Revision Test Paper : PE-II Examination : Nov, 2005 PAPER 2 : AUDITING QUESTIONS 1.

. (a) Discuss whether it is practicable and desirable, within the limits of procedures and costs, for the auditor to accept a general responsibility to detect fraud and other irregularities. (b) What procedure an auditor should follow in case there is an indication that fraud or error may exist? 2. (i) What is an Audit Evidence? (ii) What are the various methods of obtaining audit evidence? Mention the same in brief. (iii) Discuss the principles, which are useful in assessing the reliability of audit evidence. 3. 4. What are the basic principles governing an audit of financial statements? Discuss. State briefly the duty of an auditor with regard to each of the following: (a) No depreciation has been charged for the year ended 31st March, 2004, in respect of a spare Bus purchased during the year and kept ready by the company for use as a stand-by on the ground that it was not used during the year. (b) A sum of Rs.10,00,000 is received from an Insurance company in respect of a claim for loss of goods in transit costing Rs.8,00,000. The amount is credited to the Purchases Account. (c) Cost of structural alterations amounting to Rs.60,000 to self-owned factory premises has been charged to Building Repairs. (d) A loss of Rs.2,00,000 on account of embezzlement of cash was suffered by the company and it was debited to Salary Account. 5. Mention the provisions under the Companies Act, 1956 relating to: (i) Appointment of Branch Auditors. (ii) Steps to be taken by the auditor before accepting the appointment. (iii) Qualifications and disqualifications of Auditors. 6. 7. How will you conduct the audit of Incomplete Records? Discuss the provisions of the Companies Act, 1956, regarding the maintenance of proper books of accounts in respect of the following: (a) What are the items with regard to which the proper books of accounts should be maintained? (b) Where should these books be maintained? (c) What are the special provisions, where the company has a branch? (d) What are the circumstances in which proper books are not deemed to be kept? 8. You are the auditor of a private limited company. The audit notes submitted by your assistants disclose the following: (i) Purchases totalling Rs.1,54,000 are not supported by vouchers. (ii) Certain advances given to suppliers amounting to Rs.50,000 still continue to be shown as advances although the final bills of such suppliers have been settled after deducting such advances. State how you will deal with the above mentioned matters. 9. In the course of the audit of a manufacturing concern you find that goods are received on approval and also sent out on approval. To what points would you pay attention in checking the value of such goods included in the Balance Sheet of the concern?

10. Mention the points to be considered in the audit of a leasing company of capital goods.

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11. What are the provisions of the Companies Act, regarding the appointment of an auditor in the following cases: (i) When no auditor has been appointed at the Annual General Meeting. (ii) When no General Meeting has been held and no auditor appointed for two years. (iii) When it is desired to appoint an auditor other than the retiring auditor. (iv) On the resignation of the existing Auditor. 12. (a) The auditor of an EDP-based company should remember that if the quality of the input is controlled, the output will look after itself. (b) Describe six major procedural controls which the auditor would expect to find in operation, three relating to input and three to output. 13. Distinguish between: (a) Preliminary expenses and pre-production expenses (b) Explanatory notes and qualificatory notes. 14. (a) To what extent would you say that audit sampling carried out under the strict canons of statistical theory is to be preferred to judgement sampling? What are the main advantages of statistical sampling for the auditor? (b) Under what conditions is statistical sampling likely to prove most successful as an audit technique? 15. What are the basic differences in the method of auditing as followed in the case of statutory audit under the Companies Act, 1956 and propriety audit as carried on by the Comptroller and Auditor General of India? 16. Write short notes on the following: (a) Ceiling on number of company audits. (b) Additional Reporting requirements under section 227 of the Companies Act, 1956. (c) Power of company to purchase its own securities. (d) Interim Dividends 17. (a) Discuss the provision of the Constitution of India to safeguard the independence of the Comptroller and Auditor General of India. (b) Mention briefly eight special points you as an auditor would consider in conducting the audit of club. 18. What are enquiries and tests should be made by an auditor to satisfy himself that at the date of the balance sheet: (a) the balance on continuous stock records can be relied upon to provide accurate figures of stock quantities. (b) the cost figures appearing in the stock sheet are correct. 19. As you may be aware, Companies (Auditors Report) Order, 2003 has been recently amended by the Companies (Auditors Report) Amendment, Order, 2004. In this context, you may answer the following questions: (a) What is the date of applicability? (b) What are the conditions to be satisfied by a private company to get exemption from the applicability of the Order? 20. (a) Describe basic elements of Auditors Report as per AAS 28, The Auditors Report on Financial Statements. (b) What do you understand by Modified Audit Report? In this context explain what do you mean by a qualified opinion, disclaimer of opinion and adverse opinion.

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SUGGESTED ANSWERS / HINTS 1. (a) (i) The auditors have a responsibility to plan the audit so that they have a reasonable expectation of detecting material mis-statements in the financial statements resulting from irregularities or fraud.

(ii) The primary responsibility for preventing and detecting fraud must always be with the management of the enterprise. (iii) One of the problems that may arise is the difficulty of defining fraud. Associated with this is the need for the auditor to determine an appropriate level of materiality. Currently the auditor assess this in relation to true and fair view shown by financial statements. This may no longer be the correct basis if all or most frauds have to be detected. (iv) The desirability of changing the auditor's responsibility has to be considered in the light of different types of organisations and different interest parties. The auditors of public companies should have a greater responsibility than those of private companies. (v) The widening to the auditor's role would mean that additional audit costs would be incurred by all organisations to detect fraud. Perhaps more effort should go into informing management how to prevent and detect fraud and into increasing the penalties for it so that there is greater deterrent. (vi) If the auditor's objective was changed, whilst the method would principally be the same, the amount of work necessary would increase significantly. The auditor could not accept a greater responsibility for detecting fraud without a substantial fee increase. It is unlikely that this would be worthwhile for most organisations. (vii) Auditors have the skills necessary to detect most types of fraud but the cost of so doing may exceed the cost of the fraud itself. The best approach is for the auditor to make recommendations to management about how they could reduce the likelihood of fraud or irregularities and increase the possibility of their detection. (b) AAS 4, The Auditors Responsibility to Consider Fraud and Error in an Audit of Financial Statements prescribes the following procedure: (i) When the auditor encounters circumstances that may indicate that there is a material misstatement in the financial statements resulting from fraud or error, the auditor should perform procedures to determine whether the financial statements are materially misstated.

(ii) When the auditor identifies a misstatement, the auditor should consider whether such a misstatement may be indicative of fraud and if there is such an indication, the auditor should consider the implications of the misstatement in relation to other aspects of the audit, particularly the reliability of management representations. (iii) When the auditor confirms that, or is unable to conclude whether, the financial statements are materially misstated as a result of fraud or error, the auditor should consider the implications for the audit. AAS 13, "Audit Materiality," paragraphs 12-16, and AAS 28, The Auditors Report on Financial Statements, paragraphs 37-47, provide guidance on the evaluation and disposition of misstatements and the effect on the auditor's report. Where a significant fraud has occurred or the fraud is committed by those charged with governance, the auditor should consider the necessity for a disclosure of the fraud in the financial statements. If adequate disclosure is not made the auditor should consider the necessity for a suitable disclosure in his report. 2. (i) Audit Evidence: Audit evidence refers to any information, verbal or written, obtained by the auditor on which he bases his opinion on financial statements. The audit evidence may be of varied nature and can assume various forms. For example, a signature on the voucher of a designated official, the payees receipt, etc. Even the information obtained by the auditor by discussing with the officials of the company also constitutes audit evidence. Generally

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audit evidence depending on its source may be classified as internal evidence or external evidence. Internal evidence is one that has been created within the clients organisation and without its ever going to outside party. Examples are duplicate sales invoices, employees time reports, etc. External evidence on the other hand is the evidence that originates outside the clients organisation; for example, purchase invoice, suppliers challan and forwarding note, debit notes and credit notes coming from parties, quotations, confirmations, etc. Sometimes in certain transactions, external evidence is obtained, directly by the auditor, e.g., certificates as regards bank balance, confirmation of balances of debtors and creditors, etc. The auditor also obtains evidence by performing various analytical procedures. The auditor should evaluate whether he has obtained sufficient appropriate audit evidence before he draws his conclusions therefrom. The reliability of audit evidence depends on its source internal or external, and on its nature-visual, documentary or oral. The auditor may gain increased assurance when audit evidence obtained from different sources or of different nature is consistent. In these circumstances, he may obtain a cumulative degree of assurance higher than that which he attaches to the individual items of evidence by themselves. Conversely, when audit evidence obtained from one source is inconsistent with that obtained from another, further procedures may have to be performed to resolve the inconsistency. Audit evidence should, in totality enable the auditor to form an opinion on the financial information. (ii) Methods of Obtaining Audit Evidence: The auditor obtains evidence by one or more of the following methods: 1. Inspection: Inspection consists of examining records documents, or tangible assets. Inspection of tangible assets is one of the methods to obtain reliable evidence with respect of their existence but not necessarily as to their ownership or value. Four major categories of documentary evidence, which provide different degrees of reliability to the auditor, are: (a) documentary evidence originating from and held by third parties; (b) documentary evidence originating from third parties and held by the entity; (c) documentary evidence originating from the entity and held by third parties; and (d) documentary evidence originating from and held by the entity. 2. Observation: Observation consists of witnessing a process or procedure being performed by others. For example, the auditor may observe the counting of inventories by clients personnel. Inquiry and Confirmation: Inquiry consists of seeking appropriate information from knowledgeable persons inside or outside the entity. Inquiries may range from formal written inquiries addressed to third parties to informal oral inquiries addressed to persons inside the entity. Responses to inquiries may provide the auditor with information which he did not previously possess or may provide him with corroborative evidence. Confirmation consists of the response to an inquiry to corroborate information contained in the accounting records. For example, the auditor requests confirmation of receivables by direct communication with debtors. Computation: Computation consists of checking the arithmetical accuracy of source documents and accounting records or performing independent calculations. Analytical Review: Analytical review consists of studying significant ratios and trends and investigating unusual fluctuations and items.

