CA Final Auditing Notes Recall Tips

CA.
Aseem Trivedi’s
Supreme
75
THOROUGHLY REVISED
Other Topics under

Advanced Auditing
Enough for Exams………
1 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

CHAPTER AUDIT OF ENTITIES
1
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
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 risks
i. @ 50% for Fire and Marine Cargo and Miscellaneous Business.
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.
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
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 o f 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 prescribed
manner.
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 amended
Regulations 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
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 normall y 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 the
following 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 company‟s 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.
(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.10What 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 to
be 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 company‟s share and the balance has to
be debited to others insurance companies
PART- D
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 at
one 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 it‟s one of the offices in India a sum equivalent to three percent of total
gross premium written in India in any financial year.
o The maximum limit of deposit under this section is Rupees ten crores.
o The deposit is to be for and on behalf of the Government of India.
o The deposit can be made either by way of cash or investment in approved
securities.
o The 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.12 As 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 was
a 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
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.

CHAPTER AUDIT OF
2 BANKS
PART-A
SHORT NOTES {4 Marks} – Generally not asked
PART B
Describe a Concept { 4 to 6 Marks }
Q.13. What is cash reserve?
Every banking company, except a scheduled bank, shall maintain in India by

way of cash reserve with itself, or by way of balance in a current account with the
Reserve Bank, or by way of net balance in current accounts, or in one or more of
the aforesaid ways, a sum equivalent to at least three per cent of the total of its
demand and time liabilities in India as on the last Friday of the second preceding
fortnight.
Every scheduled bank is required to maintain with the Reserve Bank an average
daily balance the amount of which shall not be less than three per cent of 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 company shall maintain in India in 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:
i. Classified in this category at the time of purchase. Reclassification is also
permitted but as per rules as 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 thereafter profit should be appropriated to `Capital
Reserve Account'
Held for Trading
following are the features of this type of investments:
i. Purchased with the intention to trade in short term
ii. The object is making profit by short term movement in prices.
iii. These investments are to br sold with 90 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. Shifting to / from Held to Maturity category can be shifted only once in a year
only after approval of of Board of Directors, preferably at the beginning of the year.
b. Shifting from Available for Sale category to Held for Tradingcategory is

permitted with the approval of Board of Directors / Investment Committee
except in case of emergencies where Chief Executive of the bank can authorise
such shifting provided later approval is taken from Board of Directors.
c. Shifting from Held for Trading to Available for Sale is generally not permitted
unless the bank is not able to sell those with in 90 days due to extreme market
conditions. However approval of Board of Directors / Investment Committee is
required.
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 at acquistion cost except
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
decline in the value of investment in subsidiaries and joint ventures under this
category should provided.
2.Available for Sale: All the scrip in this category should be marked to market at
the interval of a quarter or less. Net depreciation in any category should be
provided for in the profit and loss account and 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.17What 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 as
NPA if it remains out of order as indicated above. An account should be treated as
'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 is ‘overdue’ if 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 Income
Recognition, 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
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, stockstatements
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 fromstock
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
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 distinct
possibility 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 or
external 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 the
books 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
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 Bank‟s 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.23Bill 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.
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 balance of the
customer With the bank before accepting payment should be properly
installed.
4. There should be a system of prompt reporting by the merchants of all
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 and
attended to carefully.
1. There should be a system of periodic review of credit card holder's accounts.
LOANS and advancesinternal 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 require special attention in the examination of Inter Branch
transactions.
(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 irregular
payments 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
havebeen included in inter branch accounts. Any unusual items put
through inter branchaccounts 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.

