some of such errors will be detected by the non- agreement of the Trial Balance. On the other hand, if a mistake has been committed in the invoice for the sale of goods, the error will not be detected as the mistake will appear both in the original books as well as in theledger. ° 2. Errors of Principle Such errors arise when the entries are not passed according to ans s the fundamiental principles of accountancy, c.g. wrong allocation of expenditure between capital and revenue, } assets and liabilities, valuation of assets a. gnoring the outstanding book-keeping. gainst the principles of | Such errors may be committed either intentionally, or uninten- tionally. Ifthey are committed intentionally, the object is to falsify and aaenipalate the accounts cither to shaw more profits or less profits than they actually are. Such errors ulti timately aff Sheet. Therefore, it is very § ii wat ane Balance : 2 '¥ important for an auditor to pay particular aeINTRODUCTION 7 attention towards this type of error. Such an error is not disclosed by the Trial Balance or by routine checking. It can be detected only by a searching enquiry and independent checking. 3, Compensating Errors. A compensating error is one which is counter-balanced by any other crror or errors, ¢,g., if A’s AJC was to be debited for Rs. 100 but was debited for Rs. 10 while B’s A/G which was to be debited for Rs. 10 was debited for Rs. 100. Thus both the accounts have been debited for Rs. 110 which amounts ought to have been debited. ‘This type of crror will not affect the Trial Balance and will not be detected easily. Such errors may affect the Profit & Loss Account or not. An over-casting of an account may be counter-balanced by the under-casting of another account to the same extent. This type of error will not be detected by the Trial Balance. Location of Differences. The question is how to locate an error if it is found that there has been an error. If the following methods are adopted, there will be no difficulty in finding out an error :— 1, Check the totals of the Trial Balance, 2. Compare the names of the accounts in the Ledger with the names of the accounts as have been recorded in the Trial Balance. It is possible that balance of some account might not have been transferred to the Trial Balance especially in the case of the balance of Cash Book or some other subsidiary book. 3. Total the lists of debtors and creditors and compare them with the Trial Balance. 4, Ifthe books are maintained on the self-balancing system, sce that the total of different accounts agree with the total of these accounts with the balance of account as recorded in the Trial Balance. 5. Whatever the difference is in the Trial Balance, halve it and * see if there is any item of this value. This is done to avoid the putting of the debit balance on the credit side of the Trial Balance or vice versa. If in spite of the above methods, the error cannot be located, the error may be due to the following causes :-— 1. An error of say Re. 1 or 10 or 100 etc., ic. a round sum, may be due to wrong totalling. Ifthe difference is rupees, andA HANDBOOK OF PRACTICAL AUDITING pice, it may be due to wrong posting or extracting a wrong balance. 2. An error which is divisible by 9 may be duc to misplace- ment or transposition of figures, c.g., 32 for 23, 52 for 25 or 54 for 45 and so on, Il. Detection and Prevention of Fraud, Having dealt with the first object of audit, viz., detection and prevention of errors, Iet us proceed further and discuss the second object namely : Detection and Prevention of Fraud. Detection of fraud is considered to be the mast important duty ofan anditor. Asa matter of fact, originally audit was conducted, mainly with a view to detect frauds whenever it was so suspected. Fraud means false representation or entry made intentionally or without belief in its truth with a view to defraud the proprictors of the business. Fraud is of two kinds : 1. Defaleation of money or goods ; and 2. Fraudulent manipulation of accounts not involving the misappropriation of money or goods. 1. Defalcation of money or goods. There is a greater possibility of defalcation of money or goods in a big business honse than in the case of a small proprietary business where the proprietor has a direct control over the receipts and pay- ment of cash and purchase and sale of goods. Ina big business house, the receipt and payment of cash and the purchases and sale of goods should be so organised that the work of one clerk may be automatically checked by another clerk which system is known in auditing as ‘Internal check” system and which will be dealt with in detail later on. As between the two, namely misappro- priation of cash and goods, it is casier to misappropriate cash, and therefore the auditor will do well to pay particular attention towards cash transactions. Cash may be misappropriated by (a) omitting to enter any cash received ; or & te ane egret than what is actually received sor book tos s entries on the payment side of the cash (d)_ entering more amount on the Payment si book than what has actually boon, paid, side of the cashINTRODUCTION 9 In order to discover fraud under (q) and (6) above, the auditor should check the debit side of the cash book with rough cash book, salesmen’s reports, counterfoils of the receipt books and other original records while the fraud under (c) and (d) can be discovered by ref-. erence to the vouchers, wage sheets, salary book, invoices etc.” Again fraud may be in respect of goods, i.e,, defalcation and misappropriation of goods. This type of fraud is very difficult to detect. Proper methods of keeping accounts in regard to purchases and sales, stock taking, periodical checking of stocks, the necessity for- collusion, will help to avoid misappropriation of goods. 2. Fraudulent manipulation of accounts, not involving any misappropriation of money or goods, This type of fraud is more difficult to discover as it is usually committed by directors or managers with the object of (a) showing more profits, than actually they are (7) so that if” they get commission on profits, they may get more commis~ sion; or (ii) their service may be retained by showing to the shareholders that because of their efficiency they have shown more profits and thus maintain the confidence of the- shareholders and the public ; or (iti) if they hold shares, they may sell them at high price by declaring higher divi- dends ; or (iy) to obtain further credit by showing that the- position of the business is better than what actually it is ; or (vy) to attract more subscribers for the shares of the company etc. (b) Showing less profit than actually they are (7) in order to- purchase shares in the market at a Jower price ; or (#/) to- reduce or avoid the payment of income tax ; or (iii) to give a wrong impression about the success of the business to. competitors etc. Falsification of accounts may be resorted to = (a) By not providing any depreciation or providing less. depreciation or providing more depreciation ; of (b) By under-valuation or over-valuation of assets and abilities ; or (c) By including fictitious sales or purchases or returns in order to show more profits or less profits. Such frauds are difficult to detect as they are committed by the- people at the helm of affairs, who are presumed to be trustworthy,. honest and responsible, and therefore, no suspicion falls on them.10 A HANDBOOK OF PRACTICAL AUDITING ‘They are very cleverly made and as such, the auditor should be very careful in detecting such frauds. He should carry out the routine checking and vouching most carefully and make searching enquiries intelligently. Advantages of an Audit. On account of the following advantages people get their accounts -audited especially in cases where audit is not compulsory : 1, Errors and fraud are located at an early date and in future no a(tempt is made to commit such frauds or one is rather careful not to commit a mistake as the accounts are audited at regular intervals. The auditing of accounts keeps the accounts clerks regular and vigilant as they know that the auditors would comp- lain against them if the accounts are not prepared up to date or there is any irregularity. Audit of accounts by an independent auditor minimises the chances of dispute amongst the partners. In the case of joint-stock companies, the shareholders, who have no hand in the actual running of the business, are assured that the accounts have been properly maintained and that the directors have not taken any undue advantage of their position and thus misappropriated money. In case of fire, the insurance company may settle the clair on the basis of the audited accounts of the previou years. Money can be borrowed easily on the basis of the pre vious audited balance sheet. If the business is to be sold, price can be fixed on th basis of the previous audited balance sheet. Income tax authorities generally accept the profit and loss account which has been prepared by a qualified auditor and they do not go into details of the accounts. Ifa new partner is to be taken in or one of the partners retires or dies, the audited balance sheet will be a good basis to estimate the value of the capital of such a partner or partners. ‘Different Classes of Audit and their Advantages, + The audit of the accounts of pri indivi r ie Ptivate individ: Je 3 proprietor and the advantages derived from ite uals oF a , 7 af oy goo CeINTRODUCTION lt When an auditor is asked to audit the accounts of a private “individual or a sole trader, he must get clear instructions from his F -elient in writing as to what he is expected to do. As he is appointed by an individual or a sole trader under an agreement, therefore, his dutics and the nature of the work will depend upon such an agree- ment It is very important because if later on any charge of negligence is levied, he can produce the agreement as to what he was asked todo. In the case of an auditor to audit the acconnts of joint-stock ‘companies, this question does not arise as his duties are defined by the Companics Act itself, Sometimes an auditor is appointedby an individuay to prepare the accounts ors ometimes he is asked to prepare the accounts for the purpose of presenting them to the income tax authorities. Therefore. it is very essential that he must know his -duties and the nature of the work he is called upon to perform. The is called upon to perform the full audit, he must see that the accounts are properly prepared and that the balance sheet is correct. It is possible that his client might propose to take a loan on the basis of the balance sheet signed by him. In such a case if the lender later on finds that the balance sheet does not represent the true and correct financial position of the individual, “the auditor might be held responsible to the banker to make good the loss, In short he snust act strictly according to the instructions ofhis employer. Advantages. 