3.

4. 5.

(iii) Reliability of Audit Evidence: The reliability of audit evidence depends on its sourceinternal or external, and on its nature-visual, documentary, or oral. While the reliability of audit evidence is dependent on the circumstances under which it is obtained, the following generalisations may be useful in assessing the reliability of audit evidence: (i) External evidence (e.g. confirmation received from third party) is usually more reliable

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than internal evidence. (ii) Internal evidence is more reliable when related internal control is satisfactory. (iii) Evidence in the form of documents and written representations is usually more reliable than oral representations. (iv) Evidence obtained by the auditor himself is more reliable than that obtained through the entity. 3. Basic Principles Governing an Audit: AAS 1, Basic Principles Governing an Audit describes the basic principles which govern the auditors professional responsibilities and the same should be complied with whenever an audit is carried out. The Council has clarified that it is a duty of the member of the Institute to ensure that the, Statements relating to auditing matters are followed in the audit of financial information covered by their audit reports. If, for any reason, a member has not been able to perform an audit in accordance with such Statements, his report should draw attention to the material departures therefrom. The basic principles are discussed below briefly: (i) Integrity, objectivity and independence : The auditor should be straight forward, honest and sincere in his approach to his professional work. He should maintain an impartial attitude and both be and appear to be free of any interest which might be regarded, whatever is actual effect, as being incompatible with integrity and objectivity.

(ii) Confidentiality : The auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose. (iii) Skills and Competence : The audit should be performed and the report prepared with due professional care by persons who have adequate trainning, experience and competence in auditing. The auditor requires specialised skills and competence alongwith a continuing awareness of developments including pronouncements of the ICAI on accounting and auditing matters, and relevant regulations and statutory requirements. (iv) Work performed by others : When the auditor delegates work to assistants or uses work performed by other auditors and experts, he continues to be responsible for forming and expressing his opinion on the financial information. However, he will be entitled to rely on work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. (v) Documentation: The auditor should document matters which are important in providing evidence that the audit was carried out in accordance with the basic principles. (vi) Planning : The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. Plans should be based on a knowledge of the clients business. (vii) Audit evidence: The auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial information. (viii) Accounting system and Internal Control: The auditor should gain an understanding of the accounting system and related controls and should study and evaluate the operation of those internal controls upon which he wises to rely in determining the nature, timing and extent of other audit procedures. (ix) Audit Conclusions and Reporting: The auditor should review and assess the conclusions drawn from the audit evidence obtained and from the audit evidence obtained and from his knowledge of business of the entity as the basis for the expression of his opinion on the financial information. The audit report should contain a clear written opinion on the financial information and should comply the legal requirements. When a qualified opinion, adverse opinion or a disclaimer of opinion is to be given or reservation of opinion on any matter is to be made, the audit report should state the reasons therefor. 4. (a) Depreciation on Stand-by Asset: As per AS-6 on "Depreciation Accounting", depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset

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arising from use, effluxion of time or obsolescence through technology and market changes. Thus, depreciation has to be charged even in case of these assets which are not used at all during the year but by mere effluxion of time provided such assets qualify as depreciable assets. When the spare bus was kept ready for use as stand-by, it means it was intended to be used for the purpose of business. Depreciation in respect of this bus ought to have been provided in the accounts for the year ended 31st March, 2004. If there is an intention to use an asset, though it may not have actually been used, it is a 'constructive' or 'passive' use and eligible for claim of depreciation. (b) Amount Received from an Insurance Company: AS-5 on "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies" requires that all items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period. The claim for loss of goods in transit is arising out of ordinary activities of the enterprise as a part of its normal course of business. However, the cost of goods lost in transit is only Rs.8,00,000 while the insurance money received is Rs.10,00,000. Purchases Account need not be credited since it would distort the purchases done during the year and as also the gross profit. Therefore, entire amount of Rs.10 lacs needs to be taken to profit and loss account under an appropriate head. This is an income arising from an ordinary activities of the enterprise but having regard to amount involved and exceptional nature, a separate disclosure be made in the profit and loss account. Such disclosure would enable the users to understand the performance of an enterprise for the period. (c) Cost of Structural Alterations: Any subsequent expenditure on fixed assets which increases the future benefits arising from them beyond their previously assessed standards of performance amounts to capital expenditure and, thus, must form part of the cost of the asset. The words "structural alteration" would generally signify that some significant changes have taken place in the design of building to provide more strength to the building or expansion in the capacity of the building. Therefore, cost of Rs.60,000 represents the cost of expansion or extension or may increase the life span of premises, it is a capital expenditure, and an adjustment entry debiting Buildings Account and crediting Building Repairs Account should be made and depreciation should also be provided accordingly. (d) Embezzlement of Cash: AS-5 on "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies", requires that "all items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period". It further states that "when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately". Embezzlement of cash during the course of business is a 'business loss'. It is a business hazard which can occur once in a while. It cannot be merged with any other head much less the salary. Being material item, it is required to be disclosed under a distinct head in the profit and loss account. 5. (i) Appointment of Branch Auditors: Sub-section (1) of Section 228 of the Companies Act, 1956 requires that the accounts of the branch office of a company must be audited either by the company's auditor appointed under Section 224 or by a person qualified for appointment as an auditor as contemplated by Section 226 or where the branch office is situated in a foreign country outside India either by the company's auditor or by a person qualified as aforementioned or by an accountant duly qualified to act as an auditor in accordance with the laws of that foreign country. A company may at general meeting decide whether it have accounts of its branch office audited by a person other than the company's auditor. Upon such a decision being taken, the company may either appoint a person who may be a person qualified under Section 226 or in the case of a foreign branch a person qualified according to the laws of that country to audit the accounts of the branch or authorise the Board of Directors to appoint such an

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auditor in consultation with the company's auditor, as required by clause (a) of Section 228(3) of the Companies Act. (ii) Steps to be taken by the auditor before accepting the appointment: (a) Issuing a certificate that on appointment by the company, the limit on holding of company audit as contemplated under Section 224 (1B) will not be exceeded. (b) Ensuring that the requirements of Sections 224 and 225 of the Companies Act have been complied with as discussed below: (i) If the appointment of the auditor is being made for the firs time after incorporation of the Company, the auditor should verify as to whether Board of Directors have passed the resolution for his appointment within one month of the date of registration of the company.

(ii) If the Board of Directors have not appointed the first auditor but the appointment is being made by a general meeting of the company, the auditor should verify as to whether a proper notice convening the general meeting has been issued by the Company and whether the resolution has been validly passed at the general meeting of the company. (iii) If the appointment is being made to fill a casual vacancy, the incoming auditor should verify as to whether the Board of Directors have powers to fill the casual vacancy and whether the Board of Directors have passed the resolution filling the casual vacancy. (iv) If the vacancy has arisen due to resignation of the auditor, the incoming auditor should see as to whether a proper resolution filling the vacancy has been passed at the General Meeting of the Company. (v) If the vacancy has arisen as a result of removal of the auditor before the expiry of his term of office, the incoming auditor should see that proper resolution has been passed at the General Meeting of the company and that the previous approval of the Central Government has been obtained by the company. (vi) If the provisions of Section 224A apply to the company, the incoming auditor should verify as to whether a special resolution as required under the said Section has been duly passed. (vii) Where the auditor other than the retiring auditor is proposed to be appointed, the incoming auditor should ascertain whether the provisions of Section 225 have been complied with. (c) Communicating with the previous auditor, if any. (iii) Qualifications and Disqualifications of Auditors: They are governed by Section 226 of the Act. The main provisions are stated below: A person shall not be qualified for appointment as an auditor of a company unless he is a chartered accountant within the meaning of the Chartered Accountants Act, 1949; provided that a firm whereof all the partners practising in India are qualified for appointment, as aforesaid may be appointed by its firm name to be the auditors of a company in which case any partner so practising may act in the name of the firm. Under Sub-Section (3) of Section 226 the following persons are not qualified for appointment as auditors of a company; (a) a body corporate; (b) an officer or employee of the company; (c) a partner or employee of an officer or employee of the company; (d) a person who is indebted to the company for more than Rs.1,000 or who has given any guarantee or provided any security in connection with the indebtedness of any third

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person to the company for more than Rs.1,000. (e) A person holding any security carrying voting rights. It is further laid down in sub-section 226 that a person is not eligible for appointment as auditor of any company, if he is disqualified from acting as auditor of that company's subsidiary or holding company or of any other subsidiary of the same holding company. Sub-section (5) of section 226 provides that if an auditor, after his appointment, becomes subject to any of the disqualification specified in sub-sections (3) and (4), he shall be deemed to have automatically vacated his office. 6. Audit of the Incomplete Records: Normally, the audit of incomplete records may be necessitated under two circumstances (i) when accounts have been maintained on single entry basis; or (ii) accounting records may be destroyed by firm, flood, etc. or seized by government authorities. In fact, many sole proprietors maintain accounts in a very loose form. Under either of the circumstance the audit objective would remain the same and thus, auditor would have to follow extensive audit procedure before expression of an opinion on such financial statements. Steps which may be followed in this regard are as under: (i) Ascertain the exact status of accounting records available including memoranda records, if any. Also obtain a list of records, i.e., accounting memoranda, statistical records, etc.