CHAPTER AUDIT OF
CO-OPERATIVE SOCIETIES
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:Registrar of co-operative societies appoints the
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 of scale of 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
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 a
registered 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 other society with 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
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.28What 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 the
auditor 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 management
committee has to approve the write offs.
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.
CHAPTER AUDIT OF
4 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
Place of keeping the books are to be intimated to the Board and the records should
be preserved for a period of 5 years. The SEBI can 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 can investigate the 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 being
followed by a depository, participants, beneficial owners, issuer or its agent

5. Suo motu to 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 whether proposals for Leasing are accepted only after adequate
appraisal.
b. The auditor should verify whether there is an adequate system in place for
ensuring installation of assets and their periodical physical verification.
c. The system for ensuring that the asset is adequately insured and properly
maintained should be in place.
d. The auditor should ensure that leasing transactions are classified and accounted
as per AS- 19 “Leases”.
e. Ensure that the provisions relating to asset 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 for adequate
appraisal of proposals.
b. The auditor should verify that payments 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, the registration certificate

should contain an endorsement in favour of the financing company.
e. The auditor should verify whether there is adequate system to ensure that no
charges are created on the assets by the borrower with proper approval of the
financing company.
f. The auditor should check whether interest income is properly recognized.
g. The auditor should verify that hire purchase assets are adequately 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.

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.
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 AUDIT OF
5
MEMBER OF STOCK EXCHANGE
Q.35Who 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.
(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 the not-too-active
scrip‟s. 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.
Q.37What 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 the
member 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.38How 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 less
than 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-à-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 & protection
fund.
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.
At NSE and BSE, 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.
CHAPTER
AUDIT OF
6 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 the Comptroller and Auditor General. Audit of public enterprises in India
is not restricted to financial and compliance audit; it extends also to efficiency, economy
and effectiveness with which these operate and fulfill their objectives and goals. Another
aspect of PSU audit relates to questions of propriety and 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.42WHAT 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 dependence
on documents vouchers, supporting of expenses etc. it shifts the emphasis to the
substance of transactions and looks into appropriateness thereof on ground of financial
prudence, public interest and waste less expenditure.

Thus propriety audit is concerned with scrutiny of exclusive decisions bearing 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 expenditure
the 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 as general 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

CHAPTER AUDIT OF
7 COST RECORDS
Q.44What 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.45What 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.
(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.46What 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 that
company. 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
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.

CHAPTER AUDIT UNDER
8 FISCAL LAWS
Q.47 Write short note on EXCISE AUDIT?
The concept of Excise Duty came into force with effect from 1st December 1999. But
that time it was applicable only for limited manufacturers. At present it is
applicable to entities based on following slabs
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
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:-
Quantum of annual total ST ( Cash Frequency of audit

+CENVAT) payment
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
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. The turnover 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 and
the auditor has to fill in all the columns of the audit report that are applicable. His
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 Scientific
Research (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 thereforethe
amount of tax paid on such distributed profit at the prescribed rate plus 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 firmhas received the entire audit fees of Rs. 25,000 in
April, 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
companyfor 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.
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 under
section 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 and correct then he can give unqualified report in form 3CA or 3CB. But in the
given case the tax auditor has found that the form
3CD contains the incomplete, misleading and false information. Disallowance
under section 40A(3) is attracted if the assessee incurs any expenses in respect of
which payment of aggregate of payments made to a person in a day, otherwise than
by an account payee cheque drawn on bank or account payee draft exceeds Rs.
20,000/-. However, exemption is provided in respect of certain expenditure in Rule
6DD. In such cases, disallowance under section 40A(3) would not be attracted.
Under clause 17(h) of Form 3CD, amounts inadmissible under section 40A(3), read
with Rule 6DD, have to be reported. Cash payment made on insistence of other
parties on the contention that they do not have bank accounts is not covered under
the list of exceptions provided under Rule 6DD. Mr. Ram has to report
the payments inadmissible under section 40A(3) under clause 17(h) of Form 3CD.
.Q.55. Mr. V carries on the business of dealing and export of diamonds. For the
year ended31st March 2012, you as the tax auditor, find that the entire exports are
to another firm in U.S.A. which is owned by Mr. V‟s brother.
Hint Ans: Clause 18 of form 3CD, annexed to tax audit report in Form 3CA/3CB,
requiresthe tax auditor to specify particulars of payments made to person specified
u/s 40(A)(2)(b) of the IT Act 1961. Persons specified in the said section are relatives
of an assessee andsister concerns, etc. Mr. V has not made any payments to his