1, Th? individual is assured that his accounts are properly maintained and that he is not being defrauded by the accountant and his agents. ‘This is specially important when the proprietor is a landlord and has a large estab- lishment and consequently cannot have proper control over it, 2. The accounts which have be2n audited by a qualified auditor are generally taken as correct by the income tax authorities and hence an individual does not feel any difficulty in regard to income tax. 3. The audited books of a deccased are very helpful to the executors and administrators as such accounts will form the basis for the preparation of the death duty accounts. 4 Ifthe accounts have been prepared on a uniform basis, accounts of one year can be compared with other years and if there isan increase in expenditure, cause may12 A HANDBOOK OF PRACTICAL AUDITING be enquired into as to why the expenditure has increased. and cfforts may be made to reduce the expenditure, ‘ Where agents ate appointed, it is difficult to keep a check on their accounts and if the auditors are appointed, ine agents will keep proper accounts. If they have committe any defalcation etc., these can be easily discovered by the auditors, B. The Audit of the Accounts of a Firm. The auditor of a firm is not appointed under any statute. He is appointed by the partners and hence his scope of work will ex- tend according to the terms of appointment and instructions issued to him. He should strictly adhere to the instructions, Some- times he is appointed by a firm to prepare the accounts, in which case he will act more or less like an accountant. Sometimes an auditor is called for an interview and after having discussed the work to be done by him and the terms of appointment, he is verbally asked to begin his work. In such a case, it will be in the interest of the auditor to get in writing the nature of his work, to avoid any difficulty later on. Inthe case of Apfel vs. Annan Dexter & Co., it was held by the court that according to the instructions issued to the auditors, it was clear that they were to prepare the accounts for the purpose of income tax and hence they were not to audit the accounts. The responsibility of any fraud will not lic on their head. Therefore it is very important that an auditor should get clear instructions from his clients. In the above-mentioned case, fortunately, the auditors had instructions in writing and hence they were freed from any responsibility for any fraud, This point has clearly been decided in several cases, viz., Leech vs. Stokes, the Scarborough Harbour Commissioners vs, Robinson, Coulson Kirkbey & Co., ctc., where their lordships said that if the auditors had acted to the clear instructions of their clien's, the auditors would not be responsible. The advantages derived by getting the accounts of a. firm audited. lL The partners are satisfied with accounts which have been maintained by one of the Partners This will avoid any dispute amongst the partners. This is why usuall Provisions regarding audit of the firm’ de P a S accounts are in the Partnership Deeds of most of the firms. . madeINTRODUCTION 13 2. Although there is no provision regarding the sleeping partner under the Indian Partnership Act of 1930, all the partners do not take active part in the business. If the accounts are audited by an auditor such a partner who did not take active part in the business, will be quite satisfied that there has been no fraud. 3. ‘Incase of the death or retirement of a partner or when a new partner comes in, the valuation of goodwill or the settlement of accounts will become very easy. 4. Negotiation for loans from a bank or an individual will be much facilitated if the audited accounts are presented. The bank in such a case can casily form a correct opinion about the financial position of the firm, 5. The Income Tax authorities generally take such audited accounts as correct for the purpose of assessment of income tax, 6. The auditor can sometimes suggest better methods of keep- ing the accounts. 7. Ifthe business is sold asa going concern, there will not be much difficulty regarding the valuation of the business if the accounts had already been audited. In addition to the above-mentioned particular advantages, a firm derives all the advantages which are usually derived in getting the accounts audited. ‘C. The advantages derived bya Joint-Stock Company in getting the accounts audited. 1. The sharcholders of a company have no access to the books of accounts and therefore if the accounts which have been maintained by the directors are audited by an auditor who is a professional accountant, they are assured that they have not been defrauded. 2. The audit keeps a check on dishonest employees. 3. The auditor of a company may give sound financial advice though it is not his duty. In addition to the above-mentioned particular advantages, a Company derives all the advantages which are usually derived in getting the accounts audited. Distinction between the audit of a Joint-Stock Company and a Partnership or firm. i, The audit of joint-stock companies is compulsory under4 A HANDROOK OF PRACTICAL AUDITING the Companies Act of 1956 while that of a partnership is not. 2. The duties, powers, rights etc., of an auditor of a joint- stock company are defined by the Companies Act, 1956, while in the case of a partnership they depend upon the agreement between the auditor and the firm. 3. Inthe casc of a joint-stock company, its auditor must bea qualified auditor as is laid down under 5. 226 of the Companies Act, 1956, while in the casc of a partner ship, its auditor need not hald those qualifications. D. The Audit of Trust Accounts. ‘Trusts are created for the benefit of some institutions, widows: minors etc. The trustees look after the propety left over by the testator- They collect the rents of the property, dividends on the shares ete. and distribute the income to the beneficiaries according to the terms of the Trust Deed. As the widows, minors etc. for the benefit of whom these trusts are created, are not in a position to have access to the books of accounts and criticise them, they are often defrauded by the trustees, There have been cases where the trustees have misappropriated large sums of trust moncy without the knowledge of the beneficiaries, Sometimes the trustees them- szlves do not know how to keep accounts or sometimes they do not do so at all, not because they are dishonest but because they are ignorant of the trust Jaws and the fundamentals of book keeping To avoid such a thing, sometimes a provision is made in the Trust Deed for the appointment of auditors to check the accounts of tht trust. This step will avoid the misappropriation of money by the trustees. If the accounts are audited by a qualified auditor, it wil help both the trustees and beneficiaries. Trustees will be benefitec because there will be no unnecessary criticism against them, Th beneficiaries will also be bencfited because they will be assure that the accounts have been properly maintained and that ther has been no misappropriation of trust money or fraud. Conduct of Audit, Audit may be Z Continuous, or II, Periodical, Fes yA Continsous Audit or a detailed audit, as it is. som imes called, is an audit which involves a detailed examinati he books of accounts at a regular interval of, sa ee wonths, ‘The auditor visits » SAy one month or thre . his clients at regular intervals durinINTRODUCTION iy the financial year and checks cach and every transaction. At the- end of the ycar he checks the profit and loss account and the balance sheet. Advantages of Continuons Audit. a 1, Mistakes and frauds are discovered easily and quickly as 6. the auditor checks the accounts at regular intervals and in detail. If he were to check the accounts after one: year, it would be difficule to locate an error. As the auditor visits his clients, say after a fortnight or,a month or so, the number of transactions will be small and hence the error will be detected easily and quickly. Since the auditor remains more in touch with the- business, he is in a position to know the technical details. of it and hence can be of great help to his clients by making valuable suggestions. Most of the checking work having been already performed during the course of the year, the final audited accounts can be presented to the shareholders soon after the closing of the financial year at the annual general meeting. As the auditor visits the clients at regular intervals, the clerks will be very regular in keeping the accounts up to date and they will see that there is no inaccuracy or fraud as it would be detected by the auditor at his next visit, and lest the clerk might be taken to task. Ifthe auditor pays surprise visits, it will have a consider- able moral check on the clerks preparing the accounts as they do not know when the auditor may come and check. the accounts: The auditor, having more time at his disposal, can check. the accounts with greater attention and detail. - Disadvantages of Continuous Audit. In spite of the above-mentioned advantages of a continuous audit, there are certain drawbacks of such an audit which are as. under : 1. Figures in the books of accounts which have already been 2. 3. checked by the auditor at his previous visit, may be altered by a dishonest clerk and the frauds may thus be perpetuated, The frequent visits by the auditor may disturb his client. It is an expensive system of audit.16 A HANDBOOK OF PRACTICAL AUDITING 4, The audit clerk may loose the thread of his work and the queries which he wanted to make may remain out- standing. These disadvantages and dangers may be avoided by taking some precautions, ¢.g., 1. No alteration should be allowed to be made after the transactions have been checked by the auditor, without his permission. 2. Ifany alteration has to be made, it should be done by means of a rectifying entry. 