(ii) Ensure that the management compiles/reconstructs accounting records to the extent practicable. In case of single entry, the accounts may be converted to double entry basis. (iii) Perform compliance procedure to assess whether any control system is in operation. (iv) Vouch transactions recorded in books of accounts with reference to appropriate audit evidence. Check posting, casting, etc. in depth. Auditor may also obtain external evidence as far as possible like-confirmation from third parties. Bank reconciliation should also be examined in detail. (v) Examine the system in operation in respect of custody managed cash memos, receipts, cheque books, etc. (vi) Conduct surprise checks to verify cash in hand, inventory, etc. (vii) Verify fixed assets by observing physical verification. (viii) Obtain indirect evidence to verify the existence of fixed assets, e.g., payment of local taxes to municipal authorities, electrical bills, etc. in case of building. (ix) Check veracity of memoranda records and obtain further evidence to confirm the same. (x) Apply analytical review procedures in depth and notice deviations to investigate in detail. Ratio analysis shall be of particular importance since it would provide substantive audit evidence. (xi) Formulate an appropriate audit opinion based on above findings. A disclaimer of opinion may be appropriate in case there is any restriction on the scope of an audit. 7. (a) Section 209(1) of the Companies Act, 1956 requires that a company shall maintain proper books of account with respect to the following items: (i) all sums of money received and expended by the company and the matters in respect of which the receipt and expenditure take place;

(ii) all sales and purchases of goods by the company; (iii) the assets and liabilities of the company; and (iv) in the case of a company pertaining to any class of companies engaged in production, processing, manufacturing or minuting activities, such particulars relating to utilisation of material or labour or to other items of cost as may be prescribed, if such class of companies is required by the Central Government to include such particulars in the books of account.

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(b) Every company is required to keep proper books of account at its registered office. It is, however, provided in sub-section (1) of section 209 that all or any of the books of account may be kept at such other place in India as the Board of Directors may decide and when the Board of Directors so decides, the company shall within seven days of this decision, file with the Registrar a notice in writing giving the full address of that other place. (c) Sub-section (2) of section 209 of the Companies Act, 1956 states that where a company has a branch office, whether in or outside India, the company shall be deemed to have complied with the provision or sub-section (1), if proper books of account relating to the transactions effected at the branch office are kept at that office and proper summarised returns, made upto-date at intervals of not more than three months, are sent by the branch office to the company at its registered office or the other place referred to in sub-section (1) of section 209. (d) According to sub-section (3) of section 209, a company shall not be deemed to have kept proper books of account under the following circumstances: (i) if there are not kept such books as are necessary to give a true and fair view of the state of the affairs of the company or branch office, as the case may be, and to explain its transactions; and

(ii) if such books are not kept on accrual basis and according to the double entry system of accounting. 8. (i) Rs.1,54,000 by itself is a substantial amount and the auditor should therefore be cautious while vouching the purchases concerned. He should ask his assistant to provide him with particulars of these purchases as regards name of the party/parties and the commodities stated to have been purchased. Whether cash is shown to have been paid out or whether these purchases have been received by crediting any party to whom the payment is still due. He should also get from the assistant the explanations given by the management for their inability to produce supporting vouchers. It is possible that certain controlled items may have been purchased in the open market without the backing of any document - the fact about this can only be known after perusing the lists of items shown to have been purchased. It is also possible that there are fictitious entries made for the benefit of someone. What the auditor needs to be satisfied about is whether actual purchases were made, goods in fact have been received by the company and whether such purchases involved any punishable offence. The auditor should also take note of possible penalties and consequences that may arise for these and suggest suitable provision in the accounts for taking care of such an eventuality. It is also possible that goods purchased towards the end of the year have been recorded in the books of account, while the documents in support of the purchases have been received subsequent to the closing of the year. The assistant should be asked to look into the subsequent period's vouchers and purchase bills and see whether anything like that has happened. The auditor must satisfy himself about the actual receipt of the goods by the company. This can be done by tracing entries into the stock records, their subsequent utilisation or inclusion in the stock sheets, etc. Finally, the auditor, if he is satisfied with the indirect evidence and explanations, should insist on the Board confirming the purchases at its meeting and also on a certificate stating that such purchases have actually been made and the goods have been received by the company. However, mere certificate or confirmation will not serve any purpose, if other evidence fails to corroborate what has been stated in the certificate. The auditor also must have regard to the materiality of the amount with reference to total purchases and total profit or loss. (ii) From the situation given two possibilities emerge - whether showing advances even after final settlement of bills is intentional or a mere omission. The answer may be found by an

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examination of the entries passed in the concerned parties' accounts. If these amounts show no outstanding in respect of the supplies made against advances, inspite of the fact that the advances remained unadjusted, the auditor must necessarily look into the entries that were passed to wipe off the liabilities. Frauds may be committed by this process to convert a loss into profit by taking fictitious credits in the revenue account while debiting the suppliers. If, however, the situation merely represents the fact that necessary adjustment between the creditors' accounts and the advance accounts has not been made and the creditors' accounts reveal an aggregate outstanding of Rs.50,000 on the bills, the position should be rectified by making a proper entry. There is a further probability of mistake or fraud; if the bills show only the net amounts payable after adjustment of the advances, intentionally or by mistake the net amounts may have been accounted for as liabilities in the suppliers' accounts with a corresponding understatement of the purchases. As a result, the suppliers' accounts would not disclose any outstanding; under the circumstance the profit would be overstated. In the context of these probabilities, the auditor should satisfy himself that the assistant has carefully examined the receipts issued by the creditors against the balance payments on the bills and they confirm a full and final settlement. Also, it would be useful to obtain confirmation from the concerned parties that they are not holding any advance as regards the matter under reference. The auditor is to decide his course on the basis of the further findings that he can make on the lines discussed. In any case, if he is satisfied that the omission to adjust the advance was a mistake, he can suggest correction thereof. Even if he is satisfied that the matter was intentional, which is very difficult to prove, the better course for him would be to suggest necessary corrections so that the accounts cease to be misleading. From a study of the combined effect of the two notes under consideration, it appears that they are at cross purposes. It is unlikely that these have been committed intentionally and consequently non-availability of the vouchers and mistake can be the reasonable inference. However, since the auditor cannot base his judgement merely on inferences, it is advisable that the steps outlined above for further enquiry should be carried out to ascertain whether any motive existed behind these matters. 9. Receiving or sending of goods on approval does not constitute a purchase or a sale transaction and the title to the goods is retained by the sender in either case. Only when the party receiving the goods intimates his acceptance or is continuing to hold the goods after the expiry of the approval period, that the title passes and consequently a sale or purchase transaction takes place. Goods which have been received "on approval" should not be included in the books or balance sheet unless they have been definitely accepted as purchases and taken into stock as such, in which case they would be recorded through the purchase book. Enquiries should be made to ascertain whether any basic record, may be in memorandum form, has been maintained by the concern to record the "goods received" on approval and whether such record contains the relevant particulars about the date of receipt, supplier, period of approval and other terms. Also, it should be enquired whether the internal control on goods received on approval are such as would preclude their being taken into stock and purchases. The goods that have been accepted as purchases within the year-end and remaining with the concern should, however, be included in the stock and should be valued on the normal basis adopted for other stocks; because, then, the need for any distinction in respect of such goods will not exist. If goods are there with the concern which are not accepted or the periods for approval in respect of such goods are not over on the balance sheet date, it would be proper not to include them in stock and the question of their valuation would then be redundant. If any of such goods have been lost or have suffered damages after being received, it would be the duty of the auditor to ensure creation of a suitable provision to take care of the loss. The auditor should also satisfy himself that the goods on hand awaiting approval on the balance sheet date are identifiable and have been stored separately; also that inventory is taken and tallied with the record for "goods on approval".

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Where goods are sent out on approval as the normal feature of the business, the schedule of balance on the approval ledger should be agreed and the cost of the goods should be indicated against each. Where goods have been sent out on approval not as a regular feature of the business, it is likely that a separate recording of goods on approval may not be there and the goods have been included in the normal sales. In such a case, the concern should be asked to compile a schedule of balances for sale on approval included in sales and debtors accounts and the latter accounts should be reduced by the amount by which they were loaded in respect of the goods should further be reduced to cost if the cost was less and should be included in the value of stock. In case the invoice price was lower than the cost, the goods on approval should be included in the stock at the priceless selling expenses thereon. In this connection, it is important to bear in mind that though technically goods sent on approval becomes a sale if the goods are not returned within the time given, in practice often returns are accepted even after such period is over. In checking the items in the schedule, the auditor should take care to see that the practice of the trade and past experience of the client in this respect have been taken into consideration in deciding whether an item has been sold or is still under approval. The schedules should be certified by a responsible official of the company and due provision should be made for losses arising from "goods on approval" being received back damaged, the party becoming, untraceable or the goods going out of fashion. In verifying the valuation of goods already received back, the auditor should look into the internal controls on receiving back of such goods and should ensure that the values have been adjusted for depreciation in the value of the goods on account of the aforesaid factors. Special care is needed to see that the goods returned during the last few days of the year are not included twice in the stocks - once as a normal item in the inventory and the second time as "goods on approval". Sales, returns and cash accounts for the subsequent period should also be scrutinised to ensure that the "goods on approval" were genuine and they have either been converted into a sales or have been returned in due course, and cash has been collected for the sold out items. 10. A lease is a contract between the 'lessor' who is the legal owner of the asset and the 'lessee' who acquires the right to use the specific asset on the payment of fixed rental. Lessor retains ownership of asset, for an agree period of time, in return for payment of specified rental. Thus, lease finance is an alternative whereby project costs could be met by taking in assets and equipments on hire rather than buying. In respect of leasing transactions entered into by a leasing company involved in the leasing of capital goods, the auditor should check/verify the following: (a) The object clause of the leasing company to see that the company can take such activities. Further, check whether the company can undertake financing activities or not. (b) Whether there exist a procedure to ascertain the credit analysis of lessee like lessee's ability to meet the commitment under lease, past credit record, capital strength, availability of collateral security, etc. (c) The lease agreement should be examined and the following points may be noted: (i) the description of the lessor, the lessee, the equipment and the location where the equipment is to be installed. (the stipulation that the equipment shall not be removed from the described location except for repairs. For the sake of identification, the lessor may also require plates or making to be attached to the equipment.)