brother. On the contrary, he must have received payments from him against
exports made and, thus, this clause would be required to verify whether the exports
are genuine, i.e. , whether the diamonds have been delivered by verifying the
necessary delivery documents, relevant invoices, etc., the reasonableness of the
price and whether the export realization have been received
Q.56 TUI Ltd. an Indian company, subject to IT Act, 1961, discloses advance
Income-tax
paid (Current tax asset) and provision for Income-tax (Current tax liability),
separately in
B/S for the year ended 31.3.2011, i.e., it does not offset the amount.
Comment.
: As per AS 22 – Accounting for Taxes on Income, an enterprise should offset assets
and liabilities representing current tax if the enterprise: (i) Has a legally enforceable
right to set off the recognized amounts and (ii) Intends to settle asset & liability on
a net basis. An enterprise will normally have a legally enforceable right to set off an
asset and liability representing current tax when they relate to income taxes levied
under the same governing taxation laws and the taxation laws permit the
enterprise to make or receive a single net payment. Since TUI Ltd is an Indian
Company, and as per IT Act, 1961, such set off is allowed which is legally
enforceable. In view of Provisions of AS 22 and IT Laws, TUI Ltd. should offset
advance tax paid against provision for IT & show only the net amount in B/S.
Q57. ABC Printing Press, a proprietary concern, made a turnover of above Rs.
63 lacs for the year ended 31.03.2011. The Management explained its auditor
Mr. Z that it undertakes different job work orders from customers. The raw
materials required for every job are dissimilar. It purchases the raw materials
as per specification/requirements of each customer, and there is hardly any
balance of raw materials remaining in the stock, except pending work-in-
progress at the year end. Because of variety and complexity of materials, it is
rather impossible to maintain a stock-register. Give your comments.
Hint Ans: The explanation of the entity for the use of varieties of raw materials for
different jobs undertaken may be valid. But the auditor needs to verify the specified
job-orders received and the different raw materials purchased for each job
separately. The use of different papers (quality, quantity and size) ink, color etc.
may be examined. If possible, the auditor may also enquire with the other similar
printers in the locality to ensure the prevailing custom. At the same time, he has to
report and certify under the Para 28(b) and Para 9(b) of Form 3CD read with the
Rule 6G (2) of the Income-tax Act, 1961, about the details of stock and account
books (including stock register) maintained. He (or his deputy) must verify the
closing stock of raw materials, work-in-progress and finished goods of the concern,
at least on the date of its balance sheet. In case the said details are not properly
maintained, he has to specifically mention the same with reasons for non-
maintenance of stock register by the entity.

CHAPTER
Diverse
9 Audits
Q.58 Write Short note on ENERGY AUDIT

The increasing cost and the shortage of energy has laid profit-making industries
into a loss making one. Industries are running behind the energy management
plans to cope with the situation. This can be achieved by reducing avoidable
losses, improving the effectiveness of energyuse or increasing energy use
efficiency. The steps in energy management involves:
a. Conducting energy audits
b. Implement the energy conservation measures
c. Post installation monitoring
d. Setting targets etc.
Energy audit is the first steps in energy management plans. Energy audit involves
assessing energy use pattern of a factory or energy consuming equipment and
identifying energy saving opportunities. The functions of energy auditor is not
like an financial auditor who express an opinion, while an energy auditor
recommends the steps for improving the efficiency of the energy consumption
leading to monetary benefits. To make energy audits truly effective audits must be
conducted round the clock and by an internal energy audit department. Internal
energy audit department should include the members from each energy
consumption areas within the entity.
Q. 59 Write short note on Environmental Audit?

Environment reporting deals with the disclosure by an entity of environmentally
related data like environmental risks, impacts, policies, strategies, targets, costs
etc to those who have an interest in such information. These reports may be

provided along with annual reports, a stand-alone corporate environmental
performance report or in any other form. These information could be audited or
unaudited. But now, the central government has made energy audit compulsory for
some industries and the report has to be submitted to concerned State Control
Board on or before 15th day of May every year for 31st march. Environmental audit
deals with verification of the information contained in such reports with a view to
expressing an opinion there on.
Environmental audit is a critical analysis of (i) Policies (ii) principles (iii) systems (iv)
procedures (v) practices and (vi) performance of the aspect, which relates the
environment.
CHAPTER
PEER
10 REVIEW
Q. 60 Write short note on Peer Review?
Peer review means review by a PEER means person of same standing. What do you
mean by Peer Review
means an examination and Review of the systems and procedures to
determine whether the same have been put in place by the Practice Unit for
ensuring the quality of assurance services as envisaged by the Technical,
Professional and Ethical Standards and whether the same were consistently
applied in the period under review.
Q.61What is Practice Unit and who is reviewer?