3. Checking of a book should be complete as far as possible at one visit. However, if this is not possible, the auditor should check the transactions up to a particular date and make a note of it in his diary and, if possible, he should make a note of the totals up to that date in his diary or note-book. 4. Well drawn-up programme by the auditor will prevent any loose ends. ‘Ul. Periodical Audit or Final Audit or Balance Sheet Audit or Complete Audit. Periodical audit is one which is taken up at the close of the financial or trading period when all the accounts have been balanced and a Trading and Profit and Loss Account and the Balance Sheet have been prepared. At this juncture, the auditor gets hold of the books and checks the accounts. He is in possession of the full facts relating to accounts for the year under review. In the case of such an audit, the auditor visits his client only once a year and goes on checking the accounts until the work for the whole of the period is completed. ‘This type of audit is verysatisfactory especially in the case of small concerns. This class of audit is usually adopted by almost all concerns, But in the case of large concerns, it takes more time to complete the audit and hence presentation of accounts to the shareholders is delayed. The share- holders are usually very anxious for the dividends which cannot be declared until the final accounts shave been prepared and audited, . The question often put is, what type of audit is satisfactory which may be adopted, as both the continuous and periodical audit ve Advantages as well as drawbacks. a Itis suggested that an interim audit followed by the final ‘tis the most satisfactory type of audit although it is veryaN INTRODUCTION 17 expensive. The type of audit to be adopted depends upon the magnitude of the business. Procedure. How to proceed with the work will depend upon the circum- stances of each case. The method of work varies with the training, experience, and knowledge of the auditor. Some gencral points are given below; Distinctive ticks of different colours for, say additions, postings, ledger balances, carry forwards etc, should be adopted. The significance of these ticks should not be made known to the clerks ofthe client. The same kind of ‘tick’ should not be used for every firm and for the same kind of transactions or for all the visits. As far as possible the work of checking of one book should be completed at one sitting for if it is not done, some fraudulent alterations may ‘be made by the clerks after the audit clerk has left the office for the day, Onthe next visit, the audit clerk should see thar -there has been no alteration by rubber or by scratching of the work he had already checked on the previous visit. If it has been done, he should get an explanation and check the whole of the work again. If any adjustment is found to be necessary, it should be made by a journal entry and no alteration ofa figure should be allowed. Special ticks should be used for figures which had_already been erased. Pencil figures should not be accepted. It sometimes so happens that the clients put the total figures with pencil. The auditor should refuse to commence his work until these figures are inked. The audit clerk should not balance the books. {t is not his work. Sometimes he is asked to balance the books, in which case, he will be acting in the capacity ofan accountant rather than an auditor. Frequently, the auditor is asked to begin the audit work even before the balancing of books, so that the audit may be completed sooner. ‘However, this procedure should be discouraged as there is a danger of the errors being overlooked because there has been no clerical test like the preparation of the Trial Balance. No transaction should ‘be passed unless he understands it, for an auditor must not certify what he does not believe to be true. The auditor should not discuss anything in regard to the meaning of different ‘ticks’ etc., lest the client’s staff may know about the secret meaning and defraud the auditor. Vouching should be carried out by two clerks, the senior examining the voucher and calling out the amount and the junior agrecing the amount and placing a special tick against the item in the Cash Book, When18 A HANDROOK OF PRACTICAL AUDITING calling back the figures, the audit clerk must be very clear in speaking out the figures otherwise mistakes may crop in ¢.g.. when one clerk calls out the figure as Rs. 60, nP. 9, he might be understood. as Rs, 69. Therefore the clerk should make a pause between 60 and 9, Similarly there might be confusion between ninety and nincicen, cighty and cighteen. It would , be advisable to pronounce ninety as ninetic and so on. As already mentioned, work done by cach clerk should be recorded in the Audit Note Book which is known by different names such as Working Papers, Audit Notes, Memoranda etc. In addi- tion to the programme mentioned above, it contains full record of all important notes and queries, which were not satisfactorily ex- plained, missing vouchers and invoices, all important matters which. may be useful for future audit, points which have to be mentioned in the report, answers to queries, together with the names of the officers who gave such answers. Unimportant and minor matters should not finda place inthe Audit Note Book. They may be settled at the spot. These Note Books should never be destroyed for they may be used for future reference and especially when a question of the liability of the anditor arises. Such a question may arise after many years when the clerk responsible for the work might have resigned or the auditor might have altogether forgotten abour the particular events. The Audit Note Book will be the best evi-+ dence in favour of the auditor. QUESTIONS 1, What is an Audit ?- What are its advantages ? 2. Briefly explain the difference between Book-Keeping, Ac~ countancy and Auditing, (Allah. B. Com. 1945) 3. Explain the difference between Auditing and Investigation. 4, State the qualities that are required of an anditor, , 5. What are the main classes into which errors in the books of accounts are divided? Briefly explain and illustrate such errors. 6. What are the principal objects of an audit ? (CG. U. Com. 1939) 7. Explain and illustrate “manipulation or falsification of accounts,”” 8. How is money or goods misappropriated ? Suggest methods to prevent such a fraud. 9. Mention some of the types of frauds on the part of the ors which the auditor must be on the look-out for and theINTRODUCTION 19 precautions he should take so as not to be liable for such frauds. (C. A. Final, Nov. 1951) 10. What do you mean by “routine checking’? ? 11. Describe the value of an audit for trading and non-trading concerns, 12. State briefly the difference in principle between the audit of accounts of a firm or a sole trader or a trust and that of a joint- stock company. 13, “The auditor of an individual or a firm has no statutory obligation to comply with.” Discuss briefly the implications and limitations of this statement. 14. What is a Continuous Audit ? What are its advantages and disadvantages ? 15. Distinguish between (a) Complete and Partial Audit. (b) Continuous or Running and Final or Balance Sheet Audit. 16, What is your opinion as to the value of an Audit Note Book ? 17. Write a short note on the “Method of work” and “Check Marks or Ticks” generally adopted during audit. 18. Isita part ofan auditor’s duty to trace and locate a dif- ference in the books he is auditing? What steps should be taken when asked to sign the Balance Sheet if the Trial Balance shows a difference ? 19. The Trial Balance of a company does ‘not agree. What steps would you take to locate the error if you are asked to discover the error or errors ? 20. What isan auditor’s duty in relation toa difference in books undiscovered at the time of commencing the audit ? 21. Differentiate between (a) the fundamental principles of auditing, and (b) the technique of auditing, Explain why the latter must be subject to change though the former may remain constant. (C, A. Final, 1951) 22. Give examples of errors which might still exist in a set of books after the Trial Balance had been agreed, and state th | ee auditor would take to detect them.CHAPTER II INTERNAL CHECK OR CONTROL Meaning of Internal Check. Internal Cheek is a method of organising the accounts system of an office or factory and the duties of the different clerks in such away that the work of one person is automatically checked by ane other and thus the possibility of fraud, or error or irregularity is minimised unless there is a collusion between the clerks; eg. the reccipt of cash is entered by the cashier on the debit side of the cash book ; this entry is carried to the ledger by another clerk ; the statement of account relating t2 th's transictioa is sent to the cus- tomer by a third clerk and so on. Thus we sec that the same transaction has passed through three different hands, and the work ofone is checked automatically by the other. This minimises the possibilities of fraud and errors unless all the three join hands in defrauding their employer. Again, the clerk in charge of a book of prime entry should not have access to the ledger and vice versa. Self- balancing ledger system, time recording clocks or automatic tills for recording cash receipts, are some of the devices by which the com- mission of fraud may be prevented. No one is allowed to deal with one book throughout. Under this system, wages sheets are pre- pated and checked from different records by different clerks. In case of cash sales, the salesman does not receive the moncy from the customer, nor does he deliver the goods to him. Cash is received by. the cashier ; the goods are delivered by the gate-keeperand all the three, viz. the salesman, the cashier and the gate kecper send their own statement regarding the sales, receipt of cash and the delivery of goods in the evening to the Gencral Manager who compares these statements and if he finds any discrepancy, he makes an in- vestigation. Under such a system, unless all the three joi hands, there is no possibility of fraud. Similarly when the goods are purchased on credit, entries are made regarding the purchase by the gate-keeper, who records the name of the supplier, the quantity and the date; another entry is made by the keeper of the purchases book, the godown keeper etc. ‘Thus the same entry is recorded by different clerks and the possibi- lity of fraud or mistake is reduced to the minimum. ook Tt must be ,, 1 Clear here that the students should not confuse between the iINTERNAL CHECK OR CONTROL “ at Internal Check and Internal Audit. The internal audit implies an audit of the accounts by the employces of the business. The clerks go on auditing the accounts throughout the year. Itisa kind of a continuous audit, but conducted by the clerks of the concern. Tn the case of large concerns like banking companies or local bodies, they have a separate Internal Audit Department. The Objects of the Internal Check The internal check system is organised to achieve the follow- ing objects :— 1. To prevent the commission of any fraud by a clerk, 2. To prevent the misappropriation of cash or goods by any clerk by kecping a check on the receipts and payments of cash and reccipts and delivery of the goods. 3. To throw responsibility on a particular clerk when the fraud or mistake is detected, 4. To detect a fraud or an error quickly and easily. 5. To have an accurate record of all business transactions, Auditor’s duty in regard to Internal Check System. Te what extent should an auditar depend upon the Internat Check system will depend upon the magnitude of the business whose accounts he is auditing. In case ofa concern where there is no internal check system and the clerk has full control over all the books of accounts, it would be better if the auditor checks all the transactions from the begin- ning to the end, irrespective of the fact whether the concern is, small or big. Of course, it would entail more time but it is worth }* while to do so. He must not assume that there is no error. Ifhe Bet does so, he would be running a great risk. neo In the case ofa big concern where there is a good internat check system, the auditor may rely upon it and may, toa great extent, presume the accuracy of the accounts. But he must not be negligent. He should apply a few test checks, i.e., he should check a few transactions here and there at random or check fully the accounts for a few months, say for January, April, July etc,, and carry out a thorough check of the whole of certain classes of trans- actions taking place during that particular period, e.g., cash sales, or cash received or credit purchases during that period. In selecting certain transactions for ‘test checks’ the auditor should see that such sample transactions are representatives and true specimens of such entries throughout the year.INTERNAL CHECK OR CONTROL 23 books and their specimen signatures. Such a list should be duly signed by a responsible official of the company. If internal check system is followed, he should get a written statement to that effect. 