(ii) the tenure of the lease, dates of payments of lease charges, deposits or advances etc. should be noted. (iii) whether the equipment shall be returned to the lessor on the termination of the agreement and the cost shall be borne by the lessee. (iv) whether the agreement prohibits the lessee from assigning or subletting the equipment and authorises the lessor to do so. (d) Examine the lease proposal from submitted by the lesee requesting the lessor to provide him on lease the equipment.

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(e) Ensure that the invoice is retained safely as the lease is a long term contract. (f) Examine the acceptance letter obtained from the lessee indicating that the equipment has been received in order and is acceptable to the lessee.

(g) See the Board resolution authorising a particular director to execute the lease agreement with the lessee. (h) See that the copies of the insurance policies have been obtained by the lessor for his records. (i) (j) See that the RBI guidelines have been complied with. List of clients from which lease rents are overdue, reconciliation statements and confirmation of balances.

(k) Adequacy of the provision for bad and doubtful debts with reference to recovery of payments, litigation, subsequent realisation, etc. (l) Proper accounting treatment in case the assets have either been repossessed or given on a lease.

(m) Nature of lease agreement as to whether it is a finance lease or operating lease and accounting treatment in either of the case. 11. (i) Under section 224(3) of the Companies Act, if in the annual general meeting no auditors are appointed or re-appointed, the Central Government may appoint an auditor to fill the vacancy. A duty has been cast on the company to give notice to the Central Government about no auditor having been appointed within seven days of the holding of the annual general meeting, under sub-section (4) of section 224.

(ii) Once an auditor is appointed under section 224 of the Companies Act, he holds the office as auditor till the conclusion of the next annual general meeting. Under this rule, if no annual general meeting is held for two years the auditor appointed in the last held annual general meeting continues to be the auditor of the company. If an auditor is to be appointed under this situation, the company must convene an annual general meeting to appoint a new auditor or to re-appoint the retiring auditor. In case of appointment of a new auditor in place of the retiring auditor, a special notice must be received by the company proposing the name of the new auditor for appointment, a copy of which should be forwarded to the retiring auditor at the earliest. If the retiring auditor makes a representation in writing, the same should be circulated to the members of the company, if time permits. Also a certificate should be obtained from the proposed auditor before actual appointment to the effect that if the appointment is made in his favour, the holding of the proposed audit by him will be within the limit specified by section 224(1B) of the Companies Act. If the retiring auditor is to be reappointed, it is to be ensured that none of the circumstances specified in section 224(2) of the Companies Act exists. Also, a certificate referred to above should be obtained from him. A resolution appointing the new or the retiring auditor is to be passed in the annual general meeting by a simple majority unless the company is one which is covered by either section 224A or section 619B of the Companies Act. (iii) Section 225(1) of the Companies Act requires that a special notice must be sent to the company by the member desiring to appoint a person as auditor in the place of the retiring auditor. On receipt of the notice, the company shall forthwith send a copy thereof to the retiring auditor. Also, the company shall give notice of the proposal, conveyed through the special notice, to its members at least seven days before the meeting. Thereafter, the proposal shall be placed before the general meeting for its consideration. The retiring auditor, if he chooses to send a representation to the company in the matter of the move to remove him, will be free to do so and the representation to the company in the matter of the move to remove him, will be free to do so and the representation must be circulated to the shareholders if reasonable time is available to do that. In any case, the retiring auditor will have the right to be heard and, or to read out his representation in the annual general

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meeting. However, if the representation is meant to give needless publicity to defamatory matter, the retiring auditor may be restrained from getting the representation circulated or read at the annual general meeting. In the annual general meeting, the proposal to appoint the new auditor is to be passed by a simple majority, unless the company is covered by either section 224A or section 619 B of the Companies Act. (iv) Resignation of the existing auditor gives rise to a casual vacancy in the office of the auditor. In terms of the proviso the section 224(6) (a), such vacancy can be filled by the company only at a general meeting. In view of this, the company should convene an extraordinary general meeting to fill the vacancy, and make appointment of the auditor. Before giving the appointment to the auditor, the company should ascertain that the number of company audits held by the auditor will not exceed the specified number in terms of section 224(1B) of the Companies Act. 12. (a) There can be no doubt that the quality of output from an EDP-based system depends greatly, although not totally, on the quality of the input. The input consists of the raw data taken from source documentation and this is what the programme will process to provide the output. An example of this situation is the processing of a batch of sales despatch-notes to produce sales invoices and update a sales ledger. There are two circumstances which could lead to inaccurate output. Firstly if the data on the despatch notes is incorrect and secondly if that data is inaccurately converted into machinereadable input. Thus it is clear that controls must be established to ensure errors do not occur at either stage. However, this is not the end of the need for controls, and the auditor should be aware of the vital need to check the processing and output stages. Even if the input is completely and accurately transcribed, the output will not be correct if errors can occur at the processing stage, such as data not being processed or processed more than once. Also the quality of the output will be impaired if it is not in the format required and does not meet the needs of the user or if the output is altered before it reaches the user. In conclusion it may be more correct to state that the auditor must consider controls over each stage of input, process and output before he can be satisfied with the accuracy of the system. (b) Major procedural controls which an auditor would expect to find are as follows: (i) Input Controls: (a) Batch preparation and recording of batches so each document can subsequently be traced to a particular batch and so the completeness and accuracy of input can be checked by reference to totals, both real and hash. (b) Authorisation procedures for input. Only batches which have been checked and approved should be input. Authorisation should be carried out by a suitablyqualified member of staff. (c) Division of duties should occur between those responsible for raising the documents and those responsible for input. (ii) Output Controls: (a) Completeness checks should be carried out to ensure all data input and processed is output. This can be usually effected by comparing file totals before and after processing. (b) Physical controls should be exercised over the distribution of output. Printouts should only be sent to authorised personnel with no opportunity for the output to be altered before reaching the user. (c) Output in the form of exception reports should be recorded along with subsequent action taken on the report. This should be checked regularly by an independent official.

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13. (a) Preliminary expenses and pre-production expenses: Preliminary expenses are incurred by promoters of a company to bring the company into existence. They normally include: (i) Legal costs in drafting the Memorandum and Articles of Association. (ii) Stamp duty and other fees on registration of the company. (iii) Cost of printing the Memorandum and Articles of Association. (iv) Cost of statutory books to be maintained by the company. (v) Any other expenses incurred to bring into existence the corporate structure of the company. These expenses, when approved by the Board of the company after its incorporation, become the expenses of the company and instead of being charged off in the year itself as revenue expenses, these are generally carried forward in the asset side of the balance sheet under the heading Miscellaneous Expenditure:. This accounting treatment is meted out because of the nature of these expenses. These are expenses necessarily to be incurred to bring the company into existence and consequently these assume a capital expenditure character. Since, these are not backed by any specific item of asset, it is also a recognised accounting practice to write them off from profits of subsequent three to five years. Under the provisions of the Income-tax Act, these expenses can be amortised over a period of ten years. Pre-production expenses are incurred by an industrial company after its incorporation. Often such a company needs considerable time to set up the plant and other production facilities. In the meantime, it has to incur certain revenue expenses which cannot be capitalised. Preproduction expenses refer to such expenses. They include expenses in the accounts as they have been incurred in the pre-production period. They are carried forward in the asset side of the balance sheet under the general heading of Miscellaneous Expenditure. These expenses are generally written off at the earliest opportunity after commercial production starts, within three to five years. (b) Explanatory notes and Qualificatory notes: An explanatory note is meant to explain or supplement a matter contained in or related to financial statements. The matter on which an explanatory note is given is one on which the auditor has not taken adverse view, e.g., note on regrouping of figures of previous year or an information on the basis of allocation of a common expense. Explanatory notes are given by the directors of the company and are usually shown under Notes to accounts. Such notes may also appear elsewhere in the statements of account. All notes to account, wherever shown, including those required by the Schedule VI to the Companies Act, 1956 constitute an integral part of the accounting statement. Qualificatory notes also refer to the matters stated in the statements of account and usually are included under Notes to accounts. Such notes may also appear elsewhere in the statements of account. All notes to account, wherever shown, including those required by the Schedule VI to the Companies Act, 1956 constitute an integral part of the accounting statement. Qualificatory notes also refer to the matters stated in the statements of account and usually are included under Notes to Accounts along with the explanatory notes. Qualificatory notes are such notes on which the auditor has taken an adverse view e.g. payment of managing director remuneration when the governments approval is awaited. In view of their impact on the statements of account and on the resulting audit report, the auditors refer to the qualificatory notes in the audit report itself in a specific manner by identifying the notes on which they have taken an adverse view and drawing attention of the shareholders thereto. The auditors usually refer to the qualificatory notes by the use of the prefix subject to in their report. One important point to be noted in this connection. Qualificatory notes are put by the directors as they are also equally obliged to make the disclosure of the adverse position. Since, both the directors and the auditors require to make the qualificatory

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notes to accounts with mutual agreement, thereby dispensing with the necessity of repeating the same note twice, one under the notes to accounts and again under the audit report. 14. (a) The advantages of statistical techniques, properly applied, over judgement sampling are: (i) conclusions about the total population can be stated with a known confidence and precision;