Practice Unit:-means a firm of Chartered Accountants or a member in
Practice, practicing whether in an individual name or a trade name or such
other entity as recognized by the Institute of Chartered Accountants of India
from time to time.
Reviewer - means a member duly approved and empanelled by the Board on
fulfilling the qualifications prescribed for a Reviewer as per Para 10.0 of this
Statement.
Q.62What do you mean by Technical, Professionl and Ethical Standards?
Technical, Professional and Ethical Standards - means
(i) Accounting Standards issued by ICAI and /or prescribed and notified
by the Central Government of India;

(ii) Standards issued by the Institute of Chartered Accountants of India
including
(a) Engagement standards
(b) Statements
(c) Guidance notes
(d) Standards on Internal Audit
(e) Statements on Quality Control
(f) Notifications / Directions / Announcements / Guidelines /
Pronouncements / Professional standards issued from time to
time by the Council or any of its committees.
(iii) Framework for the Preparation and presentation of financial

statements, framework of statements and Standard on Auditing,
Standard on Assurance Engagements, Standards on Quality Control
and Guidance Notes on related services issued, from time to time, by
the Institute of Chartered Accountants of India and framework for
assurance engagements;
(iv) Provisions of the various relevant statutes and / or regulations which
are applicable in the context of the specific engagements being
Reviewed including instructions, guidelines, notifications, directions
issued by regulatory bodies as covered in the scope of assurance
engagements;
Q.63What is Scope of Peer Review?
The Peer Review process shall apply to all the assurance services provided by a
Practice Unit. Once a Practice Unit is selected for Review, its assurance
engagement records pertaining to the Peer Review Period shall be subjected to
Review. The Review shall cover:
(i) Compliance with Technical, Professional and Ethical Standards:
(ii) Quality of reporting.
(iii) Systems and procedures for carrying out assurance services.
(iv) Training programmes for staff (including articled and audit assistants)
concerned with assurance functions, including availability of
appropriate infrastructure.
(v) Compliance with directions and / or guidelines issued by the Council
to the Members, including Fees to be charged, Number of audits
undertaken, register for Assurance Engagements conducted during
the year and such other related records.
(vi) Compliance with directions and / or guidelines issued by the Council
in relating to article assistants and / or audit assistants, including
attendance register, work diaries, stipend payments, and such other
related records.

CHAPTER
CORPORATE GOVERNANCE
11 AND AUDIT COMMITEE
Q.64 WHAT DO YOU MEAN BY CORPORATE GOVERNANCE? AND HOW IT IS
IMPLEMENTED IN INDIA?
Corporate governance is the system by which companies are directed and
controlled by the management in the best interest of the stakeholders and other
ensuring greater transparency and better and timely financial reporting. The
Board of Directors are responsible for the governance of their companies.
Clause 49 of the Listing Agreement
Where a company desires to list its shares and other securities on a stock
exchange, it has to agree and implement the code of corporate governance. The
clauses of the agreement are discussed ahead. The responsibility of the auditor is
to verify that the requirement of these clauses have been complied with and report
non-compliance, if any.
Q.65What do you mean by Audit Committee

According to clause 49 of listing agreement there should be a. Qualified and Independent
Audit Committee in a listed company.A qualified and independent audit committee shall be
set up, giving the terms of reference subject to the following:
1. The audit committee shall have minimum three directors as members. Two-thirds of the
members of audit committee shall be independent directors.
2. All members of audit committee shall be financially literate and at least one member
shall have accounting or related financial management expertise.

