sureme 75 finalxcbcvbvcb

7/25/2019 Sureme 75 Finalxcbcvbvcb

1/61

CA. Aseem Trivedis

Supreme

75THOROUGHLY REVISEDOther Topics underAdvanced Auditing

Enough for Exams

1 CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


2/61

CHAPTE

R

1

AUDIT OF ENTITIES

CARRYING ON GENERAL

INSURANCE BUSINESS

PART A

SHORT NOTES { 4 Marks}

Q.1 What is Premium Deficiency?

The Regulations require that premium deficiency should be recognized if the sum

of expected claim costs, related expenses and maintenance costs exceeds related

unearned premium. After ascertainment of total unearned premium one is

required to estimate the expected claim costs, related expenses and maintenance

costs. These estimates are based on the information available on the balance

sheet date and the company's knowledge about the trend. If the unearned

premium exceeds the expected claim costs, related expenses and maintenance

costs, the excess of unearned premium is ignored. IF the total of expected claim,

costs related expenses and maintenance costs exceeds the related unearned

premiums, a provision for premium deficiency is created in the financial

statements. In the case of insurance contracts exceeding four years, estimation of

claims is required to be done on actuarial basis subject to regulations that may

be prescribed by the Authority. A certificate from a recognized actuary is required

" CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


3/61

to be obtained. It may be noted that the Regulations require that for contracts

exceeding four years, once a premium deficiency has occurred, future changes in

liabilities, that might arise, should be based on actuarial or technical evaluation.

The actuarial assumptions used for estimation of liabilities or claims are required

to be disclosed in the financial statements.

Q.2 Solvency margin in case of an insurer carrying on general insurance

business ( Nov. 06, May 12}

Answer

Solvency margin in case of an insurer carrying on general insurance

business:In case of an insurer carrying on general insurance business, the

solvency margin should be the highest of the following amounts :

(i) fifty crore rupees (one hundred crores of rupees in case of reinsurer), or

(ii)a sum equivalent to twenty percent of the net premium income; or

(iii)a sum equivalent to thirty percent of net incurred claims.

Subject to credit for reinsurance in computing net premiums and net incurred

claims being actual but a percentage, determined by the regulation but not

exceeding fifty percent. It may be noted that conditions regarding maintenance of

the above mentioned solvency margin may be relaxed by the authorities in

certain special circumstances.

If, at any time, an insurer does not maintain the required solvency margin, the

insurer is required to submit a financial plan to the authority indicating the plan

of action to correct the deficiency in the solvency margin. If, on consideration of

the plan, the authority finds it inadequate the insurer has to modify the financial

plan.

Sub-section (2c) of Sec 64 A states that if an insurer fails to comply with the

requirements of the insurance Act, 1938, it shall deemed to be insolvent and may

be wound up by the court.

Q.3 What is Unexpired Risk Reserve?All policies are renewed annually except in specific cases where short period

policies are issued. Since the insurer closes his accounts on a particular date not

all risks under policies expire on that date. Some policies extend beyond this date

into the following year and the risks continue based on two different ways as

discussed above. Therefore, at the closing date, there is un-expired liability under

the various policies, which may occur during the remaining terms of the policy

beyond the year-end, for which we have to defer revenue. Calculating the revue to

be deferred is very time consuming thing and hence a simple method is adopted

to provide for un-expired risks. According to the requirements of the Insurance

Act, 1938 it is sufficient if the provision is made for un-expired risksi. @ 50% for Fire and Marine Cargo and Miscellaneous Business.

# CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


4/61

ii. @ 100% for Marine Hull.

It may be mentioned that the provisions of section 44 of the Income Tax Act,

1961, govern Insurance companies. The Income Tax Rules also provide for

creation of a reserve for un-expired risks. The deduction of these reserves is also

allowed under the Income Tax Act.

Q.4 What is reinsurance ?

( Nov. 00, Nov.03, Nov.05, Nov. 08, Nov.09 },

Virtually all insurers require the help of reinsurance because in insurance

business, there are certain risks, which, because of their magnitude or nature,

one insurance company cannot afford to cover. The arrangement where by one

insurer obtains insurance from another insurer on risks assumed by the former

is called reinsurance. The former is called the ceding company, where the latter is

called the reinsurer.

Types of Reinsurance Contracts

A. Facultative Reinsurance: Reinsurance whereby separate contracts are

entered into for each particular risk that is mentioned in the policy. Each

transaction under facultative reinsurance has to be negotiated individually.

B. Treaty Reinsurance: Under this reinsurance a treaty is entered into between

the ceding company and the reinsurer for reinsurance of the limits covered under

the treaty. The limits may be monetary, geographical, section of business, etc.

under this reinsurance it is obligatory on the part of both to accept and cede the

risk with the limit specified.

Q.5 What is Co-insurance? { May 2000}

When the insured prefer to have more than one insurer for the same risk, it

would amount to coinsurance. Large business risks are shared between more

than one insurers under co-insurance arrangements at agreed percentages. All

the formalities like issues the documents, collection of premiums and settlement

of claims are handled by the leading insurer. The leading insurer renders

statements of Accountants to the co-insurers. The auditor should see that the

premium account is credited on the basis of statements received from the leading

insurer. Incase the statement is not received, the premium is accounted for on

the basis of advices to ensure that all premium in respect of risks assumed in

any year is booked in the same year. As a normal audit procedure the audit

should also review the communication in the post audit period. The auditor

should insist in obtaining a written confirmation to the effect that all incoming

advice has been accounted for. The claims provisions and claims paid should also

be verified with reference to advice received from the leading insurer. In case of

outgoing co-insurance the auditor should scrutinize the transactions relating to

outgoing business; i.e. where the company is the leader. These should be checked

with reference to the relevant risks assumed under policies and correspondingly

for debits arising to the co-insurer on account of their share of claim. It is

recommended that all the co-insurer specify all the terms and conditions in their

agreement.

$ CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


5/61

PART B

DESCRIBE The Concept { 6 marks}

Q.6 State the procedure for verification of Agents Balances in the

course of audit of a General Insurance Company.

( Nov.04, May 09,Nov.10,Nov.11,)

Answer

General Insurance Company Verification of Agents Balances:The

following are the audit procedures for verification of outstanding agents

balances:

(i) Scrutiny and review of control accounts debit balances and their

nature should be enquired into.

(ii) Examination of inoperative balances and treatment given for old

balances be looked into.

(iii) Enquiring into the reasons for retaining the old balance.

(iv) Verification of old debit balances which may require provision or

adjustment. Explanation be obtained from the management in this

regard.

Q.7 In the context of audit of general insurance business, state the

provisions regarding management expenses.{Nov.01}

Answer

Provisions regarding Management Expenses: Section 40C of the

Insurance Act, 1938 read with Rule 17E lays down the provisions regarding

limit on expenses of management in general insurance business. It

requires that no insurer shall, in respect of any class of general insurance

business transacted by him in India, spend in any calendar year as

expenses of management including commission or remuneration for

procuring business an amount in excess of the prescribed limits and in

prescribing any such limits regard shall be had to the size and age of the

insurer. However, any excessive amount over the permissible limits may be

approved by the Insurance Regulatory Development Authority after

consultation with the Executive Committee of the General Insurance

Companies. Further every insurer as aforesaid shall incorporate in the

revenue account a certificate signed by the Chairman and two directors and

by the principal officer of the insurer, and by an auditor certifying that all

expenses of management wherever incurred, whether directly or indirectly,

in respect of the business referred to in this section, have been fully debited

in the revenue account as expenses. Such expenses mean all charges,

wherever incurred whether directly or indirectly, including commission

payments of all kinds and, in the case of an insurer having his principal



6/61

place of business outside India, a proper share of head office expenses,

which shall not be less than such percentage as may be prescribed, of his

gross premium income (that is to say, the premium income without taking

into account premiums or re-insurance ceded or accepted) written direct in

India during the year, but in computing the expenses of management in

India the following, and only the following, expenses may be excluded,

namely:

(i)In the case of an insurer who has his principal place of business in

India, a share of head office expenses in respect of general insurance

business transacted by him outside India not exceeding a prescribed

percentage of his gross direct premium written outside India.