(ii) sample size is objectively determined; (iii) time and money may be saved by limiting sample size to that required to achieve a given result. For these reasons, whenever the size and homogeneity of the group to be checked permits, statistical sampling is generally to be preferred to judgement sampling. (b) Statistical sampling is most likely to be successful when the following conditions are present: (i) a large population to be checked; (ii) the population consists of similar items; (iii) items for checking easily selected and located; (iv) the error rate is reasonably low (e.g. good system of internal control in force). 15. The statutory audit carried on by the statutory auditor connotes on examination of the transactions with a view to ascertaining the true and fair character of the financial statements. It is essentially a reporting function and involves the expression of an opinion in the form of a report. The opinion is developed on systematic application of certain techniques and procedures which in turn depends upon: (1) Assessment of internal controls; (2) Adherence to the accepted accounting principles; and (3) Compliance with legal and internal rules and regulations. In examining the transactions and evaluating their impact on the annual results, the auditor takes into consideration the documents and evidence at each stage in ascertaining the reliability of such transactions. This is a process of exercise of judgement which is heavily aided by professional guidance, legal provisions and connected judicial pronouncements. However, a statutory auditor does not concern himself with the prudence or imprudence and efficiency or inefficiency of the manner in which the business is being carried on but only concerns himself with the fact that is on record and gives his opinion on the basis thereof. The law also does not require the auditor, except in a few matters specified in Section 227(1A) and in the MAOCAR Order issued under Section 227(4A), to go into justification and efficiency aspect of the transactions. The propriety audit conducted by the C &AG requires him to go deeper into certain areas to see whether the undertakings have fulfilled the objectives with which targets have been achieved as scheduled, whether avoidable delays either in construction or production have occurred or whether there is infructuous or extravagant expenditure. Thus, the propriety audit stands for verification of transactions on the tests of public interest, commonly accepted customs and standards of conduct. E.L. Kohler has defined the term "propriety" as "that which meets the tests of the public interest, commonly accepted customs and standards of conduct and particularly as applied to professional performance, requirements of law, Government regulations and professional code". On an analysis, the tests boil down to tests of economy, efficiency and faithfulness. Therefore, the method of conducting propriety audit encompasses evaluation of transactions in the light of these tests and thus extends beyond the statutory audit. While under statutory audit, there is depending on documents, vouchers and evidence to ascertain the true and fair character of financial statement, under the propriety audit, the emphasis shifts and it extends to examining the substance of the transactions. The C & AG looks into the appropriateness of transactions on a consideration of financial prudence, public interest and wasteful expenditure. Thus, property audit is concerned with scrutiny of executive actions and decisions bearing on the financial and the profit and loss situation of the company, with special

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regard to the public interest and commonly accepted customs and stands of conduct. It is also seen whether every officer has exercised the same vigilence in respect of expenditure incurred from public money, as a person of ordinary prudence would exercise in respect of expenditure of his own money under similar circumstances. Propriety requires the transactions and more particularly expenditure to conform to certain general principles. These principles as laid down by the C & AG are: (a) That the expenditure is not prima facie more than the occasion demands and that every official exercises the same degree of vigilence in respect of expenditure as a person of ordinary prudence would exercise in respect of his own money. (b) That the authority exercises its powers of transactioning expenditure to pass an order which will not directly or indirectly secure to its own advantage. (c) That funds are not utilised for the benefit of a particular or group of persons and (d) That, apart from the agreed remuneration, no other avenue is kept open to indirectly benefit the management personnel, employees and others. Thus, under the propriety audit, the auditors try to bring out the cases of improper, avoidable or infructuous expenditure even though the expenditure has been incurred in conformity with the existing rule and regulations. Therefore, such an audit goes beyond the scope of the normal duties of a statutory auditor and to that extent the method of conducting audit is also different. Another point to be noted in this connection is that the statutory auditor is guided by specific responsibilities imposed on him by Section 227 of the Companies Act. On the other hand the propriety audit by C & AG is guided not only by Section 227 of the Companies Act but also by the guidelines by C & AG in this regard. 16. (a) Ceiling on Number of Company Audits: Section 224(1)(B) provides that on and from the financial year next following the commencement of the Companies (Amendment) Act, 1974, no company or its Board of Directors shall appoint or re-appoint any person or firm as its auditors if such person or firm is at the date of such appointment or re-appointment, holding appointment as auditor of the specified number of companies or more than the specified number of companies. The Companies (Amendment) Act, 1988 has further specified that no company or its Board of Directors shall appoint or re-appoint any person who is in full employment elsewhere. In the case of a firm of auditors, it has been further provided that specified number of companies shall be construed as the number of companies specified for every partner of the firm who is not in full time employment elsewhere.* This limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 20 = 60 company audits of which not more than 30 should be in companies having paid up capital of Rs. 25 lakhs or more. Sometimes, a chartered accountant is a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account. Subject to the overall ceiling of company audits, how they allocate the 20 audits between themselves is their affairs. Explanation II after sub-section (IC) of section 224 further amplifies the manner of identifying the audit units for calculating the specified number. Under this explanation, when an auditor is appointed to audit even a part of a companys accounts, the part will be considered as a unit of audit for the purpose of calculation of the ceiling. Often, now-a-days, one comes across what is known as joint audit - when two or more auditors are appointed to audit the account of a company. Each of the joint auditor is considered a part auditor for the purpose. Any joint audit held by an auditor will be included a one audit unit for the purpose of
*

Students may note that the intention of government in amending section 224(1B) was to plug the loop hole whereby even a chartered accountant in whole time employment could audit twenty companies if he held the certificate of practice. However, there seems to be drafting error whereby the amended section tends to suggest that the limit of twenty audits is no longer applicable to individual chartered accountants in practice provided may are not in wholetime employment. This anomaly is already under the consideration of the Department of Company Affairs.

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calculating the ceiling of audits. However, audit of a branch of company is not included in the computation of the ceiling. Similarly, audit of corporations which are not companies and foreign companies are also not to be included. Further, it may be noted that even non-profit companies would be counted for the purpose of ceiling. However, guaranteed companies not having share capital, special audit and investigation of companies will not be counted for the purpose. Students may also note that the Companies (Amendment) Act, 2000 has amended section 224(1B) by adding a proviso that provisions shall not apply to a private company on and after the commencement of the Companies (Amendment) Act, i.e. 13.12.2000. Therefore, with this amendment, while computing the ceiling a number of audits, only audit of public companies would be taken into consideration. In other words, an auditor can accept audit of any number of private companies. This may, however, be subject to guidelines of the Institute. No.1-CA(7)/53/2001: In exercise of the powers conferred by clause (ii) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of the Institute of Chartered Accountants of India hereby specifies that a member of the Institute in practice shall be deemed to be guilty of professional misconduct, if he holds at any time appointment of more than the specified number of audit assignments of the companies under Section 224 and /or Section 228 of the Companies Act, 1956. Provided that in the case of a firm of chartered accountants in practice, the specified number of audit assignments shall be construed as the specified number of audit assignments for every partner of the firm. Provided further that where any partner of the firm of chartered accountants in practice is also a partner of any other firm or firms of chartered accountants in practice, the number of audit assignments which may be taken for all the firms together in relation to such partner shall not exceed the specified number of audit assignments in the aggregate. Provided further that where any partner of a firm or firms of chartered accountants in practice accepts one or more audit assignments in his individual capacity, or in the name of his proprietary firm, the total number of such assignment which may be accepted by all firms in relation to such chartered accountant and by him shall not exceed the specified number of audit assignments in the aggregate. Explanation: 1. for the above purpose, the specified number of audit assignments means: (a) in the case of a chartered accountant in practice or a proprietary firm of chartered accountant, thirty audit assignments whether in respect of private companies or other companies. (b) in the case of a firm of chartered accountants in practice, thirty audit assignments per partner in the firm, whether in respect of private companies or other companies. Provided that out of such specified number of audit assignments, the number of audit assignments of public companies each of which has a paid-up share capital of rupees twenty-five lakhs or more, shall not exceed ten. 2. In computing the specified number of audit assignments. (a) the number of such assignments, which he or any partner of his firm has accepted whether singly or in combination with any other chartered accountant in practice or firm of such chartered accountants, shall be taken into account. (b) the audit of the head office and branch offices of a company by one chartered accountant or firm of such chartered accountants in practice shall be regarded as one audit assignment. (c) the audit of one or more branches of the same company by one chartered

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accountant in practice or by firm of chartered accountants in practice in which he is a partner shall be construed as one audit assignment only. (d) the number of partners of a firm on the date of acceptance of audit assignment shall be taken into account. (e) a chartered accountant in full time employment elsewhere shall not be taken into account 3. 4. This notification shall come into force from the date of its publication in the Official Gazette. A chartered accountant in practice as well as firm of chartered accountants in practice shall maintain a record of the audit assignments accepted by him or by the firm of chartered accountants, or by any of the partner of the firm in his individual name or as a partner of any other firm as far as possible, in the following former.