Explanation (i): The term “financially literate” means the ability to read and understand
basic financial statements i.e. balance sheet, profit and loss account, and statement of cash
flows.
Explanation (ii): A member will be considered to have accounting or related financial
management expertise if he or she possesses experience in finance or accounting, or
requisite professional certification in accounting, or any other comparable experience or
background which results in the individual‟s financial sophistication, including being or
having been a chief executive officer, chief financial officer or other senior officer with
financial oversight responsibilities.
3. The Chairman of the Audit Committee shall be an independent director;
4. The Chairman of the Audit Committee shall be present at Annual General Meeting to
answer shareholder queries;
5. The Audit Committee may invite such of the executives, as it considers appropriate (and
particularly the head of the finance function) to be present at the meetings of the
committee, but on occasions it may also meet without the presence of any executives of the
company. The finance director, head of internal audit and a representative of the statutory
auditor may be present as invitees for the meetings of the audit committee;
6. The Company Secretary shall act as the secretary to the committee.
Q.66 What are the Powers of Audit Committee
The Audit Committee shall have powers, which should include the following:
1. To investigate any activity within its terms of reference.
2. To seek information from any employee.
3. To obtain outside legal or other professional advice.
4. To secure attendance of outsiders with relevant expertise, if it considers necessary.
CHAPTER AUDIT UNDER COMPUTER

INFORMATIONS SYSTEM
12 ENVIRONMENT
Q.67 What is CAATs and explain their utility?

CAAT means Computer Assisted Audit Techniques.To increase the audit efficiency
CAATs are the advanced tools with the auditor. Commonly following are known as
CAATs
1. Audit software: -
Audit software consists of computer programs used by the auditor, as a part of his
auditing procedure. This software interacts with the data of the entity‟s computer
to process data of audit significance from the entity's accounting system. Audit
software can be classify into,
i. Package programs: These are generalised computer programs used by the
auditor to perform general data programming functions like creating data file,
preparing specific reports.
ii. Purpose written programs: These programs are specifically designed to perform
some specific audit tasks in specific circumstances. Generally the auditor develops
these programs by himself or some times modify the programs used by the entity
itself.
iii. Utility Programs _These programs are not designed specially for audit
purposes. These are the programmes of general utility like sorting, creating and
printing files.

iv. System Management Programs: These programs are generally a part of
operating system itself. The use of these in audit requires extra skills and care
unlike utility programs.
2. Test data: -
Test Data Techniques involves processing of test data and comparing the results
with predetermined results. The purpose is to test controls in operation
Q.68What is utility to apply CAAT? What considerations required to apply it?
Following are the utilities of using CAATs

1. Tests of details of transactions and balances
2. Analytical review procedures.
3. Compliance test of general EDP controls
4. Compliance test of EDP application controls
5. Sampling programs to extract data for audit testing
6. Reperforming calculations performed by the entity's accounting systems
In determining whether to use CAATs, the following factors should be considered: -

1. Computer Knowledge, Expertise And Experience of the Auditor: -
2. Availability of CAATs and Suitable Computer Facilities with the client
3. Impracticability of Manual Tests due to lack of visible audit trail.
4. Comparison of effectiveness and efficiency as against the manual tests
6. Control over the whole process of the CAATs Application .
7. Documentation about CAATs.
Q.69 what is Service Bureau ?

Some clients may decide to get their data processed by outside agencies because of
many reasons. Service Bureaus are agencies, which process accounting data on
behalf of their clients. The auditor should consider the following matters in detail
along with the client:
1. Ownership & stability of service Bureau
2. Location of the bureau.
3. Back _ ups maintained by the bureau.
4. Documentation of the system provided to the client.
5. Liability of the bureau in case of loss or unauthorized access / modification of
data.
6. The internal controls built in the software used by the bureau to process the
client's transactions.
7. Security provisions over the client's data and files, and the effectiveness of
supervision.
Advantages of service bureaus to the auditor
1. The auditor can rely on grater control since a service bureau will be independent
of the client's user department.
2. Input data will be available for longer period and more detailed printouts will be
available.
Disadvantages of service bureaus to the auditor
1. The auditor will have no legal right to examine the controls in operation at the
bureau unless permission is sought at the time the service contact is drawn up.
2. Security of data and its retention in case of loss or destruction is at risk.