6. He should get a list of the officers of the company together with their duties and powers. 3. Ifthe business is of a technical nature, he would do well to visit the works, acquire technical knowledge to some extent, before he actually commences the business so that he may put intelligent questions to his clients and may not ut appear to be ludicrous by putting absurd questions and pt may also not be deccived by the clerks who may take undue advantage of his lack of technical knowledge. 8. He should ask his clients to balance the books, prepare the final accounts and the balance sheet, file the vouchers in, ihe order of the occurrence of the transactions, prepare the 2 schedules of the debtors, good, doubtful and bad debts, creditors, important legal papers, contracts, list of securities etc., if this has not been done so far. He should never begin his work until the books have been balanced. 9. He should get the previous year’s balance sheet and see that the accounts during the current year have been opened with those balances with appeared in the previous balance shect. 10. He should get the report of the auditor, ifany, relating to the accounts of the previous year for information regarding the state of affairs of the company during that year. 11. He must read those clauses of Memorandum of Association and Articles of Association of the company which have a bearing on the accounts or the Articles of Partnership of the firm whose accounts he is auditing or Will or Trust Deed in case of an audit of a Trust. 12, Ifit is the first audit of a company, he must go through the prospectus. Division of work between Senior and Junior Audit Clerks. Having considered the above points, the auditor has now to chalk out a programme and divide the work amongst his assistants as the chief auditor has simply to supervise and give a finishing touch to the work already done by his assistants. Of course, it should be borne in mind that the ultimate responsibility is his,24 A HANDBOOK OF PRACTICAL AUDITING The auditor will do well if he allots the audit work ofa concern toone of his senior audit clerks who in his turn will be assisted by a few junior clerks selected by him. Sometimes the senior clerk himself sclects the juniors to help him. Both the methods have advantages. These junior clerks will get instructions from their senior audit clerk regarding the work and will be responsi- ble directly to him under whom they are working. The work, assigned to the juniors will be of routine nature which requires less skill and technical knowledge, such as checking of original records with documentary evidence such as vouchers, casting of subsidiary books, posting of such books into the ledger, checking of stock and wages sheets etc. Incase of doubt or difficulty, they should refer the matter to their senior audit clerk who will get a clarification from the client. In selecting the senior and junior audit clerks for the work factors like expericnce, tact, skill etc, must be borne in mind and one should not be led by the age of the clerk or the Iength of his service. It is possible that a clerk with many years of service, may not be tactful or may not be skilful. The juniors should not do the work mechanically. They should try to understand the transactions. They should take lively interest in their work and suggest ways of improvement to the senior audit clerk under whom they are working. They should workin full co-operation with the senior. This is the ground work where they get their initial training. They should pass no entry which they do not understand. Notes should be made for such entries to enable the senior to get further explanation about such entries. ‘The senior audit clerk will supervise the juniors working under him. He will come in contact with the client or with the manage- ment. At the outset, the senior in consultation with the auditor, will chalk out the programme, assign duties to different juniors and decide as to what work is to be done by himself. Usually the vouch- ing of the receipts and payments, verification of the cash balance, verification of the journal entries, adjustments, apportionment of the capital and revenue items etc., are done by the senior audit clerk. Having done so, he submits the final accounts tog¢ther with his notes to the auditor who in his turn certifies the balance sheet, and prepares ‘he report to be submitted to the shareholders of the company. As tioned above, it is he who is responsible for the whole work and ss he who signs the balance sheet,INTERNAL CHECK OR CONTROL 25° Audit Programme or Audit Note Book The auditor having selected a senior and the juniors to do a particular assignment, the senior will chalk out the programme as to what work is to be done by each junior and by himself and with the tinie by which the work is to be finished and this is Jaid down in the Audit Note Book. There are three metheds by which the programme is carried out, viz.— 1. There isa complete programme on the file from which the items to be completed by a particular junior are ticked off and thus the junior hnows what he has to do and by what date each item is to be completed. 2. In other cases the senior chalks out a programme for each clerk according to the nature of the business of the client. In this case there is no previous chalked-out programme. 3. In the third case, the senior never prepares a programme in advance but may allow it to grow as the work pro- gresses, Each worker signs for the work he has performed so that the responsibility may rest upon him for the work he has done. This is very important. Advantages of Audit Programme. The advantages of such audit programme or Audit Note Books. may be outlined as below -— 1. The auditor is in a position to know about the progress of the work done by his assistants. 2. A uniformity of the work can be attained as the same programme will be followed at subsequent audits. 3. Work of the audit can be divided amongst the different juniors who will be responsible for their work. In case a clerk goes on Jeave, his work can be resumed by another clerk who is jn a position to hnow what work has already- been done. 4, Incase of a charge of negligence for not having done some work against the auditor, the auditor can defend himself that the work had been done by him or his assistant who had duly signed the Note Book. 3. Itisa kind of guidance to the audit clerk for the work he has to perform.26 A HANDBOOK OF PRACTICAL AUDITING After the above preliminaries are scttled, the senior clerk must ‘inform the clients beforehand that they would begin the work on -such and such date. Though giving of this information may not he ne- scessary, it is but in the interest of both the parties. In case he does not give the information regarding his visit, he may find that the books are not ready for checking, schedules of debtors and creditors may ‘not have been prepared, vouchers might not have been arranged “properly, no satisfactory and comfortable room for the audit work may be available and above all he may find himself unwelcome. “Loss of time and disappointment may result. To avoid all this, a previous intimation to the client will result in cordial relations, mutual co-operation and smooth working. Ifthe work is to be finished by a particular time, the senior ~must sec that it is done so. Ifnecessary, juniors may be asked to -do overtime work, S. of The senior audit assistant equipped with a letter of introduc. ‘tion from the principal auditor, should reach the office of the client -with his assistants on the dey previously intimated after having ‘gone through the whole of the correspondence which had passed ‘between the auditor and the client and previous year’s balance shect -and the auditor’s report. a ‘ QUESTIONS 1, What do you understand by the term “Internal Check” ? ‘Has the auditor any responsibility in regard thereto? Show by illustrations under what circumstances and to what extent, if any, he is justified in relying upon it in the course of an audit. (Agra B. Com. 1944) 2. What are the general principles which should influence an auditor in deciding whether or not a system of internal check is -adequate ? (Agra B. Com. 1936) 3. You are appointed auditor to a private firm, the partners in which devote no time whatever to the books. You find that the office work is apportioned as follows amongst “the three clerks :— | A keeps the Cash Book, pays the wages, fills in the calcula- ‘tions and makes the additions of the wages sheets, and posts the ‘Cash Book and sometimes posts the Sales Book to the Sales Ledger. B keeps the Sales Book and posts part of it to the Sales - He also does some correspondence,INTERNAL GHECK OR CONTROL 27 G keeps the Purchases Book and posts it to the Bought Ledger. ‘He also keeps the Private Ledger (which contains the nominal -accounts) and does some of the correspondence. All these clerks make entries in the Returns (in and out) ‘Book. Do you approve of this arrangement? Ifnot, submit a report embodying any suggestions you have to make for the protection of your clients. 4, What is meant by “Internal Check”? What are the principles upon which you would found a system of “Internal ‘Check’’, and what is the position of an auditor in relation to such -a system ? (Rajputana Af, Com. 1.950) 5. It is said that an auditor is entitled to rely on the system -of internal check in force. Is thisa correct statement or does it require ‘any modification ? : 6. Prescribe a system of internal check to your clients, who sare the proprietors of a big departmental stores, for control of cash sales. 7. Your client, who conducts an extensive Ready Moncey ‘Business (not Mail Order) requests you to advise him how to protect himself against losses of cash sales, Outline your recommendations. 8. You have been appointed as an auditor to (a) a firm, consisting of three persons, and (b) a joint-stock company, both of which were newly formed. Describe briefly what steps you would ‘take before commencing the detailed work of audit. 