(b) Additional Reporting Requirements: The Companies (Amendment) Act, 2000 has amended section 227 and introduced two more clauses as under: "(e) in thick type or in italics the observations or comments of the auditors which have any adverse effect on the functioning of the company; (f) whether any director is disqualified from being appointed as director under clause (g) of sub-section (1) of section 274." As far as clause (e) is concerned, the intention of the legislature appears that any observation or comments which are likely to have an adverse effect on the functioning of the company should be highlighted either in thick type or in italics. It is felt that such highlighting of the comments would bring these to the attention of the shareholders. Clause (f), however, is required to be read with the provisions relating stated in section 274 (1)(g). Accordingly, the auditor may ensure that certificates are taken from each director are taken on record by the Board to the effect that a director who happens to be on the Board of other companies are not hit by section 274 (1)(g). Section 211(3A) provides that it is the responsibility of the company to ensure that every profit and loss account and balance sheet of the company shall comply with the accounting standards. In case a company fails to comply with accounting standards, such companies shall disclose in its profit and loss account and balance sheet the deviation from accounting standards, the reasons for such deviation, and the financial effect, if any, arising due to such deviation. Under this sub-clause, a duty has been imposed on auditor under Section 227 (3) (d) to see whether in his opinion, the profit and loss account and balance sheet complied with the accounting standards. (c) Power of Company to Purchase its Own Securities: The Companies (Amendment) Act, 1999 contains elaborate provisions enabling a company to buy-back its own securities. The word security here includes employee stock option, i.e., sweat equity share or any other security notified by the government. The word security includes both equity and preference share. But preference share can be redeemed, perhaps the reform is intended to equity share only. As per section 77A, a company may purchase its own shares or other specified securities (hereinafter referred to as buy-back) out of (i) its free reserves; or (ii) the securities premium account; or (iii) the proceeds of any earlier issue other than from issue of shares made specifically for buy-back purposes. (2) No company shall purchase its own shares or other specified securities unless (a) the buy-back is authorised by its articles; (b) a special resolution has been passed in general meeting of the company authorising the buy-back;

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(c) the buy-back is or less than twenty-five per cent, of the total paid-up capital (equity shares and preference shares) and free reserves of the company; (d) The debt-equity ratio is not more than 2 : 1 after such buy-back : Explanation For the purposes of this clause, the expression debt includes all amounts of unsecured and secured debts; (e) all the shares or other specified securities are fully paid-up; (f) the buy-back of the shares or other specified securities listed on any recognised stock exchange is in accordance with the regulations made by the Securities and Exchange Board of India;

(g) the buy-back in respect of shares or other specified securities other than those specified in clause (f) is in accordance with the guidelines as may be prescribed. (3) The notice of the meeting at which special resolution is proposed to be passed shall be accompanied by an explanatory statement stating (a) a full and complete disclosure of all material facts; (b) the necessary for the buy-back; (c) the class of security intended to be purchased; (d) the amount to be invested; and (e) the time limit for completion of buy-back. (4) Every buy-back shall be completed within twelve months from the date of passing the special resolution. (5) The buy-back under sub-section (1) may be (a) from the existing security holders on a proportionate basis; or (b) from the open market; or (c) from odd lots, (d) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity. (6) A solvency certificate to be filed before making buy-back. (7) A company buy-back its own securities, it shall extinguish and physically destroy the securities so bought-back within seven days of the last date of completion of buy-back. (8) A company shall not make further issue of same kind of shares (including allotment of further shares under clause (a) of sub-section (1) of section 81) or other specified securities within a period of twenty-four months except by way of bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares. (9) A company maintains a register of the securities so bought, the consideration paid for the securities bought-back, the date of cancellation of securities, the date of existing and physically destroying of securities and such other particulars as may be prescribed. (10) A company shall, after completion of the buy-back under this section, file with the Registrar and the Securities and Exchange Board of India, a return containing such particulars relating to the buy-back within thirty days of such completion, as may be prescribed : Provided that no return shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognised stock exchange. The auditor should ensure that the proper accounting entries have been passed immediately after the buy-back. Further prohibition to buy-back shares is contained in section 77B.

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(d) Interim Dividends: A company may distribute part of its profits during the two annual general meetings. That means, a company may declare dividends before the close of the accounting year and finalisation of accounts. Regulation 86 of Table A of Schedule I to the Companies Act, 1956, provided that the Board may from time to time pay to the members such interim dividend as appeared to be justified by the company. However, the definition of dividend has been amended by the Companies (Amendment) Act, 2000, whereby the interim dividend is part of dividends. With the further amendment of section 205, the interim dividend has been brought completely at par with dividends declared in the normal course since it has been specified that provisions contained in sections 205, 205A, 205C, 206, 206A and 207 shall also apply to any interim dividend. The amended provisions read as under: (1A) The Board of directors may declare interim dividend and the amount of dividend including interim dividend shall be deposited in a separate bank account within five days from the date of declaration of such dividend. (1B) The amount of dividend including interim dividend so deposited under sub-section (1A) shall be used for payment of interim dividend. (1C) The provisions contained in sections 205, 205A, 205C, 206, 206A and 207 shall, as far as may be, also apply to any interim dividend. Therefore, conditions and procedures laid down in section 205A, 205C, 206, 206A and 207 would have to be complied with while declaring interim dividends. Right to dividend, Right Shares and Bonus Shares to be held in abeyance pending registration of transfers of shares - Section 206A inserted by the Companies (Amendment) Act, [1988] requires that where any instrument of transfer of shares has been delivered to any company for registration and a transfer of such shares has not been registered by the company, the company shall transfer the dividend in relating to such shares to the special account referred to in section 205A. Further the company shall also keep in abeyance and offer to right shares and any issue of fully paid up bonus shares in respect of such shares which have not been registered by the company. However, the company may transfer the dividend in case it has been authorised by the registered holder of such shares in written to pay such dividend to the transferee specified in such instrument of transfer. Penalty for failure to distribute dividend within the prescribed period, i.e., thirty day, has been made quite stiff by prescribing imprisonment for three year. Rupees one thousand everyday for which the default continues as also liability to pay simple interest at the rate of 18% p.a. 17. (a) The Constitution of India gives a special status to the Comptroller and Auditor General of India (C&AG) and contains special provisions to safeguard his independence. Article 148 of the Constitution provides that the CA&G shall be appointed by the President. His salary and other conditions of service are also determined by the President. He can be removed from the office only in a like manner and on the like grounds as a judge of the Supreme Court. Thus, the C&AG can be removed only on the ground of proven mis-behaviour or incapacity. His removal can be made only through an order of the President after each house of Parliament has recommended the removal by the required majority i.e. by not less than 2/3rd of the members present and voting. Further, the Comptroller and Auditor Generals Act, 1971 prescribes that Comptroller and Auditor General (C & AG) shall held office for a fixed term which aims to strengthen his independence. The C & AG Act also prescribes salary of the C & AG which is equal to the salary of the Judge of the Supreme Court thereby further strengthening his independence. Finally, Article 151 requires that C&AG shall submit his reports relating to the accounts of the Central/State Government to the President/Governor who shall cause them to be laid before the Parliament/State Legislature. (b) (i) Examine the constitution, powers of governing body and relevant rules relating to preparation and finalisation of accounts. In case, it is constituted as a company limited by guarantee, application of provisions of the Companies Act, 1956 should also be seen.

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(ii) Vouch the receipt on account of entrance fees with members applications, counterfoils issued to them, and minutes of the Managing Committee. (iii) Vouch Members subscription with the counterfoils of receipts issued to them. Trace receipts for a selected period to the Register of members; reconcile the amount of total subscription due with the amount collected and the outstanding. Check totals of various columns of the Register of Members and tally them across. See the Register of Members to ascertain the Members dues which are in arrear and enquire whether necessary steps have been taken for their recovery. The amount considered irrecoverable, if any should be written off. (iv) Ensure that arrears of subscriptions for the previous year have been correctly brought over and arrears for the year under audit and subscription received in advance have been correctly adjusted. (v) Verify the internal check as regards members being charged with the price of foodstuffs and drinks provided to them and their guests as well as with the fees chargeable for the special service rendered such as billiards, tennis, etc. Trace debits for a selected period from subsidiary registers maintained in respect of supplies and services to members to confirm that the account of every member has been debited with amounts recoverable from him. (vi) Vouch purchase of sports items, furniture, crockery, etc., and trace their entries into the respective stock registers. Vouch purchases of food-stuffs, cigars, wines, etc. and test their sale price so as to confirm that the normal rates of profit have been earned on their sales. The stock of unsold provisions and stores, at the end of the year should be verified physically and its valuation checked. (vii) Check the stock of furniture, sports material and other assets physically with the respective stock registers or inventories prepared at the end of the year. (viii) Inspect the share scrips and bonds in respect of investments, check their current values for disclosure in final accounts, also ascertain that the arrangements for their safe custody are satisfactory, check the accrual of income therefrom and provision of income tax thereon. 18. (a) In order to satisfy himself whether the balances can be relied upon to provide accurate figures of stock quantities, the auditor should consider the following points, and carry out the tests stated below: (i) (ii) Does the business keep continuous stock records based on a proper double-entry system? Are stock records checked systematically throughout the year with the physical quantities? Is the checking carried out in such a way that each category of stock is checked at least once a year?