CHAPTER
MANAGEMENT AUDIT
13 AND OPERATIONAL AUDIT
Q.70What is Management Audit and what are its Objectives?
It is the audit of the management, by the management and for the management which attempts
to evaluate the performance of the various management processes and functions. Management
audit is systematic independent appraisal activity within an organization, which aims to evaluate
the decision-making efficiency of the management. Unlike the annual review by outside accounts,
which focuses on financial results of the past year and thus is backward-looking, a management
audit represents a more positive, forward-looking approach that evaluates how well management
accomplishes its stated organizational objectives, In a management audit, the auditor will look to
see whether management is getting information relevant to the decisions and actions. Hence
management audit is an intensive analysis of information needs and the efficiency of the existing
system in meeting them. Management Audit is a tool to improve management performance by
recognizing facts and information about management presented after appropriate examination,
verification and evaluation, by professionally qualified and competent people. To assess how
effective management is in planning, organizing, directing, and controlling the organizations
activities, and how appropriate management's decisions are for reaching stated organization
objectives. This evaluation of managerial performance is achieved with the aid of management
audit questionnaire.
Q.71 What is Operational Audit and What are its objective?

Operational audit has been defined as a systematic process of evaluating an organization‟s
effectiveness, efficiency and economy of the operations under management‟s control and
reporting to appropriate persons the results of the evaluation along with recommendations
for payment. Since operational auditing is a newly emerged term, there is lack of consensus

in the definition of this. However there is not many opposition of the view that operational
audit is a review and appraisal of the operations of the organization carried out by a
competent independent person and also in understanding operational auditing as an
extension of internal auditing with a definite work content which stretches beyond the
traditional field of internal auditors, i.e. financial accounting The independent status is
important to maintain its objectivity and usefulness.
The concept of operational audit is a logical extension of internal audit. Operational audit
is the audit for management. Traditionally, the emphasis of internal auditing was on
accounting and financial operations only. But nowadays the audits of functional areas likes‟
production, marketing etc. are in demand. Thus, operational auditing is merely an
extension of traditional internal auditing into operational areas. Operational auditing
concentrate on effectiveness, efficiency and economy of operations and therefore it is future
oriented. The work of operational auditor doesn‟t end with the reporting of the deficiencies
but also he has to suggest the measure to be taken to meet overcome those. As
management Audit is an “audit of the management”, the same way operational audit is the
“audit for the management”. Followings are the objective of operational Audit:-
1. Appraisal of control –Operational auditing deals with the administrative controls

and its purpose is to determine whether the controls are adequate.
2. Evaluation of performance – During performance evaluation, an operational
auditor is heavily dependent upon availability of acceptable standards.
3. Appraisal of objectives and plans – Though controversial, one school of thought
holds that operational auditing can be stretched to evaluate management objectives
and plans. If the management policy favours installation of controls, controls would
have to stay within the policy frame. Therefore, the basic things that should be
evaluated is management policies, plans and objectives.
4. Appraisal of organization structure – Organisational structure provides the line of
relationship and delegation of authority and tasks. This is also another important
area for appraisal by the operational auditor.
CHAPTER INVESTIGATIONS
14
Q.72 What is Investigation and How it differs from Audit?
The term investigation implies a systematic and in-depth examination or enquiry to
establish a fact or to evaluate a specific situation. The specific purpose may be
evaluation of state of affairs or establishing of a fact. Auditing, on the other hand,
is independent examination of books of accounts and records of a business
enterprise with a view to express an opinion on the truth and fairness of such
accounts. The objective of auditing is very general in nature and is well
documented , while
INVESTIGATION-1
Q.73Define the steps involved in Investigation on Behalf of Incoming Partner
Objective :- to know whether -
(i) The terms offered to incoming partner are reasonable
(ii) His capital contribution would not be unreasonable and safe.
The investigator should take care of the following -
(i) First of all the investigator should ascertain the history from the
inception and growth of the firm.
(ii) The investigator should Study the provisions of the partnership deed to
know the advantages and disadvantages to the incoming partner.