9. For the guidance of junior clerks who have been placed under your control, draft a set of instructions suitable to the ordinary commercial practice. Mention any matters of importance upon which you would question them when inspecting their work. ~ 10. Outline a system of internal check calculated to prevent the following types of frauds: (a) a bank manager allows loans to his friends and shares the proceeds ; (b) stock is written up to augment profits; and (c) dummy vouchers are printed and cheques drawn against them. (Bombay B. Com. 1939) 11, What is the object of keeping an audit programme and maintaining notes during audit ?CHAPTER HI ‘VOUCHING OF CASH TRANSACTIONS ‘The main objects of the audit of the cash book may be sura- marised thus:— 1, To ensure that all receipts are accounted for ; 2. To ensure that no fraudulent payments have been made ; 3. To know that all receipts and payments have been properly recorded ; and 4, To verify the cash in hand and at bank. Vouching : Its Meaning A voucher is a documentary evidence in support of a trans- action in the books of accounts. Vouching is considered to be the essence of auditing and therefore the auditor should be very careful while vouching. Vouching means to substantiate an entry in the books of accounts not only with any documentary evidence such as an agreements, receipts, counterfoils of a receipt book or paying-in- book, contracts, but also to sce that the transaction has been properly authorised, recorded and entered in the books of accounts ; ¢.g., veri- fication of the entries in the invoice book with the invoices, checking of the cash receipts with the counterfoils of the receipt book, the checking of the cash payments with the receipts of the payces and so. on. Vouching means testing the truth of items appearing in the books of original entry. The success of an auditor in vouching depends upon his intelligence, critical bent of mind, common sense, obser- vation and tact with which he handles his work. He should go behind. the books of accounts and go to the source of a transaction. If he simply compares the entry, say on the credit side of the cash book vith the voucher, it is possible that he might be deceived; ¢.g., the surchase might not have been for the business or the receipt might iave been for the previous year. Ifitisa receipt side entry and if he compares the entry with the counterfoil of the receipt book, it is possible that Iess amount might have been entered on the counter= foil than the money which has actually been received. Clever frauds can be discovered only by proper vouching. Therefore, it is very important that the auditor should vouch the items with great care and intelligence. It is through vouching that an auditor can satisfy himself as to the authenticity and completeness of trans~ ‘fons in the books of accounts, In case he is negligent, he will be ‘\ guilty as was decided in the case of Armitage vs. Brewer & Knott.VOUCHING OF CASIT TRANSACTIONS 29 Vouching also means checking of additions, ledger postings, extracting of balances in the ledger, etc. The extent to which the auditor should check will depend upon the size of the business, the accounts of which he is auditing. If it is a big business, efficient internal check will be in operation and hence the auditor will be justified in relying upon a few test checks, while ina small business, internal check may not be in operation and hence the auditor will “have to check every entry. To be on the safe side, the auditor will do well to check in detail because the curtailment of work will not In any way reduce his responsibility. Voucher. As explained above, a voucher is a documentary evidence in support of a transaction in the books of accounts. It may be a receipt, a counterfoil of a receipt book, an agreement, resolution passed by the Board of Directors or sharcholders and as recorded in the minute book, an invoice etc. While examining the vouchers, following points must be borne in mind :— 1, All the vouchers are consecutively numbered and filed in order of occurrence. If the client has not done so, the auditor has a right to ask him to doso. Ifthey are not properly arranged, much valuable time will be lost in finding out a particular voucher to check it. 2, He should pay attention to the dates, which must corres- pond with the cash book, name of the party to whom the voucher is issued, the name of the party issuing the voucher and the amount, etc. 3. The vouchers inspected should be cancelled by a stamp lest they may be produced again. Subsidiary documents such as statements, invoices, etc, relating to such a voucher should also be cancelled. In case stamp is not available, the audit clerk should affix his initials or put a tick right across the face of the voucher. Such a mark or stamp should be put in the centre of the voucher to avoid its removal by a dishonest clerk. ~4. Special attention should be paid to those vouchers which are in the personal name of one of the partners, directors, manager or secretary, etc., as such a voucher may not relate to the business. In such a case, original invoice, inward book, etc. should be examined to see whether the goods were purchased for the business or for the individual30 10. ii. A HANDBOOK OF PRACTICAL AUDITING to whom the voucher is addressed. He should ask the client to issue instructions to the customers not to address the vouchers to any individual of the firm or the company. If on enquiry it is found that the goods were meant for one of the officers, personal account of such an officer should be debited, He should see that every voucher is passed as in order by a responsible officer. The signature of the officer should be noted. If the receipt isa printed one or it bears a rubber stamp of the name of the firm, the voucher should be taken as a genuine one. He should also note if the voucher is properly stamped, if the amount of the voucher is above twenty rupecs. He should also find out the nature of payment as to whether: it relates to the business. ‘To which account the payment is posted revenue or capital. This is important as Wrong posting will affect the profit and loss account and ultimately the balance sheet. Attention should be paid to the amount both in words and figures. If they differ, the matter shi Amount mentioned in figures only, taken care of asa cypher or figure a figure by a dishonest employee w difference. ould be investigated. should be particularly may be easily added to hich will make a lot of Note should be made of any item which requires further elucidation or information or i evidence which is available from Partnership Deed, Contracts, Articles of Association, Minute Book, Leases etc, If duplicate voucher for a missing one is produced, it should. be properly scrutinised to avoid any fraud. List of missing vouchers should be Prepared and reason and explanation for their loss should be obtained from the client and if the auditor is not satisfied with the explanation, he should mention this fact in his Teport. Transactions relatin to such vouchers should be carefully examined. Sometimes Youshers may not be available for Certain types of payments as salaries, wa; y ex: can be verified by refereme oon sect eens to salari k " Petty cash book respectively. aries book, wages book,VOUCHING OF GASH TRANSACTIONS 3h 12. Above all, the audit clerk should not take the help of any- members of the staff of the client while vouching except for an explanation, - 13, Reccipted invoices should not be accepted as a voucher as there is a danger of the payment being made twice—once- as a credit purchase and again as a cash transaction. 14. Sometimes business houses issue their own printed receipts to be signed by the payee, which receipts are considered as. vouchers. The practice must be discouraged as the dis- honest employees of the client themselves may fill up such. receipts and forge the signatures of the supposed payecs. In case this has been done, the auditor should get more documentary cvidence such as statement or invoices ete., which should be attached with sucha receipt, before he passes such a voucher. , 15. While examining the vouchers for insurance, rent, rates, and taxes etc., the audit clerk should note the period for which the payment has been mads, Ifthe payment is made for some months in advance, proper adjustments. should be made. Internal Check as regards Cash. Before the auditor starts the vouching of the cash book, he should enquire as to the system of internal check in operation. There- are lot of chances of misappropriation of cash if there is no well-- organised system of internal check. He should enquire as to the duties of the cashier, and whether he has access to the Iedger and other books of original entry. If'so, there are chances of fraud. In case of big concerns, the question will not arise as the cashier will have no time but to write his cash book. This danger is usually in small concerns, The following system of internal check as regards cash receipts is suggested : i. When cash is received, it should be acknowledged by means ofa printed receipt which should have a counterfoil or by a carbon copy receipt. Cashier should not sign receipts and counterfoils. The receipts should be consecu- tively numbered. The unused receipt books should be kept under lock and key. Spoiled receipts should be cancelled and must not be detached from the counterfoils. No blank counterfoils should be accepted. 2. As soon as cash is received, it should be entered in a rough. cash book or diary,32 10. YW. 12. j3. 4. A HANDBOOK OF PRACTICAL AUDITING Remittances should be opened by the cashier in the presence of a responsible officer. All cheques received should be crossed ‘Not Negotiable—A/c Payee only.’ Automatic tills or cash registers are very useful for check- ing receipts. Some cash registers or tills are so made that a receipt is issued only when money is deposited in the till, which device is very useful. All the reccipts of the day should be deposited in the bank at the end of the day or the next morning. Bank reconciliation statement should be prepared frequent- ly by the cashier aud also by some one else. The cashier should not have any control over the ledgers. Petty cash should be organised under the Imprest System. Before a cheque is issued, it should be presented along with the account of the payee to a responsible officer for his signature. Cheques should be crossed ‘A/c Payee only,’ before they are despatched. Unused cheque books should be kept under lock and key by a responsible official lest they may be used by forging the signature of the officer. Castings of the cash book should be independently checked. Internal control should be exercised over the preparation of wage shects to prevent fraud and manipulation. All payments as far as possible, except for petty cash, should be made by cheques. If travellers are permitted to collect money on behalf of the company, the issue of receipts by them and deposits of such moneys into the bank should be carefully control- led. Asa matter of fact, the system of collection by the travellers should be discouraged as far as possible. Fide- lity insurance policies should be taken out as an additional protection to the business if travellers are allowed to collect money. The travellers should be given receipt books having three copies—one to be e1 : another to be sent to the head of} retained by them. erg methed or wecording the cash sales has been dealt chances ak ail low, This should be so organised that of misappropriation are reduced to minimum, given to the customer, ffice and the third to beVOUCHING OF CASH TRANSACTIONS 33 15. Cashier should not sanction the payments of special nature. Directors should do so. Procedure in regard to vouching the debit side of the Cash Book, After satisfying