(ii)Any expenses debited to the profit and loss account relating exclusively

to the management of capital and dealings with shareholders and a

proper share of managerial expenses calculated in the prescribedmanner.

Rules 17E of the Insurance Rules, 1939 deals with the computation and

limitation of expenses of management in general insurance business.

Q.8 What are Investment norms for General Insurance Companies?

In exercise of the power conferred by the Insurance Act, 1938, the Authority, in

consultation with the Insurance Advisory Committee, has made the Insurance

Regulatory and Development Authority (Investment) Regulations are subject to

revision by the Authority from time to time. Regulation 4 of the amendedRegulations on investments prescribes that every insurer carrying on the

business of general insurance should invest and at all times keep invested its

total assets in the following manner:

Investment in other than approved investment if

(1)Such investment is less than 25 % of total investment and

(2)Consent of all the directors have been obtained for such

Insurer shall not invest in any one insurance or investment company exceeding

(1)10% of the total asset of insurer(2)2% of share capital/debenture of the company (insurance or investment

company such 2% may be 10% for investment in other than insurance or

investment company.

It should be noted that funds of the policy holders shall not be invested outside

India.

Every Insurer shall keep invested all the times

1.At least 20% of investment In government Securities

2.At least 30%(including (1)) State Government and other guaranteed

securities

3.At least 5% Housing and Loan to state government

% CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


7/61

4.At leat 10% Approved securities under

Infrastructure/Social sector.

5.Up to 55% Other Securities

Part C

Describe in Details { 8 Marks}

Q.9 Describe the audit procedures to be followed for verification of

premiums by a statutory auditor of a general insurance company.{ May

01,Nov.2002}

Answer

Verification of Premiums:In the audit of a general insurance company,verification of premium is one of the most important aspects for the

statutory auditor. The following procedure should normally be applied for

verification of premium:

(i) Ascertain that all the cover notes relating to the risks

assumed have been serially numbered for each class of

business.

(ii) Ensure that the premium in respect of risks starting during

the relevant accounting year has been accounted as premium

income of that year but pertaining to risk commencing in thefollowing year has been accounted as Premium Received in

Advance.

(iii) Verify the collections lodged by the agents after the balance

sheet date to see whether any collection pertains to risk

commencing for the year under audit. The auditor should

also check that the premium has been recorded originally at

the gross figure without providing for unexpired risks and re

insurances.

(iv) In case of co-insurance business, the auditor should see that

the companys share of premium has been accounted for on

the basis of the available information on nature of risk and

the provisional premium charged by the leading insurer.

(v) Check whether premium register have been maintained

chronologically, for each underwriting department, giving full

particulars including service tax charged as per acceptance

advise on the day to day basis.

(vi) Verify the year-end transactions to check that the amounts

received during the year in respect of risks commencing or

installments falling due on or after the first day of the next

financial year are not credited to premium account but to

Premium Received in Advance Account.



8/61

(vii) Verify the collections remitted by the agents after the cut-off

date to verify the risks assumed during the year for those

collections. If the premium originally received has been

refunded, the auditor should verify whether the agency

commission paid on such premium has been recovered from

the agent.

Q.10 What are the specific areas to which you will give your attention

while examining Claims Paid by a General Insurance Company.

( May 04,May 2010}

Answer

a. Examination of claims paid:The following specific areas need tobe given attention while examining claims paid by the general

insurance company:

(i) Obtaining information from branches/divisions regarding

each class of business categorising the claims value-wise.

(ii) Ascertaining the status of claims outstanding at the year-end

on the basis of information available, with the company,

claims for which company is liable, etc.

(iii) To verify in the case of claims paid on the basis of advices

from other insurance companies whether share of premium

was also received by the company. Claims communicated to

other insurance companies after the year end for losses

which occurred prior to the year must be accounted for in

the years of audit.

(iv) Claim payments have been duly sanctioned by authority

concerned and acknowledgements obtained from the

recipients.

(v) Salvage recovered has been duly accounted and letter of

subrogation has been obtained in accordance with the laid

down procedure.

(vi) Amounts deposited with the Courts where the litigation is

not completed are treated as advance/deposit and held as

assets till disposal of such claims.

(vii) Past payment made against claims are duly vouched.

(viii) Ensure that the claimant has given unqualified discharge

note in the case of final payment of claims.

(ix) In the case of co-insurance arrangements claims to be

booked in respect of companys share and the balance has to

be debited to others insurance companies

PART- D

& CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


9/61

PRACTICAL CASE STUDIES { 4 Marks Each}

Q. 11 ABC Limited, an Indian insurance company carrying on general

insurance business, is facing liquidity problems and, therefore, it has

decided to maintain deposits under section 7 of the Insurance Act, 1938 atone percent of total gross premium written in India. The company thinks

that it is sufficient, as the company has a Paid-up Capital of 150 Crores.

As an Auditor of ABC Limited what would be your suggestion to the

company for compliance of Insurance Act and rules and regulations made

there under?

o Section 7 of the Insurance Act, 1938 requires every insurer, carrying a

general insurance business,

o to deposit and

o keep deposited with RBI

o in its one of the offices in India a sum equivalent to three percent of total

gross premium written in India in any financial year.

oThe maximum limit of deposit under this section is Rupees ten crores.

oThe deposit is to be for and on behalf of the Government of India.

oThe deposit can be made either by way of cash or investment in approved

securities.

oThe amount of deposit required in the case of reinsurance business is

rupees twenty crores.

In the given case, Since ABC Limited has decided to maintain deposits at one

percent of the total gross premium written in India, which is violation of the Section

7 of the Insurance Act, 1938. The contention of the company that it has a paid up

capital of 150 Crores would not make the difference.

Q.12As at 31st March 2013 while auditing Safe Insurance Ltd you observed

that a policy has been issued on 25th March 2013 for fire risk favouring one

of the leading corporate houses in the country without the actual receipt of

premium and it was reflected as premium receivable. The company

maintained that it is a usual practice in respect of big customers and the

money was collected on 5th April, 2013. You further noticed that there wasa fire accident in the premises of the insured on 31st March 2013 and a

claim was lodged for the same. The insurance company also made a

provision for claim. Please respond.

According to section 64VB of the Insurance Act no risk can be assumed by the

insurer unless the premium is received. No insurer should assume any risk in

India in respect of any insurance business on which premium is ordinarily

outstanding in India unless and until the premium payable is paid or is guaranteed

to be paid by such person in such manner and within such time, as may be

prescribed, or unless and until deposit of such amount, as may be prescribed, is

' CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


10/61

made in advance in the prescribed manner. In view of the above, the insurance

company is not liable to pay the claim and hence no provision for claim is required.

CHAPTE

R

2AUDIT OFBANKS

PART-A

SHORT NOTES {4 Marks} Generally not asked

PART B

Describe a Concept { 4 to 6 Marks }

Q.13. What is cash reserve?

Everybanking company,except a scheduled bank, shall maintainin Indiaby

way of cash reserve withitself, or by way of balance in a current account withthe

Reserve Bank, or by way ofnet balance in current accounts, or in one or more of

the aforesaid ways, a sum equivalent to at leastthree per cent of the total of its

1( CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


11/61

demand and time liabilitiesin India as on the last Friday of the second preceding

fortnight.

Everyscheduled bankis required to maintainwith the Reserve Bankanaverage

daily balancethe amount of which shallnot be less than three per centof the

total of its demand and time liabilities in India. The said rate may, however, be

increased by the Reserve Bank by notification up to 15% of the total of demand and

time liabilities in India. The average daily balance and the additional balance

required by such a notification are generally referred to as Statutory Deposit and

Additional Statutory Deposit respectively.