(iii) The Investigator should analyse the profitability and the rate of return of
the firm‟s business over a period of time.
(iv) The investigator should also verify the assets and liability of the firm..
(v) He should also observe that what is position of orders on hand the range
and quality of customers should be thoroughly examined.
(vi) He should evaluate the competency of key personnel‟s employed.
(vii) He should study the important contractual and legal obligations.
(viii) He should evaluate why admission of partner is offered
(ix) He should evaluate that what shall be the manner of computation of good
will of admission and retirement of a partner should be ascertained.
INVESTIGATION -2
Q.74Define the steps involved in Investigation on Behalf of Bank Proposing
to Advance Loan to a Company.
Objective : To know –
(i) the purpose for which a loan is required,
(ii) the sources from which it would be repaid and
(iii) the security that would be available to it.
Procedure :The investigator should -

(1) Evaluate the purpose for which the loan is required .
(2) Evaluate the repayment schedule offered by the buyer.
(3) Evaluate the financial standing and reputation of entity.
(4) Study the Memorandum or the Articles of Association to borrow money for
the purpose for which the loan will be used.
(5) Study the history of growth and development of the entity for at least the
past 5 years.
To investigate the profitability of the business, the investigating accountant
should take the under-mentioned steps –
(a) Prepare a condensed income statement from the Profit and Loss Accounts for
the previous five years, showing various items of income and expenses, gross
and net profits earned and taxes paid annually during each of the five years.
(b) Compute the under-mentioned ratios –
Compute the under-mentioned ratios –
(i) Sales to Average Stocks held
(ii) Sales to fixed assets.
(iii) Equity to fixed assets.
(iv) Current Assets to current liabilities.
(v) Quick assets (the current assets that are readily realizable) to quick
liabilities.
(vi) Equity to long term loans.
(vii) Sales to Book debts.
(viii) Return on Capital Employed.
(c) Break-up of annual sales product-wise.
Verification of assets and liabilities included in the financial statement

submitted by the applicant:
The investigator should prepare schedule of assets and liabilities in them the
particulars given below:
1. Fixed Assets:
(i) Description of the item.

(ii) Gross value
(iii) Depreciation rate used
(iv) Total depreciation written off
(v) Nature of charge on assets created
(vi) Revaluation of the assets if carried out recently
(vii) Basis of revaluation.
2. Inventory:
(i) The different types of raw material and finished goods held.
(ii) Basis of valuation of the inventory.
(iii) Slow moving and obsolete items.
(iv) In case the stock has been pledged or hypothecated the fact should be
stated.
(v) Assessment of the redundancy of stock consequent to changes that
occurred after balance sheet.
3. Sundry Debtors:
(i) Composition of debtors.
(ii) Age wise classification debtors.
(iii) The adequacy of the provision if any created.
(iv) Classification as follows –
a. Debts due in respect of which the credit has not expired.
b. Debts due in respect of which the credit has expired.
c. Debts due from directors and employees.
d. Debts due from subsidiary companies or affiliated companies.
e. The subsequent recovery of debts after the Balance Sheet date.
4. Investment: The schedule of investment should be prepared showing date
of purchase, cost, nominal value, market value and in case it is pledged for
a loan, the details of people.
5. Secured Loans: The loans should be classified between debtor and other
showing there in the secured and unsecured classification. The particulars
of the assets pledged for securing the debt should be clearly stated.
6. Provision for Taxation: The breakup of the year wise provisions and a
note on the adequacy of a each provision shall be provided.
7. Other liabilities: A statement to the effect that all the liabilities have been
properly disclosed showing the age wise analysis of trade creditors.
8. Insurance: A statement of insurance policies giving details of the risk
covered and the particulars of the prepayment
9. Contingent liabilities: A list should be provided giving a break up of the
contingent liabilities existing.
Finally, the investigator should ascertain whether any other application has
been made by the applicant for loans to other institutions or agencies and
if so the result of such applications on the date of review.
INVESTIGATION -3
Q. 75 Define the steps involved in investigation of frauds of following
Investigation of Fraud under Cash
Receipts – The probability of cash being diverted before being entered in
the books is very high and hence
(iv) Income received from different sources should be scrutinized.
(v) Carbon copies of receipts marked „duplicate‟ should be scrutinized.
(vi) The record of small or negligible sources of income such as sales of
scrap or sale of waste paper.