himself that there is a good internal check system regarding the receipts and payments of cash, the audit clerk should now proceed to vouch the debit side of the cash book. It is rather very difficult to vouch receipts as some receipts may be omitted al- together and therefore only an indirect evidence is available. He should check a few items at random and if he finds that they are in order, he may assume that the others will be correct but he must not omit to compare the rough cash book or the diary with the cash ‘book. Ifhe fails to do so and later on a fraud is detected, he might be held responsible. Sometimes it is argued that the auditor is not responsible if he ‘does not check rough cash book or diary because such books are not ‘included in the ‘books of accounts,’ The argument may appear to ‘be sound to some extent, but if such books are a part of the system of account books maintained by the company, the auditor will be failing in his duty if he does not examine these books. The duty of an auditor is not only to examine the books of accounts but also to go beyond them which means that he should examine the memoranda books, and other evidence available in support of the correctness of the books of accounts. Some of the important items which usually appear on the debit side of the cash book and the duty of an auditor in that connection are given below :— 1, Opening Balance. This should be compared with the balance shown in the duly audited balance shect of the previous year. This is done to see that the actual balance was brought down. 2. Cash Sales. There are greater chances of fraud under this head, The salesman may sell goods and may not enter in the cash book and thus misappropriate the money. The following system should be organised to avoid fraud. The salesman should neither deliver the goods to the customer nor receive cash for the goods solid. He should prepare three carbon copies of the cash memo when goods are sold to a customer, to whom two copies of the cash memo are handed over. The goods are in the mzantime sent to thea 34 A HANDBOOK OF PRACTICAL AUDITING cashier. The customer goes to the cashier and hands over the cash memos. The cashier who receives the price of the goods, hands over the goods and a copy of the cash memo duly stamped as ‘cash paid,’ while the other copy of the cash memo is retained by him. Sometimes four copies of the cash memo are prepared. The fourth copy is retained by the gate-keeper who hands over the goods to the customer. At the end of the day, the salesman, the cashier, and the gate-keeper prepare the summaries and send them to the General Manager. The summary sent by the salesman shows the quantity and value of the goods sold ; one sent by the cashier will show the cash collections against the cash memos and one sent by the gate-keeper will show the goods delivered. All the three summaries must tally. Ifthere is any discrepancy, it will mean some fraud. The auditor should check here and there a few items from the salesman’s summaries, cashier's summaries and the gate-keeper’s extracts. If the auditor does not do so, he will be held liable ifany fraud is discovered “Jater on, as was decided in the case of Pendleburry’s Lid. vs. Ellis Green & Co., 1936, Where automatic tills are in use, the entries in the cash sales book and in the cash book should be verified from the till records. In some business houses, cash memos are issued against goods sold on credit. The reason advanced is that this system ensures prompt payment. In such a case, there may be so many cash memos against which there may be no cash. Therefore it would be rather impossible to vouch cash. The auditor should disown his responsibility in such a case. Such a system should, however, be discouraged. 3. Credit Sales, i.e, Cash received from Debtors to whom goods had been sold on credit in the past. | > The auditor should vouch cash received from debtors to whom goods had been sold on credit in the ,past. The only evidence available on account of this item is the counterfoils of the receipts issued to the debtors. But this evidence ,is not very reliable as less amount might have been inserted in the counterfoil than what had actually been reccived from the customer to whom a xeceipt for the full amount might have been issued and Jess amount recorded on the debit side of the cash book.‘VOUCHING OF CASH TRANSACTIONS 35 Again if cash has been received from a debtor, a receipt might have been issued from the unused receipt books unless they had been keept under lock and key. Particular attention should be paid to discount allowed to customers. The method of granting discounts should be enquired into as there .are chances of manipulation, ¢.g., a customer sends Rs, 95 and is allowed Rs, 5 as discount. The cashier may make an entry in the cash column Rs, 90, and in the discount column 10 and the reccipt issued to the debtor will be for Rs. 100 and the counter- foil vill show as if Rs. 90 had been received and a discount of Rs. 10 had been allowed. As a matter of fact, the company has been defrauded by Rs. 5. The auditor will do well to devote his atten- tion to such items as there are chances of fraud. He should check in detail such items and enquire into the method of granting dis- counts. He should ask for the general rate of discounts, Any unusual bigger‘ disédunt should be noted and _an explanation’ should be demanded from a responsible official, ‘He should gnquire as to who sanctions the discounts. . The same remarks apply to bad debts written off. The dis- honest clerk may cither write off the whole of the debit balance or a part of it as bad debt after he has received the whole or a part of the amount. In such cases, the auditor had better enquire as to who is responsible to write off debts as bad. Inno case the cashier thould be allowed to do so. Wherever possible, after taking permission from his clients, a statement of accounts should be sent tothe debtors to confirm the balances shown in the statements so sent. If this is done, debtors should be instructed to send letters of confirmation direct to the auditor. Ifany fraud has been committed, it would be brought to light by adopting this method. 4, Income from Interest, Dividends etc, Interest received on account of fixed deposits in the bank should be vouched with the bank pass book. Sometimes fictitious Pass Books are produced. Care-must be taken to sce that it isa genuine one. Dividends received can be vouched with the counterfoils of the dividend warrants or the letters covering the cheque. Interest received on securities can be voched from the securities themselves or from the Investment Ledger as to the date of the reccipt of interest, the amount, the raté etc. . aan36 A HANDBOOK OF PRACTICAL AUDITING If the interest has been received on account of the loan grant- ed, agreement with the borrower should be inspected to ascertain the rate of interest and the date for the payment of interest etc. If dividend warrants or securities etc., are deposited with the bank for the purpose of collection of interest and dividends, bank pass book must be referred to. Ifthe investment have been sold ‘ex-dividend’, or bought ‘cum-dividend’, the auditor should examine broker’s Sold and Bought Note respectively and should see that dividend is received subsequently. 5- Rents received. The auditor should examine the Lease Deeds and agreements to ascertain the amount of rent payable, the due date, and provision regarding the repairs etc. Rent received may also be compared with the ‘rent rolls’ if they are maintained as in the case of owners of large estates. If receipts are issued to the tenants for the rent paid, the counterfoils of the receipt would bea good evidence. If rents are collected by agents, their accounts must be examined. Particular attention should be paid towards ‘rent outstanding.’ Tt is possible, rent might have been received but misappropriated while it may be shown as outstanding. In such a case, if the outstanding is a heavy one, with the permission of the clients, the auditor should write to the tenants requesting them to confirm the amount of the arrear of rent outstanding against their names. Similar consideration must be paid towards properties shown as “unlet.” 6. Bills Receivable. Bill Receivable Book should be compared with the Cash Book and the Pass Book to see that the amount has been received on the due date. Enquiries should be made regarding the bills which have matured but the amount has not been received for them. Such bills might have been dishonoured or retired. 7. Commission. Commission account should be checked with the account of the parties from whom commission is to be received. Agreement with the parties regarding the rate of commission should be inspect- ed, Counterfoils of the receipts should be checked with the amount in the cash book. 3. Sale of Investments. The amount received on account of the sale of investmentsVOUCHING OF CASH TRANSACTIONS 37 should be vouched with the broker’s sold note. If it has been sold ‘cum-dividend’ he should see that dividend is subsequently received and that the sale proceeds is properly apportioned between capital and revenue. 9. Bad Debt Dividends. The amount received from debtors who have become bankrupt, should be vouched with the dividend warrants received from the Official Receiver or Assignee indicating the total debt and the rate per rupee payable as dividend or any correspondence which might have passed between the debtor or the official receiver and the client, xo, Subscriptions, Subscriptions received by a club or school etc. should be check- ed with the Register of Subscribers and the counterfoils of the receipts. 11. Insurance Claim Money. Insurance money received against a claim from an insurance company, should be checked with correspondence passing between the client and the Insurance Company, the account rendered by the Insurance broker or company. 12, Share Capital. For this item reference may be made to the chapter on Audit of Limited Companies’, where this item has been dealt with in greater detail. 13. Sale of Fixed Assets This item may be vouched with correspondence, auctioneer’s account, sale contract or any other evidence available. 