(iii) Are they part of double-entry costing records? (iv) Is there a procedure for recording and investigating differences revealed by stock checking, and for updating the records? Are material differences reported to management? If the auditor has observed stock checking carried out during the year, he will know whether or not this is carried out under proper supervision and in accordance with established instructions, and by competent people. Tests must be carried out of the entries in the stock records. Attention must be given to the period surrounding the balance sheet date. A sample of items must be selected for checking "in depth" in order to ascertain that proper stock taking procedures and internal check principles have been applied throughout. Thus in the case of goods purchased the auditor must examine the authority for the order, the order itself, the goods received note and inspection records, the bin card and the stores ledger account. The auditor must ascertain

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whether proper "cut-off" procedures have been used to ensure that all goods entered in the stock records before the year-end are included in purchases in the financial records, and that all sales contained in the financial accounts have been eliminated from the stock records. (b) Cost may be made up of the following items: (i) direct expenditure on the purchase of goods and raw material used in the manufacture of finished products of the business;

(ii) other direct expenditure incurred in acquiring the stock or bringing it to its existing location and condition; (iii) an appropriate part of the overhead expenditure, though in some business overhead expenditure is not included in stock. The basis of valuation of stock must be examined and the auditor must establish that it has been consistently applied. If the basis has been changed during the period under review, the effect on the profit and loss account would need to be disclosed by note. Stock should be valued at the lower of cost or net realisable value. It may be possible to arrive at cost on a "unit" cost basis, as this involves identifying the individual cost of a stock item, it is more likely that one of the following methods will have been used: (i) first-in first-out (FIFO); (ii) weighted average cost. Depending on the method used, the auditor will need to test the figures stated for "cost" by examination of invoices, stock records, calculations of "average" price or standard costing records. It will be necessary to ensure that any allocation of overhead expenditure has been on a consistent basis and that neither selling overhead nor finance charges have been included. "Net realisable value" means that amount which it is estimated will be realised from the disposal of stock in the ordinary course of business after allowing for all expenditure to be incurred on or before disposal. The auditor should make tests of "net realisable value" with current selling prices and, in particular, determine what procedures are applied to identify and value stock which, because of its age, condition or nature, is not likely to be sold at current selling prices. 19. (a) The Companies (Auditors Report) Order, 2003 (CARO, 2003) was issued in June 2003 and came into force on the 1st day of July 2003. The said Order, from the date it came into force, superceded the MAOCARO, 1988. Further, the Order requires that every report made by the auditor under section 227 of the Act on the accounts of every company examined by him to which the Order applies, for every financial year ending on any day on or after the commencement of this Order, shall contain matters specified in paragraphs 4 and 5 of the said Order. This implies that the auditors report, on accounts in respect of financial year ending on or before 30th June 2003, even if issued on or after 1st July 2003 is not required to contain report on matters specified in the CARO, 2003. However, the auditors report, in such cases, should include a statement on matters specified in the erstwhile MAOCARO, 1988. (b) The Order also exempts from its application a private limited company which fulfils all the following conditions throughout the reporting period covered by the audit report: (i) its paid-up capital and reserves are rupees fifty lakhs or less; (ii) it has no outstanding loan exceeding rupees twenty five lakh from any bank or financial institution; and (iii) its turnover does not exceed rupees five crores. A private limited company, in order to be exempt from the applicability of the Order, must satisfy all the conditions mentioned above cumulatively. In other words, even if one of the

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conditions is not satisfied, a private limited companys auditor has to report on the matters specified in the Order. 20. (a) Title: The auditors report should have an appropriate title. It may be appropriate to use the term Auditors Report in the title to distinguish the auditors report from reports that might be issued by others, such as by the officers of the entity, the board of directors, or from the reports of others. Addressee: The auditors report should be appropriately addressed as required by the circumstances of the engagement and applicable laws and regulations. Ordinarily, the auditors report is addressed to the authority appointing the auditor. Opening or Introductory Paragraph: The auditors report should identify the financial statements of the entity that have been audited, including the date of and period covered by the financial statements. The report should include a statement that the financial statements are the responsibility of the entitys management and a statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. Scope Paragraph: The auditors report should describe the scope of the audit by stating that the audit was conducted in accordance with auditing standards generally accepted in India. The reader needs this as an assurance that the audit has been carried out in accordance with established standards. The report should include a statement that the audit was planned and performed to obtain reasonable assurance whether the financial statements are free of material misstatement. The auditors report should describe the audit as including: (a) examining, on a test basis, evidence to support the amounts and disclosures in financial statements; (b) assessing the accounting principles used in the preparation of the financial statements; (c) assessing the significant estimates made by management in the preparation of the financial statements; and (d) evaluating the overall financial statement presentation. The report should include a statement by the auditor that the audit provides a reasonable basis for his opinion. Opinion Paragraph: The opinion paragraph of the auditors report should clearly indicate the financial reporting framework used to prepare the financial statements and state the auditors opinion as to whether the financial statements give a true and fair view in accordance with that financial reporting framework and, where appropriate, whether the financial statements comply with the statutory requirements. Date of Report: The date of an auditors report on the financial statements is the date on which the auditor signs the report expressing an opinion on the financial statements. The date of report informs the reader that the auditor has considered the effect on the financial statements and on the report of the events and transactions of which the auditor became aware and that occurred up to that date. Since the auditors responsibility is to report on the financial statements as prepared and presented by management, the auditor should not date the report earlier than the date on which the financial statements are signed or approved by management. Place of Signature: The report should name specific location, which is ordinarily the city where the audit report is signed. Auditors Signature: The report should be signed by the auditor in his personal name. Where the firm is appointed as the auditor, the report should be signed in the personal name of the auditor and in the name of the audit firm. The partner/proprietor signing the audit

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report should also mention the membership number assigned by the Institute of Chartered Accountants of India. The Auditors Report: An unqualified opinion should be expressed when the auditor concludes that the financial statements give a true and fair view in accordance with the financial reporting framework used for the preparation and presentation of the financial statements. An unqualified opinion indicates, implicitly, that any changes in the accounting principles or in the method of their application, and the effects thereof, have been properly determined and disclosed in the financial statements. An unqualified opinion also indicates that: (b) Modified Reports: An auditors report is considered to be modified when it includes: (a) Matters That Do Not Affect the Auditors Opinion emphasis of matter (b) Matters That Do Affect the Auditors Opinion qualified opinion disclaimer of opinion adverse opinion Uniformity in the form and content of each type of modified report will enhance the users understanding of such reports. Accordingly, this AAS includes suggested wordings to express an unqualified opinion as well as examples of modifying phrases for use when issuing modified reports. A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion, or limitation on scope is not so material and pervasive as to require a disclaimer of opinion. A qualified opinion should be expressed as being subject to or except for the effects of the matter to which the qualification relates. A disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and is, accordingly, unable to express an opinion on the financial statements. An adverse opinion should be expressed when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements.

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Appendices Appendix I Amendment of the Companies (Auditors Report) Order, 2004 Appendix II - Text of Companies (Auditors Report) Order, 2003 Appendix III AAS 28 - The Auditors Report on Financial Statements Appendix IV AAS 30 - External Confirmations Appendix I Published in the Gazette of India Extraordinary Part II, Section 3 Sub-section(I) Government Of India Ministry of Company Affairs Notification New Delhi, the 25th November, 2004 G.S.R. 766(E): In exercise of the powers conferred by sub-section (4A) of section 227 of the Companies Act, 1956 (1 of 1956) and after consultation with the Institute of Chartered Accountants of India [constituted under the Chartered Accountants Act, 1949 (38 of 1949)], the Central Government hereby makes the following amendments in Companies (Auditors Report) Order, 2003, namely:1. (1) This Order may be called the Companies (Auditors Report) (Amendment) Order, 2004. (2) It shall come into force on the date of its publication in the Official Gazette. 2. In the Companies (Auditors Report) Order, 2003, (1) In paragraph 1, in sub-paragraph (2), for clause (iv), the following clause shall be substituted, namely: (iv) a private limited company with a paid up capital and reserves not more than rupees fifty lakh and which does not have loan outstanding exceeding rupees twenty five lakh from any bank or financial institution and does not have a turnover exceeding rupees five crore at any point of time during the financial year. (2) in paragraph 2, the clauses (c) to (i) shall be omitted; (3) in paragraph 4, (a) for clause (iii), the following clause shall be substituted, namely: (iii) (a) has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and amount involved in the transactions; and (b) whether the rate of interest and other terms and conditions of loans given by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and (c) whether receipt of the principal amount and interest are also regular; and (d) if overdue amount is more than rupees one lakh, whether reasonable steps have been taken by the company for recovery of the principal and interest; (e) has the company taken any loans, secured or unsecured from companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and the amount involved in the transactions; and (f) whether the rate of interest and other terms and conditions of loans taken by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and (g) whether payment of the principal amount and interest are also regular.

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(b) for clause (iv), the following clause shall be substituted, namely: (iv) is there an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control system; (c) in clause (v), for sub-clauses (a) and (b), the following clauses shall be substituted, namely:(a) whether the particulars of contracts or arrangements referred to in section 301 of the Act have been entered in the register required to be maintained under that section; and (b) whether transactions made in pursuance of such contracts or arrangements have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time;; (d) in clause(vi), (i) for the words, figures and letters sections 58A and 58AA of the Act , the words, figures and letters sections 58A, 58AA or any other relevant provisions of the Act shall be substituted. for the words Company Law Board, the words Company Law Board or National Company Law Tribunal or Reserve Bank of India or any Court or any other Tribunal shall be substituted;

(ii)

(e) in clause (ix) (i) (ii) in sub-clause (a), for the words Wealth tax, the words Wealth tax, Service tax shall be substituted; for sub-clause (b), the following sub-clause shall be substituted; namely:-

(b) in case dues of Income tax/ Sales tax /Wealth tax/ Service tax/ Custom duty/ Excise duty/ cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned. (f) in clause (x), for the words in the financial year immediately preceding such financial year also the words in the immediately preceding financial year shall be substituted;

(g) in clause (xiii); (i) (ii) in sub-clause (b), for the word default the word doubtful shall be substituted; in sub-clause (d), the words and would be conducive to recovery of the loan amount shall be omitted;

(h) in clause (xiv), for the words other securities, the words other investments shall be substituted; (i) (j) in clause (xvii), the words and vice-versa shall be omitted. in clause (xix), for the words securities have, the words security or charge has shall be substituted.