(vii) Recoveries from customers and sundry parties along with
deductions on account of cash discounts should be reviewed and
checked thoroughly.
Payments –
1) Acknowledgement for payments has to be carefully scrutinized
2) Care is required where a figure appears to have been erased on altered
on such acknowledgement.
3) Payment by bearer Cheques should be checked.
4) Payment as regards wages should be examined for possible over
totaling of wage sheets and entries regarding dummy workmen.
5) Check whether payment has been made in respect of supplies which
have not been received.
6) Petty Cash Book itself should be vouched and totaled.
Investigation of Frauds Under Ledger

Balances in customers’ ledger – The first steps is to find out
(1) Whether the customers are properly debited in respect of goods
received.
(2) Test the entries in the order book with those in the sales daybook.
(3) Amounts adjusted on account of goods returned or difference in price
as well as amounts written off as bad debts should be checked.
(4) Balance confirmations from customers.
Balances in Suppliers ledger –
(1) The Bought Journal should be vouched by reference of Goods Inward
Book.
(2) Amounts have been correctly credited in respect of goods duly
received or not.
(3) Request the supplier to furnish statements of their accounts to find
out whether or not any balance is outstanding or due and
(4) Confirm that allowances and rebates given by them is correctly
adjusted.
Investigation of Fraud of stock –

(5) The defalcation of trading stock, etc. is usually possible through a
collusion among a number of persons.
(6) Check whether there is
(a) A system of stock control, and existence of detailed record of the
movement of stock, or
(b) Availability of sufficient data from which such a record can be
constructed.
(7) Physically check the quantities in stock and those shown by the
stock book.
(8) Shortages observed on physical verification of stock should be
reconciled with the discrepancies observed on checking the books.
Q.75What is Due Diligence?
'Due Diligence' is a term that is often heard in the corporate world these
days in relation to corporate restructuring. The term 'corporate
restructuring' normally includes internal reconstruction, amalgamations,
spin-offs, divestiture, mergers, joint ventures, split-off, etc. Certain
corporate restructuring exercises are not within the group (also known as
external corporate restructuring exercises, for example, a joint venture
between two parties where one party hives off an existing unit or division

into another company into which the joint venture partner then acquires
an interest or has acquired an interest. These are all corporate
restructuring exercises that involve more than one party. For such a
corporate restructuring exercise to succeed, it must be planned properly.
A key element in such an exercise, where it involves the acquisition of
another entity, unit or assets of an entity, is the performance of a 'due
diligence' review. Due Diligence may also required to be performed in
cases of venture capital financing, lending, leveraged buyouts, public
offerings, disinvestments, coporatisation, etc. Sometimes, in a
restructuring exercise, while the unit may remain within a group, it may
pass from under the charge of one management team to that of another
team. This situation also gives rise to the need for a due diligence review.
Due Diligence can be sub-classified into discipline-wise exercises be as
follows:
(a) Commercial /operation Due Diligence :i.e. to check whether
the target is commercially feasible.
(b) Financial Due Diligence :To check the financial feasibility of
the target by examining the financial statement and devising
their profit trends.
(c) Tax Due Diligence (Direct and Indirect) :Whether the target
is paying appropriate taxes on a regular basis. Moreover,
ascertain what are the tax benefits available to target.
(d) Information system Due Diligence : Whether information
system of target is providing right information to the right
management at the right time in the right quantity.
(e) Legal Due Diligence :Whether the target is complying with all
the applicable laws and regulations.
(f) Environmental Due Diligence :To check the compliance of
target with environmentally related rules and regulations.
(g) Personnel Due Diligence :To ascertain whether the employees
of target company are efficient.

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1 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

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SHORT NOTES {4 Marks} – Generally not asked

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Q.13. What is cash reserve?

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9 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

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

Held to Maturity{ Nov.2005,

Shifting among Categories: Following guidelines should be followed while shifting

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

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

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

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LOANS and advancesinternal control procedures {Nov.2009} :

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

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

18 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

19 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics

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

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

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f. The auditor should check whether interest income is properly recognized.

Q. 33 Describe the checklist of audit of Investment Company

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20 CA. Aseem Trivedi’s SUPREME 75 – Enough for Other Audit Topics