Q.14 What is Statutory Liquidity Ratio {May 02,Nov.03}

Everybanking companyshall maintainin Indiain cash, gold or unencumbered

approved securities an amount equivalent to, at the close of business on any day,twenty-five per cent, or such other percentage not exceeding forty, as the Reserve

Bank of India may from time to time specify, of the total of its demand and time

liabilities in India as on the last Friday of the second preceding fortnight. This is

known as statutory liquidity ratio' (SLR). All banks are required to advise their

statutory central auditors to verify the compliance of statutory liquidity ratio on

twelve odd dates in different months not being Fridays.

Topic - AUDIT OF INVESTMENTS IN BANK

Q. 15 Define HTM,AFS and HTM category of investments? Is shuffling from

one category to another is permissible? { Nov.2008}

Held to maturity :- This category would comprise securities acquired by the

bank with the intention to hold them aupt to maturity

Held for Trading :- are short term investments held with an intention of

trading

Available for sale:- Investment which can not be classified into above two

categories.

Held to Maturity { Nov.2005,

following are the features of this type of investments:



12/61

i. Classified in this category at the time of purchase.Reclassificationis also

permitted but as perrulesas discussed later.

ii. Maximum investment under this category can be 25% of the total investment by

the bank.

iii. Profit / loss on sale of investments in this category should be first taken to profit

and loss account and thereafterprofitshould be appropriated to Capital Reserve

Account'

Held for Trading

following are the features of this type of investments:

i. Purchased with theintention to tradein short term

ii. The object ismaking profitby short term movement in prices.

iii. These investments are to br sold with90 Days.

iv. Profit / loss on sale of investments in this category should be taken to profit and

loss account.

Available for Sale

This is a residual category. The investment which are not classified among above

two categories are classified here. Profit / loss on sale of investments in this

category should be taken to profit and loss account.

Shifting among Categories:Following guidelines should be followed while shifting

the investment from one category to other:

a. Shiftingto / from Held to Maturitycategory can be shifted onlyonce in a year

only after approval of ofBoard of Directors, preferably at the beginning of the year.

b. Shiftingfrom Available for Salecategory toHeld for Tradingcategory is

permitted with the approval ofBoard of Directors / Investment Committee

except in case ofemergencies where Chief Executive of the bank can authorise

such shifting provided later approval is taken from Board of Directors.

c. Shiftingfrom Held for TradingtoAvailable for Saleis generally not permitted

unless the bank is not able to sell those with in 90 days due to extreme market

conditions. However approval ofBoard of Directors / Investment Committeeis

required.

1" CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


13/61

d. Transfer from one to other category has to done at cost / book value /market

value whichevr is least on the date of transfer.

Q.16 How investments are valued in case of Bank?

Following are the valuations rules in a Bank?

1. Held to Maturity:Investment should be carried atacquistion costexcept

where the acquistion cost is more than face value. In that case the amount above

the face value should be amortised over the period of maturity.Any permanent

declinein the value of investment in subsidiaries and joint ventures under this

categoryshould provided.

2.Available for Sale:All the scrip in this categoryshould be marked to marketat

the interval of a quarter or less.Net depreciation in any categoryshould beprovided for in theprofit and loss accountand net appreciation should be

ignored. The amount of provision made in the profit and loss account, net of taxes

and net of consequent reduction in the transfer to Statutory Reserve, should be

credited back to profit and loss account from Investment Fluctuation Reserve. In

case of subsequent reversal of this amount credit for the same to be given to

Investment Fluctuation Reserve.

3.Held for Trading:Should be marked to market in a interval of a month or less.

Q.17 What do you mean by Investment Fluctuation Reserve?

The banks are required to create Investment Fluctuation Reserve (IFR) with a

minimum of 5% of the Investment portfolio . In calculating the portfolio the

investment in "Held for Maturity" should not be included. The requirement of 5% is

the minimum requirement and banks can create the reserve to the extent of 10%.

The bank should try to credit this account with the maximun amount of gains on

sale of investment and the portion of realised gains on two categories except "Held

for Maturity" .This transfer will be an appropriation to profit and loss account.

Topic AUDIT OF ADVANCES

Q.18 What is a Non performing Assets { May 2000,Nov. 2000, May 05, May 06,

May 11,}

Non performing assets are such advances which are not performing to realise the

income from interest. Following are the norms how the advance facilities are treated

by banks as NPA

(a)Term Loans:A term loan is treated as a non-performing asset (NPA) if interest

and/or instalment of principal remain overdue for a period of more than 90 days.

(b)Cash Credits and Overdrafts:A cash credit or overdraft account is treated asNPA if it remains out of order as indicated above. An account should be treated as

1# CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


14/61

'out of order'if the outstanding balance remains continuously in excess of the

sanctioned limit/drawing power.In cases where the outstanding balance in the

principal operating account is less than the aanctioned limit/drawing power, but

there are no credits continuously for 90 days as on the date of Balance Sheet or

credits are not enough to cover the interest debited during the same period, these

accounts should also be treated as 'out of order'. Further, any amount due to the

bank under any credit facility isoverdueif it is not paid on the due date fixed by

the bank.

(c)Bills Purchased and Discounted:Bills purchased and discounted are treated as

NPA if they remain overdue and unpaid for a period of more than 90 days.

(d)Securitisation:The asset is to be treated as NPA if the amount of liquidity facility

remains outstanding for more than 90 days, in respect of a securitisation

transaction undertaken in terms of guidelines on securitisation dated February 1,

2006.

(e)Agricultural Advances: A loan granted for short duration crops will be treated as

NPA, if the instalment of principal or interest thereon remains overdue for two crop

seasons and, a loan granted for long duration crops will be treated as NPA, if the

instalment of principal or interest thereon remains overdue for one crop season. As

per the guidelines, long duration crops would be crops with crop season longer

than one year and crops, which are not long duration crops would be treated as

short duration crops. The crop season for each crop, which means the period up

to harvesting of the crops raised, would be as determined by the State Level

Bankers Committee in each State.

(f) Credit Card Accounts: RBI vide its Circular No.

DBOD.No.BP.BC.78/21.04.048/2013-14 on Prudential Norms on IncomeRecognition, Asset Classification and Provisioning ertaining to Advances Credit

Card Accounts dated December 20, 2013 advised that a credit card account will be

treated as non-performing asset if the minimum amount due, as mentioned in the

statement, is not paid fully within 90 days from the next statement date. The gap

between two statements should not be more than a month. It is further suggested

by RBI that banks should follow this uniform method of determining over-due

status for credit card accounts while reporting to credit information companies and

for the purpose of levying of penal charges,viz.,late payment charges, etc., if any .

Classification Norms relating to NPAs

Accounts with Temporary Deficiencies

The classification of an asset as NPA should be based on the record of recovery.

Bank should not classify an advance account as NPA merely due to the existence of

some deficiencies which are temporary in nature such as non-availability of

adequate drawing power based on the latest available stock statement, balance

outstanding exceeding the limit temporarily, nonsubmission of stock statements

and non-renewal of the limits on the due date, etc. In the matter of classification of

accounts with temporary deficiencies, banks have to follow the following guidelines:

(a) Banks should ensure that drawings in the working capital account are covered

by the adequacy of the current assets, since current assets are first appropriated in

times of distress. Drawing power is required to be arrived at based on current stock

1$ CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


15/61

statement. Proper computation of drawing power is imperative as the advances are

to be checked with reference thereto. The creditors should be reduced from the

stock and debtors within the stipulated period while calculating the drawing power.

However, considering the difficulties of large borrowers, stock statements relied

upon by the banks for determining drawing power

should not be older than three months.

(b) The outstanding in the account based on drawing power calculated from stock

statements older than three months is deemed as irregular.

(c) A working capital borrowing account will become NPA if such irregular drawings

are permitted in the account for a continuous period of 90 day even though the

unit may be working or the borrower's financial positionis satisfactory.

(d) Regular and ad hoc credit limits need to be reviewed/ regularised not later than

three months from the due date/date of ad hoc sanction. In case of constraints

such as non availability of financial statements and other data from the borrowers,

the branch should furnish evidence to show that renewal/ review of credit limits is

already on and would be completed soon. In any case, delay beyond six months is

not considered desirable as a general discipline. Hence, an account where the

regular/ adhoc credit limits have not been reviewed/ renewed within 180 days from

the due date/ date of adhoc sanction will be treated as NPA.