14. Income from Hire-Parchase Agreement. Where money is received on account of the instalment relating to goods sold on hire-purchase system, the auditor should examine the agreement and he should sec that the instalment which is receiv- ed includes interest and that it is properly allocated to interest account as whole of it does not include the actual sale, 15. Miscellancous receipts, Correspondence, contracts, or any other document will help the auditor to vouch such transactions. Credit side or the Payment side of the Cash Book. When the auditor has finshed the vauching of the debit side of the cash book and having satisfied himself that there isa good inter~38 ‘A HANDBOOK OF PRACTICAL AUDITING nial check system, the auditor should now proceed to vouch the cash payments which means that he should satisfy himself that the pay- ments have been actually made ~ (a) to the right persons or parties ; (6) for the business itself ; {c) have been properly recorded in the books of accounts ; and (d) have been sanctioned by a person holding some authority. The detection of misappropriation of money depends largely on an intelligent and careful vouching of this side of the cash book. Some of the important items which usually appear on the credit side of the cash book and the duty of an auditor thereto are given below :— I. Credit Purchases, i.e., cash paid to creditors from whom goods had been purchased on credit in the past. Money paid to creditors on open accounts can be vouched with the receipts issued by the creditors acknowledging the receipt of moncy. Money due to them can be compared with the accounts of the creditors and the actual invoices received from the suppliers of the goods, The auditor should enquire whether periodical state- ments are submitted by the creditors and are compared with the creditors accounts. He may have to referto minutes, contracts, and other evidences before he passes an entry. In regard to Cash Purchases, cash memos and Goods Inward Book should be compared with the entries in the cash book. Special attention should be paid to discounts, i.e. trade discounts should be deducted from the purchases and only net figure should be carried to the books of accounts. If any voucher is missing, he should insist upon getting a dupli- cate copy of it. He should vouch such an item with any possible documentary evidence. II. Wages. Another important entry, which is usually a big one, is that of wages. There arc many chances of misappropriation of cash under this head. Before he proceeds with his work, he should make a thorough investigation regarding the internal check system prevalent He should satisfy himself that the arrangement for the preparatior of wages sheets and the system of payment is adequate not to leave any Joop-hole for fraud. If he finds that there is any loop-hole, he musVOUGHING OF CASH TRANSACTIONS 39 disown his liability, The chances of fraud or errors are : (a) The inclusion of fictitious names or ‘dummy men’ in the wages book, (6) Possibility of clerical errars. (ce) Error or fraud in time and piece-work records, All the above may mean withdrawal of more money than is actually needed for payment to the workers. The following system of preparing the wages shects is, however, suggested to avoid fraud : the system will be of great help to the auditor. OF course, the best system applicable will vary in each particular case. (a) Time Records. If the wages are to be paid according to the time spent by the worker, correct record of the time spent by him in the factory should be recorded. For this purpose, Time Recording Clocks should be installed at the gate and as soon as a worker enters or leaves the factory, the time should be recorded. In case there is no Time Re- cording Clock, the gate-keeper should record the time of each worker. So that the workers may not waste their time, the time of their arrival and departure should also be recorded ineach department by means of another Time Recording Clock or by the foreman of the depart- ment. These two records, viz. one maintained by the gate-keeper and the other by the foreman of the department should be compared. {b) Piece-work Record. Where the wages are to be paid according to piece wage system. ‘each worker should be given a card which should record the amount of work done by the worker. This should be signed by the worker, foreman of the department and the store-keeper to whom the goods are delivered when they are ready. Ifany fine is to be imposed on account of faulty ‘goods, it must be recorded. {c) Preparation of Wages Sheets. Information regarding the time record and piece work record available now should be entered in the wages sheet or wages book (separate wages sheets should be prepared for time workers) which should have the following columns : (2) Worker’s, number, name, occupation and rate of wages per day or month or per unit of goods, (ii) Time : ordinary and overtime.40 A HANDBOOK OF PRACTICAL AUDITING (ii) Gross amount payable. (iz) Deduction on account of fines, contributions towards pro- vident fund, sickness insurance etc. (v) Any advance of wages. (zi) Net wages payable. ‘Whole of the above information should be collected by different clerks from the gate-keeper’s record, foreman’s record ete. and if there is any discrepancy, it should be enquired into. All the clerks who have to do something in the preparation of the wages sheets, should initial the sheets so that the responsibility may rest upon them individually if any error is discovered later on. The whole of the wages sheets should be counter-signed by the Works Manager, a partner and a director. (d) Payment of Wages. The Wages Sheets should now be handed over to the cashier who should have nothing to do with its preparation. The cashier should then withdraw the exact amount which is shown under the column ‘Net wages payable,’ plus the amount payable for ‘sickness insurance’ etc. The foreman of each depart~ ment should be present at the time of payment to prevent imper- sonation for any absentee worker. Wages of the absentees should be paid to a worker only when he has brought a letter of authority, but with due precaution. In no case should they be paid to the foreman or a fellow worker. The wages of the absentees should be paid on the following few days after satisfactory explanation from the persons entitled thereto, The Works Manager or some responsible officer should be present at the time of payment. All the officers, namely the Cashier, the Foreman and the Works Manager should sign the Wages Shect as a certificate of correct payment having been made. It is not passible to get the signatures of each payee. If the above system is followed the evidence of the Foreman, the Cashier, and the Works Manager will be sufficient proof of the payment having been made. A list of the “Unpaid Wages” should be prepared and signed by the Cashier, Foreman of the Department concerned and the Works Manager. Auditor’s Duty as regards Wages. 1, He should see whether the Internal Check System as detailed above is satisfactory and that there is no loop-VOUCHING OF CASH TRANSACTIONS 4t hole for any fraud. Ifhe finds any loop-hole he should probe into it and disown his responsibility. 2. He should check a few items of the wages sheet here and there to see that the calculations are correct. If he does not do so, he would be held responsible if Jater on it is found that the Wages Sheet was incorrectly prepared and overpayment was made. 3. He should check the total amount of wages payable with the amount of cheques drawn to see that more money has not been withdrawn than was needed, 4, He should check the names of some of the workers as mentioned in the Wages Sheet with the job cards and the Gate-Kcepers and the Foreman’s register to sec that no “dummy” workers are included. 5. He should also see that the wages sheet is properly initial- led or signed by all the persons responsible for the pre- paration of the wages sheet. 6. He may pay a surprise visiton the day of payment of wages to sec that they are paid according to the method suggested above, though it isnot his duty in the ordinary course, In short the duty of an auditor in verifying the item of wages is to see that the wages as recorded in the Cash Book have actually been paid and that they were actually due and that they were properly authorised. UE. Capital Expenditure. Capital expenditure means moncy spent on acquiring fixed assets. The duty of an auditor in this connection is to see that the payment is in order, that it is duly authorised and the money spent is properly capitalised. Such expenditure requires special’ atten- tion. The question as to which documentary evidence is required will depend upon the circumstances of each particular case. We shall take up some of the fixed asscts and deal with the duties of the auditor in vouching such expenditure in each case, {a) Freehold and Leasehold Property and Buildings. The agreement for the sale of property, or the Lease Deed, Conveyance and Title Deeds, showing the money paid, should be examined. Ifthe property has been purchased through a broker, his statement or account should be examined. If it has been pur- chased at an auction, auctioncer’s note or account will be a good42 A HANDBOOK OF PRACTICAL AUDITING ‘evidence. In case a building has been constructed, Architect's certificate, Builder’s contract and his receipt should be examined. Expenses incurred in acquiring the fixed asset, eg., auc- tioneer’s commission, brokerage, architects fees or solicitor’s charges, which can be vouched by their respective accounts, may be capitalised. In some cases, the staff of the client and his ‘materials are used in construction of the building. In such a case, allocation of materials and wages is necessary. (6) Plant and Machinery. Same considerations apply as in the case of Land and Building. “Invoice of the supplier of the machinery should be examined to see ‘the price paid for it. In case some expenses have been incurred in ‘erecting and fixing up the plant, he should see that such expenses are capitalised, {c) Patents. In case a patent has been purchased, the auditor should examine the patent and the receipt acknowledging the purchase consider- cation, Any expense incurred in acquiring it should be capitalised. Ifthe patent has been acquired through an agent, the auditor sshould see that his commission is capitalised. It should be remem~ bered that the renewal fees is not capitalised but treated as revenue ‘expenditure. {d) Investments, © Payments for the purchase of shares, securities etc. should be vouched with the Broker’s Bought Note. If possible, actually examine the Investments, If they have been purchased cum-dividend, the auditor should see that the interest accrued is received subsequently and that it is properly allocated between capital and revenue. Jn case of new issues, letter of allotment and the Banker’s receipt for the instalment should be examined. Incase of Inscribed stocks, a certificate from the Bank in -whose books the stock is inscribed, should be examined. {e} Payments under Hire-purchase and Instalment Agree- ments. The auditor should examine the agreement regarding the “ rchase or Instalment. For every instalment paid, he shouldVOUCHING OF CASH TRANSACTIONS 43 examine the vouchers. Those instalments which have been paid include interest also and thercfore he should sce that it is not capitalised but is transferred to revenue account. -TV. Loans. He should examine the receipt given by the borrower. He should make enquiry whether his clicnt is authorised to advance loans. Ifthe Joan has been advanced against certain securities, he -should examine those securities. If the loan has been advanced -against mortgage, he should examine the Mortgage Decd and the Title Deeds etc. In case of Ioan to the Directors and Officers of the company, he must sec that the provisions of the Companics Act are complied with, i.