Government Guaranteed Advances

The credit facilities backed by guarantees of Central Government though overdue

may be treated as NPA only when the government repudiates its guarantee when

invoked. This exemption from classification of Central Government guaranteed

advances as NPA is not for the purpose of recognition of income. In case of State

Government guaranteed loans, this exemption willnot be available and such

account will be NPA if interest / principal / other dues remain overdue for more

than 90 days.

Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc.

Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life

policies need not be treated as NPAs, provided adequate margin is available in the

accounts. Advance against gold ornaments, government securities and all other

securities are not covered by this exemption.

Q.19 What is Reversal of income { Nov.2010}

If any advance, including bills purchased and discounted, becomes NPA as at the

close of any year, the entire interest accrued and credited to income account in the

past periods, should be reversed or provided for if the same is not realised.This

will apply to Government guaranteed accounts also. In respect of NPAs, fees,

commission and similar income that have accrued should cease to accrue in the

current period and should be reversed or provided for with respect to past periods,

if uncollected. respectively.

Q.20 How advances should be classified ?

Categories of NPAs



16/61

Banks are required to classify nonperforming assets further into the following three

ategories based on the period for which the asset has remained nonperforming and

the

realisability of the dues:

i.Substandard Assets

ii.Doubtful Assets

iii.Loss Assets

Substandard Assets

With effect from 31 March 2005, a substandard asset would be one, which has

remained NPA for a period less than or equal to 12 months. In such cases, the

current net worth of the borrower/ guarantor or the current market value of the

security charged is not enough to ensure recovery of the dues to the banks in full.

In other words, such an asset will have well defined credit weaknesses that

jeopardise the liquidation of the debt and are characterised by the distinctpossibility that the banks will sustain some loss, if deficiencies are not corrected.

Doubtful Assets

With effect from March 31, 2005, an asset would be classified as doubtful if it has

remained in the substandard category for a period of 12 months. A loan classified

as doubtful has all the weaknesses inherent in assets that were classified as

substandard, with the added characteristic that the weaknesses make collection or

liquidation in full, on the basis of currently known facts, conditions and values

highly questionable and improbable.

Loss Assets

A loss asset is one where loss has been identified by the bank or internal orexternal auditors or the RBI inspection but the amount has not been written off

wholly. In other words, such an asset is considered uncollectible and of such little

value that its continuance as a bankable asset is not warranted although there

may be some

salvage or recovery value.

Q.21 What are PROVISIONING Norms?

For Loss assets

Loss assets should be written off. If loss assets are permitted to remain in thebooks for any reason, 100 percent of the outstanding should be provided for.

For Doubtful assets

i. 100 percent of the extent to which the advance is not covered by the realisable

value of the security to which the bank has a valid recourse and the realisable

value is estimated on a realistic basis.

ii. In regard to the secured portion, provision may be made on the following basis,

at the rates ranging from 20 percent to 100 percent of the secured portion

depending upon the period for which the asset has remained doubtful:

Period for which the advance has remained in doubtful category

Provision requirement (%)Up to one year 25

1% CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


17/61

One to three years 40

More than three years 100

In case of NPAs with balance of 5 crores or more annual stock audit by external

agencies is required.

Substandard assets

A general provision of 15 percent on total outstanding should be made without

making any allowance for ECGC guarantee cover and securities available.

The unsecured exposures which are identified as substandard would attract

additional provision of 10 per cent, i.e., a total of 25 per cent on the outstanding

balance. The provisioning requirement for unsecured doubtful assets is 100 per

cent. Unsecured exposure is defined as an exposure where the realisable value of

the ecurity, as assessed by the bank/approved valuers/Reserve Banks inspecting

officers, is not more than 10 percent, ab-initio, of the outstanding exposure.

Standard assets

(i) Banks should make general provision for standard assets at the following rates

for the funded outstanding on global loan portfolio basis:

(a) direct advances to agricultural and SME sectors at 0.25 per cent;

(b) advances to Commercial Real Estate (CRE) Sector at 1.00 per cent;

(c) all other loans and advances not included in (a) and (b) above at 0.40 per cent

How and Auditor consider when audit following in case of bank?

Q.22 Bills for Collection

Q.23 Bill purchased

Q.24 Credit card Operations

Q.25 Loans

Q.26 Inter Branch Office Adjustments

Bills for Collection

1.All documents accompanying the bill should be received and entered in the

register by a proper officer.

2. The accounts of the principals should be credited only after realisation of

the bill.

3. It should be ensured that bills sent by one branch to another branch for

collection are not included twice in the amalgamated balance sheet.

Bills Purchased

1. At the time of purchase of the bills, an officer should verify that all

documents of title are properly assigned to the bank.

2. Sufficient margin should be kept while purchasing or discounting of a bill.

3. All irregular outstanding accounts should be periodically reported to the

head office.



18/61

4. Incase of purchase or discounting of a bill, proportionate income should be

recognized between the periods.

Credit Card Operations ( Nov.09,

1.There should be effective screening of applications with reasonably good

credit assessment.2. There should be strict control over storage and issue of credit cards.

3. The system whereby the merchant confirms the unutilized balanceofthe

customer With the bank before accepting payment should be properly

installed.

4. There should be a system ofprompt reporting by the merchantsofall

settlements accepted by them through credit cards.

5. All the reimbursements should be immediately charged to the customer's

account.

6. Items overdue beyond a reasonable period should be identified andattended to carefully.

1.There should be a systemofperiodic reviewofcredit card holder's accounts.

LOANS and advances internal control procedures {Nov.2009} :

1.Auditor should verify Loan documents .

2.Auditor should verify the securities hypothecated against loan.3.Auditor shall evaluate the internal control, procedures for loans applied by the

bank.

4.Auditor shall verify whether loan agreements (sanction limits) are within

authority of bank.

5.Auditors shall verify whether bank is properly following up the loan.

6.Auditor shall verify NPA and their provisions.

7.Auditor shall verify Interest calculations.

8.Auditor shall assess whether the person loaned has healthy turnover in

account.

9.Whether repayment schedule is made considering repayment capacity of

borrower.

10.If borrower is a company, whether there is proper resolution to borrow amount

from bank.

What are Inter Branch Adjustment? { May 09,

The following points requirespecial attention in the examination of Inter Branch

transactions.

1& CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


19/61

(i) While verifying the closing balance, special attention should be paid to the

origin and validity of old outstanding unmatched entries, particularly debit entries.

The auditor may also seek confirmation of transactions relating to outstanding in

appropriate cases.

(ii) Whether there are any reversal entries indicating the possibility of irregularpayments or frauds.

(iii) Whether the balances include any items in the nature of cash in transit

included in

this head which remain pending for more than a reasonable period. This is because

such items are not expected to remain outstanding beyond a very small period

during which they are in transit.

(v)Whether transactions other than those relating to inter branch transactions

have been included in inter branch accounts. Any unusual items put

through inter branch accounts as well as old or large entries outstanding in

Inter branch accounts should be carefully looked into. The auditor should

also seek explanations from the Management in this regard in appropriate

cases.

1' CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


20/61

CHAPTE

R

AUDIT OF

CO-OPERATIVE SOCIETIES

"( CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


21/61

3

Q.27What are the significant features of audit of co operative society?

1. Qualification of the auditor: Apart from a chartered Accountant following

can be appointed as an auditor provided the State Co-operative Acts specify so.

(a) Person holding a Government diploma in co-operative accounts

(b) Person holding a Government diploma in co-operation and accountancy

(c) Person who has served as an auditor in co-operative department of a

government.

2. Appointment of auditors:Registrarof co-operative societiesappointsthe

auditor of a co-operative society and the auditor reports to the Registrar as well as

the society. But the audit fees are paid by the societies as may be prescribed by the

Registrar on the basis ofscaleof the co-operative society as may be prescribed. For

example fees of co-operative credit societies are determined on the basis of Working

Capital.

3. Books, accounts and other records maintained by the co-operative

societies:Central co-operative society Act nowhere provides for maintenance of

books of accounts but the respective state Acts do provide provisions for

maintenance of books of accounts. At least followings books of accounts should be

maintained:

(a) Detailed Cash Book along with proper narration

(b) Sales ledger

(c) Purchase ledger

(d) Stock register

(e) Accounts relating to all the assets of the society

(f) Accounts relating to all the liability of the society

However it should be noted that it is not necessary that all the above listed books

have to be maintained even if there is no such transactions in the society. It should

be appreciated that the statutory rules only provides a direction to maintain books

"1 CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


22/61

of account and the society is free to maintain any additional books of accounts for

better disclosure and transparency. Following details books can also be maintained:

1) Daily cash sales summary register

2) A register of collection from debtors if any

3) Register of recoveries of loans from salaries

4) Loan disbursement register in case of credit society

5) Any others detailed register depending on nature and volume of transactions.

4. Restrictions on Share holdings:A person cannot become a member and hold

shares of limited liabilities societies to the following extent unless it is a registered

society.

i. 20% of the total number of shares;

ii. Shares of the value of Rs. 1000, whichever is higher.

5. Restrictions on loans:A registered society shall not make loans to persons

other than its members. However, with a special sanction of Registrar loans can be

given to another registered society.

6. Restriction on borrowings:The auditor should verify that borrowings of aregistered society are with in the limits and as per the policy in laid down in

byelaws of the society.

7. Investment of funds:A co-operative society can invest in one or more of the

following:

(1) Central or state co-operative bank

(2) Securities specified in the Indian Trust Act, 1882

(3) In the shares, securities, bonds or debentures of any othersocietywith limited

liability.

(4) In co-operative banks other than those mentioned in (i) above, as approved by

the registrar.

(5) In any other moneys as permitted by Central or State Government.

8. Appropriation of profits:A co-operative society has to transfer at least 25% of

its profit to reserve funds, before distribution of dividends or bonus to members. In

"" CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


23/61

case the financial position of the society does not permit such transfer, the

Registrar can reduce the transfer to the extent of 10%.

9. Investment of Reserve fund outside the business or utilization as working

capital:The co-operative society may use its reserve fund as follows:

(1) In the regular business of the society itself

(2) Investing in the securities as per norms discussed in Point 7 above.

(3) May be used for some public purpose likely to promote the object of the society.

10. Contribution to Education Fund:Some state Acts require that every society

should contribute annually towards the Education Fund of the State Federal

Society. The amount of contribution will as may be prescribed depending on the

class of society. Further the amount of contribution will be a charge against profit

and not an appropriation. The auditor should ensure compliance of these

requirements.

Q.28 What are Special Features of such Audit of co-operative society?

Audit of co-operative society is also similar like other form of organization. The

auditor has to apply all of his normal audit procedure like checking of posting,

vouching, verification etc. However there are some special audit procedures theauditor should keep in mind while conducting an audit of the co-operative society.

1. Examination of overdue debts:The auditor has to classify the overdue debts as

overdue from six months to five years and more than five years. Further

classification as per the chance of recovery has to be made. The auditor should

check the adequacy of provision made on such debts based on the chance of

recoverability. Percentage of overdue debts to working capital and its comparison

with past years can help in identifying the trend into increasing or decreasing

overdue. The auditor should see whether proper action for recovery has been

initiated and its current status.

2. Overdue interest:The treatment of overdue interest is same as of income from

NPA assets. Interest accrued or accruing in respect of which the principle sum is

overdue is the overdue interest. Such interest should be excluded while calculating

profits and credit to a separate account called overdue interest reserve account.

3. Certification of bad debts:The laws of different state provide different

regulation for writing of the bad debt. For example, Maharastra State co-operative

Rule provides that any write off must be certified by the auditor as bad and then

only it can be written off. In absence of such a provision the managementcommittee has to approve the write offs.

"# CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


24/61

4. Adherence to co-operative principles:The auditor has to make an assessment

as to fulfillment of the objective of establishing of the co-operative society.

5. Compliance with the provisions of the Act and byeLaws:The auditor has to

point out infringement of laws and byelaws by the society. The auditor should also

quantify the effects of that infringement.

6. Verification of member's Register and examination of their passbooks:The

auditor should verify the entries in members pass book regarding loan given and its

repayments the auditor should also confirm the balance with the members in

person. This will provide corroborative evidence that the entries in the books of

accounts have not been manipulated.

CHAPTE

R

4

AUDIT OF

VARIOUS ENTITIES

Q.29 What considerations are required in an Audit of depositories?

As per SEBI Rules all the depositories and its participants are required to establish

adequate control systems depend on the level of activities. SEBI is empowered to

conduct the inspection or audit of Depositories. Depositories are required to

maintain the following records and documents:

1. Records of securities dematerialized and rematerialized

2. The names of the transferor, transferee and the dates of transfer of securities

3. A register and an index of beneficial owners

4. Records of instruction received from and sent to participants, issuer, issuer's

agent and beneficial owners

5. Details of participants

6. Details of securities declared to be eligible for dematerialization

7. Any other records as may be prescribed

"$ CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


25/61

Place of keeping the books are to be intimated to the Board and the records should

be preserved for a periodof 5 years. The SEBIcan investigate the affairs of

following persons:

1. A depository

2. A participant

3. A beneficial owner

4. An issuer

5. An agent of the issuer

The SEBI caninvestigatethe accounts and records of the above persons for the

following reasons:

1. To ensure that books of accounts are being maintained as per the regulation

2. To investigate the complaints received from depository, participant, beneficial

owner, issuer, agent of the issuer or any other person

3. To ascertain the compliance by all the acts and regulation by depository,

participant, beneficial owner, issuer, agent of the issuer

4. To ascertain the adequacy of the systems, procedure and safeguards beingfollowed by a depository, participants, beneficial owners, issuer or its agent

5. Suo motuto ensure that the affairs of depository, participant, beneficial owner,

issuer, agent of the issuer are being conducted in the best interest of the investor.

The SEBI has power to appoint the auditor to inspect or investigate, into the books

of account, records, documents, infrastructure, systems and procedure or affairs of

a depository, participant, beneficial owner, issuer, agent of the issuer.

Q. 31 Discuss the Audit Check List of Equipment Leasing Finance Company

a. Ascertain whetherproposals for Leasing are accepted only after adequate

appraisal.

b. The auditor should verify whether there is anadequate system in place for

ensuring installation of assets and their periodical physical verification.



26/61

c. The system for ensuring that theasset is adequately insured and properly

maintained should be in place.

d. The auditor should ensure that leasing transactions are classified and accounted

as perAS- 19 Leases.

e. Ensure that the provisions relating toasset classification, provisioning and

income recognition laid down for lease financing by NBFCs are observed.

Q. 32 Discuss the Audit Check List of Hire Purchase Finance Company

a. The auditor should verify whether there is a proper system in place foradequate

appraisal of proposals.

b. The auditor should verify thatpayments for assets are made directly to the

vendor and the assets are in the name of the company.

c. The auditor should verify whether an adequate system is in place to ensure

installation of the asset and their periodic physical verification.

d. If the hire purchase agreement is against vehicles, theregistration certificate

should contain an endorsement in favour of the financing company.

e. The auditor should verify whether there is adequate system toensure that no

charges are created on the assets by the borrower with proper approval of the

financing company.

f. The auditor should checkwhether interest income is properly recognized.

g. The auditor should verify that hire purchase assets areadequately insured.

h. The auditor should examine the valuation of goods sold on hire purchase and

goods repossessed.

i. The auditor should ensure that provisions relating to asset classification, income

recognition and provisioning laid down for hire purchase financing by NBFCs have

been observed.

Q. 33 Describe the checklist of audit of Investment Company

a. The investment certificates should be physically verified. In case if they are

pledged with another person; certificate to that effect should be obtained from such

institution.

"% CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


27/61

b. Verify whether investments made by the NBFC are within limits laid down under

the NBFC prudential norms.

c. Check that no loans have been advanced on the security of its own share.

d. Verify that income in the form of interest, dividend and capital gains is properly

recognized.

e. Test Check the contract notes received from brokers with the prices in the stock

market on the respective dates.

f. Ensure that there is a proper system of authorization for purchase and sale of

investments.

g. Check whether investments have been valued as per NBFC Prudential Norms

and AS 13 Accounting for Investments.

h. Check the investments made in subsidiary / group companies for basis for price

paid, quantum of investment made etc.

i. Check whether investments in unquoted debentures and bonds have not been

classified as investments but as term loans for the purpose of asset classification,

provisioning and income recognition.

j. In case of securities lent / borrowed under securities lending scheme of SEBI,

verify the terms and conditions of the agreement.

k. In respect of shares/securities held through a depository, obtain a confirmation

from the depository regarding the shares/securities held by it on behalf of the

NBFC.

l. Verify charges received or paid in respect of securities, lend/borrowed;

Q. 34 Describe the Checklist of audit of Loan Company

a. The auditor should verify whether there is system in place for proper appraisal,

and sanction of loans.

b. The auditor should verify the terms of sanction and security obtained.

c. Verify that adequate records are maintained as regards the bill discounting

facilities.

d. Check that the loans are within the limits specified for single and group

borrowers.



28/61

e. No loans should be given on the security of NBFCs own shares.

f. Check whether norms for asset classification, provisioning and income

recognition as specified for credit facilities have been adhered to.

g. The auditor may also obtain balance confirmation from the borrowers.

h. In case of companies which are engaged in the business of providing short term

funds in the ICDs market, the auditor should ascertain whether the NBFC has a

regular system for ascertaining the credit worthiness of the clients prior to placed

by the company are being rolled over and whether there is any risk of non-recovery.

i. An auditor should also verify whether provision for bad and doubtful debts has

been disclosed separately in the B/S and the same have not been netted off against

the income or against the value of assets as required by the NBFC Prudential

Norms Directions.

CHAPTER

5

AUDIT OFMEMBER OF STOCK

EXCHANGE

Q.35 Who can conduct business at stock exchanges and how SEBI controls the

same?

Business at Stock Exchange can be transacted only by its members. They enter

into transaction either on their own behalf or their clients or sub-brokers Every

active member shall get his accounts audited by a chartered accountant.

Company can also become a member of stock exchange..

SEBI may levy monetary fine & penalties on any person in following cases:

(i) Failure to furnish document information etc. required by Board

(ii) Failure to maintain books of accounts/returns.

"& CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


29/61

(iii) Failure by sponsor of any collective investment scheme including M.F.

to obtain registration certificate. To comply with terms of such

certificate, to dispatch unite certificate, to refund application money, to

invest money in desired manner & in specified securities.

(iv) Failure to Issue contract notes in form required, to deliver security,make payment to client, charging excess brokerage.

(v)Failure to enter into agreement with client.

(vi)Person dealing/communicating on basis of price sensitive information.

(vii) Failure to disclose aggregate of shareholding in body corporate before

acquiring furthers share & to make public announcement to acquire

share at minimum price in case of takeovers.

Q.36 HOW MANY TYPES OF MEMBERS GENERALLY THERE IN STOCK

EXCHANGE?

Only the members can transact business at the stock exchanges. Their

membership is restricted and is based on rules and regulations regarding the

admission of members as developed by them. There are two different categories of

members:

1.Jobbers: They do trading for their personal gain or loss. They normally

purchase or sell Shares to other members.

2.Brokers: They act as agents on behalf of their principals for buying and selling

shares on prescribed rates of brokerage. Further the members can be named

according to the acts of the members as:

1.Floor Brokers:They execute orders on the floor of the stock exchange on behalf

of other members on a small commission.

2.Dealers in non-cleared securities:They mainly deal in thenot-too-active

scrips. They do buying and selling shares on their own account. They generally

buy what is offered and sell as per demand.

3.Odd-lot dealers:They deal in shares, which are in a smaller lot than the market

lot. They buy shares in odd lot at a low price and make them into marketable

lots for sale and thus make profit.

4.Dealers in Government Securities:This is a specialized form of jobbing and

broking business, involving dealings in gilt-edged securities issued by Central

and State Governments, Electricity Boards, Municipal Corporations and

Financial Institutions.

5. Underwriters and brokers to the new issues:This is a specialized field

where the underwriters undertake to underwrite the shares/ debentures offered to

the public in consideration of a specified commission.

"' CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


30/61

Q.37 What do you mean by MARGIN and how many type of Margin stock

exchanges accept from members?

Due to wide fluctuations in prices of securities over a period of time, the exchange

levies margin on its members. This certain deposit is to be kept with exchange by

its members. This mechanism is adopted, in order to restrict excessive speculations

and safeguard the interest of the investors. The members are required to collect

margins from their clients and deposit it with the clearing house of exchange. The

three types of margins are

1.Volatility Margin :

The volatility margin is imposed to curb excessive volatility in the securities.It is

also used to prevent building up of excessive outstanding positions. This margin is

calculated at the discretion of stock exchange to charge margin on any particular

security because of its volatile nature, on specific percentage.

2.Gross Exposure Margin :

It is the percentage of net cumulative outstanding position in each security that themember should keep with the exchange at all times. This margin is calculated on

continuous basis. This margin is to be kept with stock exchange in advance. Gross

exposure is calculated on all securities unlike volatility margin which is on any

specific security.

3.Mark to Market Margin :

This margin is imposed to cover a loss that a member may incur in case the

transaction is closed out at the closing price of the trading day, which is different

from the price at which the transaction has been entered into. It is the notional loss

if net cumulative outstanding position in all the securities were closed out at

closing price of relevant transaction date, for a specific member.

Q.38 How one can classify the markets in stock exchange on the basis of

orders?

There are four types of market.

I. Normal Market All orders which are of the regular lot size or multiples thereof

are traded in the Normal Market. For D-mat shares, lot size is 1 share.

II. Odd lot Market An order is called an odd lot order if the order size is lessthan the regular lot size, such orders are traded in the odd lot market. But for

order matching both price & quantity should tally with each other.

III. Spot Market in all respects spot orders are similar to the normal market

orders except that spot orders have different settlement periods vis--vis normal

orders. Pay in pay out takes place on the same day.

IV. Auction Market Stock exchange on behalf of their members initiate auctions

to purchase from the market, the number of shares short deposited by the

members. In this way, they complete the settlement process. Loss is recovered

from members but profit it any deposited to investors education & protectionfund.

#( CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


31/61

Q. 39What is Circuit Filter

Circuit filters are price bands imposed by the Securities Exchange Board of India(SEBI) to restrict the movement of stock prices (up or down), of listed securities.

This is to curb manipulation done in share prices by operators.

Stock exchanges introduced circuit filters, as per SEBI guidelines to prevent a steep

fall/rise in stock prices and to safe guard interest of investors from volatility in

price.

How do they work?

When the stock price breaches a stipulated price band as decided by stock

exchanges, trading in that particular stock is suspended. For example, if you have a

share price of Rs 100, and there is a circuit breaker of 5%, it will stop trading if the

share price goes above Rs 105. Similarly. if the stock drops below Rs 95, the lower

end circuit filter is applied and trading is suspended.

Circuits limit for stock exchanges

There are three circuit filters for indices - 10%, 15%, and 20%. These filters are

applied to Sensex or Nifty whichever crosses the limit first. The trigger also depends

on the time at which it occurs.

Q.40 what is rolling settlement?Rolling settlement is a system to settle share transactions in predefined number or

days. It is a mechanism of settling trades done on a stock exchange on the Day Day

of Trade (T) plus "X" trading days. "X" trading days could be any number of days

like 1,2,3,4 or 5 days. So, if we say the rolling settlement for a transaction is T+3

then it means that the transaction will be settled in TODAY + Next 3 Days. In other

words, in T+3 environment, a trade done on T day is settled on the 3rd working day

excluding the T day.