¢., approval of the Central Government has been obtained. “V. Salaries. Salaries book should be examined. He should see that the total for the salaries book for a particular month agrees with the -cheque drawn for salarics or the item in the cash book under the cash column. There may be some variation in the salary of an employee during the course of a year, possibly because of the increment -which falls due in a particular month or some special increment or allowance might have been given. The auditor should see whether ‘the increment was actually due or it isa fictitious entry. To as- certain this he should examine the agreement or a copy of the letter of appointment or the minutes book of the Directors etc. “VIL Agents’ and Travellers’ Commission. The agreement with the travellers and the agents should be examined to ascertain the terms of the appointment regarding the rate of commission, Calculation should be made and the receipt given by the traveller and agent should be cramined and compared with the cash book. The auditor should test the payment of commission by examining the orders reccived through the travellers, “VIL. Travelling Allowance. : He should see the rules and regulations regarding the payment ~of travelling allowance. Calculations should be made. Where fixed travelling expenses are allowed, no calculation cis necessary. He should see that the travelling bills have been duly -checked by a responsible official,44 A SIANDBOOK OF PRACTICAL AUDITING WIE. Insurance Premiums. In case of a new policy, the receipt from the Insurance Company and the Policy itself should be examined, In case of renewal, the renewal receipt for the premium should be examined: TX. Bills Payable. Returned bill duly cancelled should be examined. It would. be a sufficient evidence of the amount having been paid. Reference may be made to the Pass Book and Bills Payable Book. X. Bills Receivable Discounted and Dishonoured. Bills Receivable which had been discounted with the bank and which have been dishonoured can be vouched with the entry in the Pass Book. The auditor should sce that the account of the acceptor or the previous endorser is debited with the amount of the bill together with the noting charges and other expenses, if any. If the bill had not been discounted, but had been sent to the bank for collection, the bank would credit the client’s account and when presented for payment and is dishonoured, the bank will debit the account of the client. These entries can be vouched with the Pass Book, Bills Payable Book and the Cash Book. The dishonoured bill should be examined. XI. Freight and Carriage and Custom Duties. The statements of account regarding the payment of freight and carriage, submitted by the shippers, Clearing or Forwarding Agents, together with the receipts issued by them, should be examined to see that the payment has been duly made and accounted. for. He should see that allowances in respect of rebates have beer brought into account. XH. Bank Charges. Bank charges such as commission, interest on overdraft, and loan etc. should be examined with the Bank Pass Book. XIU. Partner’s Drawings. Partnership Deed should be examined as to what is the- maximum amount and the time for which a partner can draw moncy and whether he is to be charged any interest on drawings. He should vouch this entry with the Partner’s Drawing Book or Account and see that the signature of the partner is there against such entry. XIV. Postage. The postage book should be compared with the Gash Book.VOUCHING OF CASH TRANSACTIONS 45 -or the Petty Cash Book and the balance of stamps in hand should be counted. XV. Petty Cash. There ate greater chances of misappropriation of cash as there are no vouchers for a number of petty payments. He should, therefore, make an enquiry into the Internal Check System of Petty ‘Cash Payments. The petty cash book should be maintained on the Imprest System. To ensure a fairly frequent inspection of the pet- ty cash book by the cashier, the fixed round sum or ‘float’ should be as low as possible. The amount of petty cash which should remain in the hands of the petty cashier should be as low as possible accor- ding to the requircment of the business. The auditor should check the receipt of money by the petty cashier with the cash book and also compare the dates. In certain cases, a certain sum is advanced to the petty cashier who is not subjected to any check by the cashier. The P. & L. Afe. is debited at the end of the month or the year with the total amount spent by the petty cashier. It is very seldom that the ‘auditor or cashier checks the petty cash book. The procedure is very defective and the auditor should disown his responsibility. He should recommend the adoption of the columnar petty cash book which should be maintained on the Imprest System as explain- ‘ed above, Postage may be compared with the postage book. He should insist upon having vouchers for every expenditure, say above Rs.2 or so. These vouchers should be properly arranged and ‘consecutively numbered, In certain cases, it may not be possible to have vouchers, say for bus fare, charity, entertainment (cigarettes and tea etc.) in which case the docket system should be introduced. According to this system a slip showing the amount of expenditure should be signed by the officer who has spent that amount. The amount in the docket should be both in words as well as in figures to prevent any alteration in the figures after the docket has been signed. Ifa docket cannot be prepared, a list of all such expenses for which a docket or voucher could not be had, may be prepared in the evening and signed by a responsible person. The purpose for which money was spent should also be shown. The auditor should check a few items at random. He should also cast the individual columns to sce whether the additions are correct. Postage can also be dealt with like the petty cash. A definite amount of stamps should be handed over to the despatcher, who will keep the records of the letters etc. sent out, Whenever he46 A HANDBOOK OF PRACTICAL AUDITING wants more stamps, he will have to get his postage book checked... Thus there will be little chance of embezzlement. The auditor should count the petty cash balance on the balance: sheet date. Ifhe cannot be present on that day, he should instruct the client to deposit the balance in the bank. If that has also not been done, he should check the expenditure from the date of the palance sheet to the date of checking and should count the petty cash balance in hand on that date, The counting of petty cash balance in hand is very important. Ifhe does not do so and if there: js any discrepancy in the balance as per the petty cash book, and actual cash in hand, he will be held responsible to pay damages as was held in the case of London Oil Storage Company Ltd. vs, Sear Hasluck & Co. in which case it was held that in not vouch~ ing the existence of petty cash in hand, the auditor had committed a breach of duty. The balance as shown by the books amounted to £796, while actual cash in hand amounted to £30 only. While counting the petty cash balance the auditor should see that it does not include any I, O. Us. If there are such acknow- ledgments, he should get confirmation, especially in the case of 1,0.Us. by high officials of the concern because there have been cases. where a dishonest petty cash clerk having embezzled the money, covered it up by forged I.0.Us. thinking that the auditor would not care to get these 1.0.Us. verified from the high officials. Petty cashier should not be allowed to lend money out of petty cash to any” employee of the company, 1 Directors’ Fee. He should examine the Articles of Association to find out the fee payable to the directors. He should also examine the minute book or the attendance register of the Board of Directors or the reso-~ lution passed at a gencral meeting sanctioning sueh a payment to ascertain the number of meetings attended by them to calculate the fee payable to the directors. He should examine the vouchers too. Where the fees are to be calculated asa percentage on profits, he should examine the agreement and find out the basis of the calculation of the profits. Te must be remembered that according to S. 211 (2) of the Companies Act, it is incumbent that the remuneration paid to the directors cither by way of fees or commission etc. must be shown sf ely in the Profit and Loss Account. If this has not beenVOUCHING OF CASH TRANSACTIONS 47 done, the auditor must make a mention of this fact in his report. The total amount paid to all the directors must be shown and not the amount paid to individual directors. According to S. 201 (1) of the Companies Act, tax-free payments are prohibited. A Company is prohibited to pay more than Rs. 50,000 in any onc year to the Directors, Managing Agents, Secretaries etc, Ifa director has foregone his fee, the auditor should refer to the minute book of the directors. This is necessary to avoid any mis- appropriation. “KVI. Miscellancous expenses, such as rent, rates, taxes, advertising, lighting ctc. He should examine the vouchers as usual and sec that the expenditure is properly apportioncd between the periods where necessary. Bank Account. During the year, cash or cheques are sent to the bank and money is withdrawn from it frequently. Therefore such receipts and payments are to be verified. These transactions in the Cash Book should be compared with the Pass Book. Payments into the bank should be vouched with the counterfoils of the paying-in-book. Sometimes customers making payment to the client, pay direct to the client’s banking account. Sucha transaction will be vouched from bank’s advice "notes of amounts having been credited to the client’s account. Pay-~ ments out of the bank can be vouched with the counterfoils of the cheques issued. In case the client has ordered the bank to transfer a certain amount to a creditor or to a society or association as subscrip- tion, counterfoils of the cheques will not be available. In such a case the receipt from the payee.and a copy of the advice to the banker for such a transfer will be sufficient proof of payment. For some items such as Bank Charges, Interest, Incidental Expenses etc. there will be no proof except the Bank Pass Book or a letter from the bank to this effect. Particular attention should be paid to dates, It sometimes happens that the cashier records the transactions on the payment side as if the money has been sent to the bank but actually it is not sent and the cashier utilises the money for some time and deposits the money later on. Though no miisappropria- ‘tion of money in sucha case has taken place yet this course is un- desirable. In some cases, there might be difference between the dates in the cash book and the pass book which might be due to the48 A HANDBOOK OF PRACTICAL AUDITING fact that cheques sent to the bank might not have been collected and hence the account might not have been credited. It may be very difficult to check all the items where cheques drawn are numerous. In such a case, the auditor will do well to ap- ply ‘test checks’, i.e. a few transactions may be checked at random. With regard to the balance at the bank, the bank reconcilia~ tion statement should be prepared to verify the balance.

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