In Rolling Settlements, share trading done on each single day are settled separately

from the trades done on earlier or subsequent trading days.

In India, after April 1, 2002, all trades done on stock exchange are settled on T+3

basis. There could be some deviations because of Bank Closing or National

Holidays.

AtNSEandBSE, trades in rolling settlement are settled on a T+2 basis i.e. on the

2nd working day. Saturdays and Sundays are excluded because the stock

exchanges remain closed on weekends.

#1 CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s
http://www.nseindia.com/http://www.bseindia.com/http://www.bseindia.com/http://www.nseindia.com/


32/61

CHAPTER

6AUDIT OF

PUBLIC SECTOR UNDERTAKINGS

Q.41 WHAT IS OBJECTIVE AND SCOPE OF AUDIT OF PUBLIC SECTOR

ENTERPRISES?

The scope and extent of Audit of Public Enterprises has not been defined in any act but is

determined by theComptroller and Auditor General. Audit of public enterprises in India

is not restricted to financial and compliance audit; it extends also toefficiency, economy

and effectivenesswith which these operate and fulfill their objectives and goals. Anotheraspect of PSU audit relates to questions ofproprietyand the propriety element is the

examination of management decisions on sales, purchases, contracts, etc. to see whether

these have taken in the best interest of the undertaking and confirm to accepted principles

of financial propriety. A multiple set of audit exists in case of public enterprises audit under

the Companies Act, 1956. Apart from audit by a statutory auditor, the C & AG issues a set

of directions to them and can also issue a separate report by way of comment on the report

submitted by the statutory auditor. The C&AG also has the right to conduct supplementary

or test audit.

The objective of Government audit is to ensure:

1.That all the expenditure is duly authorized;

2.That the expenditure is sanctioned properly and incurred by a competent person;3.That the payment has in fact been made and to competent person;

4.That in case of audit of receipts, sums are duly recovered and also credited into

correct account;

5.That all the expenditure conforms to the general principle of propriety as discussed

below.

Q.42 WHAT DO YOU MEAN BY PROPRIETY AUDIT?

The dictionary meaning of the word propriety is accuracy or justness. But in auditing

term it stands for verification of transactions on the ground of best public interest,

commonly accepted customs and standards of conduct.Instead of too much dependenceon documentsvouchers, supporting of expenses etc. it shifts theemphasis to the

#" CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


33/61

substance of transactionsand looks into appropriateness thereof on ground of financial

prudence, public interest and waste less expenditure.

Thus propriety audit is concerned withscrutiny of exclusive decisionsbearing on the

financial and the Profit and Loss situation of the company with special regard to public

interest and commonly accepted customs and standards of conduct. While performing a

propriety audit, the auditor would judge whether in making payment, incurring expenditurethe officer has exercised same level of vigilance, as an ordinary person will do in his own

expenditure. The standards of propriety in vogue with regards to Government spending in

India can be taken asgeneral principle of propriety. They are as follows:

i. The expenditure should not be prima facie more than the occasion demands and

that every official exercises the same degree of vigilance as in respect of his own

money.

ii.No authority in the exercise of its powers of sanctioning expenditure should pass an

order, which will be directly or indirectly to its own advantage.

iii.The funds should not be utilized for the benefit of a particular person or group of

persons.

iv.Apart from the agreed remuneration or reward there should not be left open any

other avenue to indirectly benefit the management, personnel, employees and

others.

v. Allowances and other payments, other than those covered in the agreed

remuneration should not be allowed to be a source of profit for the recipient (e.g., daily

allowance for outstation work)

Q. 43 write short note on Supplementary Audit?

The Audited accounts along with report of the Statutory Auditors are reviewed by

C&AG. On the basis of the review and predetermined parameters, a decision is

taken whether to conduct supplementary audit under section 619 (3) (b) of the

Companies Act, 1956 of the financial statements of a PSE. This supplementary

audit carried out independently is limited primarily to the inquiries of the statutory

auditors and Company personnel and a selective examination of some of the

accounting records. Based on such a supplementary audit, significant audit

observations, if any, are reported under section 619 (4) of the Companies Act, 1956

to be placed before the Annual General Meeting. The supplementary audit by C&AG

also oversees any undue observations of auditors, if any, and provides a safeguard

to the management of PSEs. The Annual reports of the Central Public Sector

Enterprises including financial statements are laid before both the houses of the

Parliament. A gist of significant audit observations made on the accounts of CPSEs

are compiled in C&AGs' Audit Report and are laid before both the houses of the

Parliament

## CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


34/61

#$ CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


35/61

CHAPTE

R

7

AUDIT OF

COST RECORDS

Q.44 What is Cost Audit?

Cost audit is the audit of costing records of a company. Cost audit represents the

verification of cost accounts and a check on the adherence to cost accounting plan.

In brief cost audit comprises:(a) Verification of cost accounting records such as accuracy of the cost

accounts, cost reports, cost statements, cost data and costing

technique, and

(b) Examination of these records to ensure that they adhere to cost

accounting principle, plans, procedure and objectives.

Q.45 What are the various types of Cost Audits?

(1)On behalf of management:

(i) Establishing accuracy of cost data

(ii)Whether objectives of Cost Account being achieved.(iii)Abnormal losses and gains with causes.



36/61

(iv)Determine unit cost of production

(v)Proper overhead rates.

(vi)Fixation of contract price.

(vii) Improving quality of Cost Accounting System.

(2)On Behalf of a Customer : For Cost plus contracts(3)On Behalf of Government :For subsidies etc., may be to determine

fair price.

(4)By Trade Association : Maintenance of a price.

(5)Statutory Cost Audit : U/s. 233 B of the Companies Act

Other circumstances where cost audit may be called for :

(i) Price fixation,

(ii) Cost variation within the industry,

(iii) Inefficient management(iv) Tax assessment

(v) Trade dispute.

Q.46 What are the requirements of Cost Audit in a Company?

The Central government may on its discretion order for the audit of cost accounts of

any company by the auditor in such a manner as decided by the Central

Government. The auditor will be a Cost Accountant with in the meaning of the Cost

and Works Accountant Act, 1959. However, if the Central Government is in the

opinion that sufficient number of cost accountants are not available for conducting

the cost audit of the companies generally, then the Government may, by notification

in the Official Gazette, direct that, for such period as may be specified in such

notification, Chartered Accountant with in the meaning of Chartered Accountant

Act 1949 as possess the prescribed qualification, may also conduct the audit of the

cost accounts of the companies, and thereafter the Chartered. Accountant may be

appointed to audit the cost accounts of the company. Further a firm of Cost

Accountant or Chartered Accountant may be appointed as auditor u/s 233B.

The Board of Directors of the company with the previous approval of the Central

Government will appoint such an auditor.All the disqualification applicable to a

company auditor u/s 226(3)&(4) will be applicable to a cost auditor also. Further

the statutory auditor of a company cannot be appointed as cost auditor for thatcompany. Before the appointment of the cost auditor by the Board, a written

representation should be taken from the auditor that the proposed appointment

will be in accordance with the limit prescribed under section 224(1B). Such an

auditor shall make his report to the Central Government in such form and manner

and with such time as may be prescribed and shall also at the same time forward a

copy of the report to the company concerned. The company shall, within 30 days

from the date of receipt of a copy of the report, furnish to the central government

with full information and explanation on every reservation or qualification

contained in such report. After the report has been furnished and the Central

government is of opinion that any further information or explanation is necessary,

then Government may call for such further information and explanation and

#% CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


37/61

thereupon the company shall furnish the same within the time as may be specified

by the Government. The Central Government may take any steps as deemed

necessary based on the report. It may be directed that the report should be

circulated among the members of the company, along with the notice of General

meeting held first time after submission of report. The Government may specify to

circulate the whole of the report or any part of that.

CHAPTE

R

8

AUDIT UNDER

FISCAL LAWS



38/61

Q.47 Write short note on EXCISE AUDIT?

The concept of Excise Duty came into force with effect from 1stDecember 1999. But

that time it was applicable only for limited manufacturers. At present it is

applicable to entities based on following slabs

Process of auditing

1.Preliminary review about assessee

2.Gathering information through records and documents

3.Physical verification of plant

4.Evaluation of Internal control and risk assessment

5.Verification

6.Conclusion and reporting

Q.48 Write short note on Service tax Audit

Director General of Audit, New Delhi has prepared Service Tax Audit

Manual, 2010. As per the guidelines, tax payers whose annual

service tax payment (including cash and CENVAT) was Rs.3 crore or

more in the preceding financial year may be subjected to mandatory

audit each year. It is preferable that Audit of all such Units is done by

using Computer Assisted Audit Program (CAAP) techniques. The

frequency of audit for other taxpayers would be as per following

norms:-

#& CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s

Quantum of annual total duty payment Frequency of audit

More than 3 crores Every year

From 1 Cr. Up to 3 Crore. Once in every two years

Fron 50 Lakhs to up to 1 crore Once in every five year

Below 50 Lakhs 10% of the units every year


39/61

Q.49 Describe VAT audit ?

VAT is a tax on the value added to the commodity at each stage in production and

distribution chain. VAT is an indirect tax on consumption. The total amount of tax,

which is to be collected at the final or retail point of sale, is collected in

installments. Major states who have introduced VAT have generally incorporated

audit provisions in their VAT legislation.

a. Theturnover of sales/purchases of goods has been properly determined. The

sales turnover arrived at by applying the generally accepted accounting policies

may not be the same as required under the VAT law.

b. The turnover of purchases should be verified to enable the auditor to get the

purchases eligible for grant of input tax credit segregated from other purchases.

c. The auditor is expected to list out the due dates of filing of returns and find out

the reasons for delay in filing the returns, if any.

d. The auditor should apply tests as will enable him to ascertain whether the

auditee is eligible for composition.

e. The auditor may also be expected to check the consolidation of the returns filed

for all the periods covered in the year under audit.

f. The auditor should check whether all the transactions relating to sale and

purchase are entered in the books of account and have been taken into

consideration while filing the returns.

Audit Report under the Vat Law- At the end of the audit the auditor has to

arrive at his conclusion on the matters to be reported in the audit report. The

format of the audit report is generally prescribed under the relevant VAT law andthe auditor has to fill in all the columns of the audit report that are applicable. His

#' CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s

Quantum of annual total ST ( Cash

+CENVAT) payment

Frequency of audit

More than 3 crores Every year

From 1 Cr. Up to 3 Crore. Once in every two years

From 25 Lakhs to up to 1 crore Once in every five year

Up to 25 Lakhs 2% of the units every year


40/61

opinion is on the adequacy of accounting records, correctness and completeness

and arithmetical consistency of returns filed.

TOPIC TAX AUDIT

NOTE :- questions of this topic are highly practical oriented hence you have

to answer all the questions relating to this topic according to your practical

knowledge earned in office.

Q.50. As a tax auditor, how would you report on the following:

a. Labour charges paid on which tax deducted at source at an inappropriate rate.

b. Capital expenditure incurred for Scientific Research Assets.

Ans:

a. If tax is deducted at an inappropriate rate, the amount is disallowable under

section 40(a)(ia) of the Income-tax Act. This fact needs to be reported in Form 3CD

where all amounts inadmissible under section 40(a) are to be reported.

b. Clauses 15 of Form 3CD requires to report the expenditure on ScientificResearch (capital as well as revenue) covered under section 35 of the IT Act, 1961.

Accordingly, the auditor should report the amount of capital expenditure not

debited to the P/L a/c which is eligible for deduction u/s 25 as Scientific Research

Expenditure.

Q.51 : Discuss the reporting requirements in Form 3CD of the Tax Audit

Report U/S 44AB of

the Income-tax Act, 1961 for the following:

a. Tax on distributed profits.

b. Brought forward loss or depreciation allowance. (NOV 2009 OLD)

Ans:

a. The tax auditor has to report on profit distributed during the FY and therefore

the amount of tax paid on such distributed profit at the prescribed rate plus

$( CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


41/61

surcharge at the applicable rate on tax and education cess thereon, the dates of

payment with amount, has to be reported.

b. The manner of reporting:

S.No.

Assessment Year

Nature of loss/allowance (in rupees)

Amount as returned (in rupees)

Amount as assessed (in rupees)

Remark

For giving the above information, the auditors should verify the assessment records

i.e., Income tax return filed. Assessment orders Appellate orders

Rectification/revision orders of the earlier years and ascertain if the figures given in

the above clause are correct.

Q.52 Mr. X, who conducts the tax audit u/s 44AB of the IT Act, 1961 of M/s

ABC, a partnership firm has received the entire audit fees of Rs. 25,000 inApril, 2010 in respect of the tax audit for the year ended 31.3.2010. The

audit report was however signed in September, 2010. Comment.

Ans: A person is disqualified from being an auditor if he is indebted to the company

for more than Rs. 1,000. This provision for disqualification would apply only in case

of an auditor appointed under the Companies Act, 1956. When a CA is appointed to

conduct a tax audit u/s 44AB of the Income -tax Act, 1961, his appointment is not

under the Companies Act, 1956 but under the Income-tax Act, 1961. In the

Income-tax Act, 1961 there is no such provision. Mr. X would still be able to carry

out audit and he would not be disqualified.

Q.53 A leading jewellery merchant used to value his inventory at cost on LIFO

basis. However, for the current year, in view of requirements of AS 2, he

changed over to FIFO method of valuation. The difference in value of stock

amounted to Rs. 55 lakhs which is higher than that under the previous

method. In such a situation, what are the reportingresponsibilities of a Tax

Audit under Section 44AB of Income-tax Act, 1961.

$1 CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


42/61

Ans: The change in the method of valuation of stock is not a change in method of

accounting, as it is only a change in accounting policy. However in the Income-tax

Act, 1961this is considered under method of accounting. Under the Income-tax Act,

1961, if the change in method of valuation is bonafide, and is regularly and

consistently adopted in the subsequent years as well, such change would be

permitted to be made for tax purposes. In the instant case, the change in the

valuation of stock from LIFO basis to FIFO basis is pursuant to mandatory

requirements of the AS 2 Valuation of Inventories and therefore should be viewed

as bonafide change. This apart, the tax auditor in his report has to specifically refer

to the method of valuation of stock under Clause 12 in Form 3CD.

(a) Method of valuation of closing stock employed in the previous year.

(b) Details of deviation, if any, from the method of valuation prescribed undersection 145A and the effect thereof on profit or loss. The auditor has to see that the

method of stock valuation is followed consistency from year to year. It is also

necessary to ensure that method followed for valuation of stock results is correct

profits or gain. The change from LIFO to FIFO is bonafide, the disclosure of which

would have to be made in the FS. As far as section 145A is concerned, tax auditor

need not change the method of valuation of purchases, sales & inventories which is

regularly employed by assessee. All that he has to do is to adjust the valuation for

any tax, duty, cess or fee actually paid or incurred by the assessee, if the same had

not already been adjusted.

Q.54 Mr. Ram, the Tax Auditor finds that some payments inadmissible u/s

40A(3) were

made, and advised the client to report the same in form 3CD. The client

contends that cash

payments were made since the other parties insisted upon the same and did

not have Bank

Accounts. Comment.

Ans: The audit under section 44 AB of the Income Tax Act 1961 requires that the

tax auditor should report whether in his opinion the particulars in respect of Form

3CD are true and correct. It is the primary responsibility of the assessee to prepare

the information in form 3CD. The auditor has to examine whether the information

given is true and correct. The form 3CD is not a report of Tax Auditor. The report is

in the form of 3CA or 3CB depending on the nature of the organization of the entity.

If the tax auditor is satisfied that the information contained in form 3CD is true

$" CA. Aseem Trivedis SUPREME 75 Enough for Other Audit Toi!s


43/61

and correct then he can give unqualif

sureme 75 finalxcbcvbvcb

Documents