File No: 2/28/2002-CL-V Jitesh Khosla; Joint Secretary Note: The Principal Order was issued vide notification number GSR 480(E) dated the 12th June, 2003. New Delhi, the 25th November, 2004

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G.S.R. 766(E): In exercise of the powers conferred by sub-section (4A) of section 227 of the Companies Act, 1956 (1 of 1956) and after consultation with the Institute of Chartered Accountants of India [constituted under the Chartered Accountants Act, 1949 (38 of 1949)], the Central Government hereby makes the following amendments in Companies (Auditors Report) Order, 2003, namely:1. (1) This Order may be called the Companies (Auditors Report) (Amendment) Order, 2004. (2) It shall come into force on the date of its publication in the Official Gazette. 2. In the Companies (Auditors Report) Order, 2003, (1) In paragraph 1, in sub-paragraph (2), for clause (iv), the following clause shall be substituted, namely: (iv) a private limited company with a paid up capital and reserves not more than rupees fifty lakh and which does not have loan outstanding exceeding rupees twenty five lakh from any bank or financial institution and does not have a turnover exceeding rupees five crore at any point of time during the financial year. (2) in paragraph 2, the clauses (c) to (i) shall be omitted; (3) in paragraph 4, (a) for clause (iii), the following clause shall be substituted, namely: (iii) (a) has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and amount involved in the transactions; and (b) whether the rate of interest and other terms and conditions of loans given by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and (c) whether receipt of the principal amount and interest are also regular; and (d) if overdue amount is more than rupees one lakh, whether reasonable steps have been taken by the company for recovery of the principal and interest; (e) has the company taken any loans, secured or unsecured from companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and the amount involved in the transactions; and (f) whether the rate of interest and other terms and conditions of loans taken by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and

(g) whether payment of the principal amount and interest are also regular. (b) for clause (iv), the following clause shall be substituted, namely: (iv) is there an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control system; (c) in clause (v), for sub-clauses (a) and (b), the following clauses shall be substituted, namely:(a) whether the particulars of contracts or arrangements referred to in section 301 of the Act have been entered in the register required to be maintained under that section; and (b) whether transactions made in pursuance of such contracts or arrangements have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time;; (d) in clause(vi), (i) for the words, figures and letters sections 58A and 58AA of the Act , the words, figures and letters sections 58A, 58AA or any other relevant provisions of the Act shall be substituted.

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(ii)

for the words Company Law Board, the words Company Law Board or National Company Law Tribunal or Reserve Bank of India or any Court or any other Tribunal shall be substituted;

(e) in clause (ix) (i) (ii) in sub-clause (a), for the words Wealth tax, the words Wealth tax, Service tax shall be substituted; for sub-clause (b), the following sub-clause shall be substituted; namely:(b) in case dues of Income tax/ Sales tax /Wealth tax/ Service tax/ Custom duty/ Excise duty/ cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned. (f) in clause (x), for the words in the financial year immediately preceding such financial year also the words in the immediately preceding financial year shall be substituted; (g) in clause (xiii); (i) (ii) in sub-clause (b), for the word default the word doubtful shall be substituted; in sub-clause (d), the words and would be conducive to recovery of the loan amount shall be omitted; in clause (xvii), the words and vice-versa shall be omitted.

(h) in clause (xiv), for the words other securities, the words other investments shall be substituted; (i) (j)

in clause (xix), for the words securities have, the words security or charge has shall be substituted.

File No: 2/28/2002-CL-V Jitesh Khosla; Joint Secretary Note: The Principal Order was issued vide notification number GSR 480(E) dated the 12th June, 2003. Appendix II Text of Companies (Auditors Report) Order, 2003 {after incorporating the amendments made by the Companies (Auditors Report) (Amendment) Order, 20041 dated 25th November, 2004} 1. Short title, application and commencement.

(1) This order may be called the Companies (Auditors Report) Order, 2003. (2) It shall apply to every company including a foreign company as defined in section 591 of the Act, except the following: (i) (ii) a Banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949); an insurance company as defined in clause (21) of section 2 of the Act;

(iii) a company licensed to operate under section 25 of the Act; and (iv) a private limited company with a paid up capital and reserves not more than rupees fifty lakh and which does not have loan outstanding exceeding rupees twenty five lakh from any bank or financial institution and does not have a turnover exceeding rupees five crore at any point of time during the financial year. (3) It shall come into force on the 1st day of July, 2003. 2. Definitions In this Order, unless the context otherwise requires,(a) Act means the Companies Act, 1956 (1 of 1956);
1

DCAs notification number GSR/766(E).

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(b) chit fund company, nidhi company or mutual benefit company means a company engaged in the business of managing, conducting or supervising as a foreman or agent of any transaction or arrangement by which it enters into an agreement with a number of subscribers that every one of them shall subscribe to a certain sum of instalments for a definite period and that each subscriber, in his turn, as determined by lot or by auction or by tender or in such other manner as may be provided for in the agreement, shall be entitled to a prize amount, and includes companies whose principal business is accepting fixed deposits from, and lending money to, members; 3. Auditors report to contain matters specified in paragraphs 4 and 5. Every report made by the auditor under section 227 of Act, on the accounts of every company examined by him to which this Order applies for every financial year ending on any day on or after the commencement of this Order, shall contain the matters specified in paragraphs 4 and 5. 4. Matters to be included in the auditors report. The auditors report on the account of a company to which this Order applies shall include a statement on the following matters, namely :(i) (a) whether the company is maintaining proper records showing full particulars, including quantitative details and situation of fixed assets; (b) whether these fixed assets have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of account; (c) if a substantial part of fixed assets have been disposed off during the year, whether it has affected the going concern; (ii) (a) whether physical verification of inventory has been conducted at reasonable intervals by the management; (b) are the procedures of physical verification of inventory followed by the management reasonable and adequate in relation to the size of the company and the nature of its business. If not, the inadequacies in such procedures should be reported; (c) whether the company is maintaining proper records of inventory and whether any material discrepancies were noticed on physical verification and if so, whether the same have been properly dealt with in the books of account; (iii) (a) has the company granted any loans, secured or unsecured to companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and amount involved in the transactions; and (b) whether the rate of interest and other terms and conditions of loans given by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and; (c) whether receipt of the principal amount and interest are also regular; and (d) if overdue amount is more than rupees one lakh, whether reasonable steps have been taken by the company for recovery of the principal and interest; (e) has the company taken any loans, secured or unsecured from companies, firms or other parties covered in the register maintained under section 301 of the Act. If so, give the number of parties and the amount involved in the transactions; and (f) whether the rate of interest and other terms and conditions of loans taken by the company, secured or unsecured, are prima facie prejudicial to the interest of the company; and (g) whether payment of the principal amount and interest are also regular. (iv) is there an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control system

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(v) (a) whether the particulars of contracts or arrangements referred to in section 301 of the Act have been entered in the register required to be maintained under that section; and (b) whether transactions made in pursuance of such contracts or arrangements have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time; (This information is required only in case of transactions exceeding the value of five lakh rupees in respect of any party and in any one financial year). (vi) in case the company has accepted deposits from the public, whether the directives issued by the Reserve Bank of India and the provisions of sections 58A, 58AA or any other relevant provisions of the Act and the rules framed there under, where applicable, have been complied with. If not, the nature of contraventions should be stated; If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any Court or any other Tribunal whether the same has been complied with or not? (vii) in the case of listed companies and/or other companies having a paid-up capital and reserves exceeding Rs.50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crore rupees for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business; (viii) where maintenance of cost records has been prescribed by the Central Government under clause (d) of sub-section (1) of section 209 of the Act, whether such accounts and records have been made and maintained; (ix) (a) is the company regular in depositing undisputed statutory dues including Provident Fund, Investor Education and Protection Fund, Employees State Insurance, Income-tax, Sales-tax, Wealth Tax, Service Tax, Custom Duty, Excise Duty, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated by the auditor. (b) in case dues of Income tax/ Sales tax /Wealth tax/ Service tax/ Custom duty/ Excise duty/ cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned. (A mere representation to the Department shall not constitute a dispute). (x) whether in case of a company which has been registered for a period not less than five years, its accumulated losses at the end of the financial year are not less than fifty per cent of its net worth and whether it has incurred cash losses in such financial year and in the immediately preceding financial year; (xi) whether the company has defaulted in repayment of dues to a financial institution or bank or debenture holders? If yes, the period and amount of default to be reported; (xii) whether adequate documents and records are maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities; If not, the deficiencies to be pointed out. (xiii) whether the provisions of any special statute applicable to chit fund have been duly complied with? In respect of nidhi/ mutual benefit fund/societies; (a) whether the net-owned funds to deposit liability ratio is more than 1:20 as on the date of balance sheet; (b) whether the company has complied with the prudential norms on income recognition and provisioning against sub-standard/doubtful/loss assets; (c) whether the company has adequate procedures for appraisal of credit proposals/requests, assessment of credit needs and repayment capacity of the borrower;

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(d) whether the repayment schedule of various loans granted by the nidhi is based on the repayment capacity of the borrower; (xiv) if the company is dealing or trading in shares, securities, debentures and other investments, whether proper records have been maintained of the transactions and contracts and whether timely entries have been made therein; also whether the shares, securities, debentures and other investments have been held by the company, in its own name except to the extent of the exemption, if any, granted under section 49 of the Act; (xv) whether the company has given any guarantee for loans taken by others from bank or financial institutions, the terms and conditions whereof are prejudicial to the interest of the company; (xvi) whether term loans were applied for the purpose for which the loans were obtained; (xvii) whether the funds raised on short-term basis have been used for long term investment; If yes, the nature and amount is to be indicated; (xviii) whether the company has made any preferential allotment of shares to parties and companies covered in the Register maintained under section 301 of the Act and if so whether the price at which shares have been issued is prejudicial to the interest of the company; (xix) whether security or charge has been created in respect of debentures issued? (xx) whether the management has disclosed on the end use of money raised by public issues and the same has been verified; (xxi) whether any fraud on or by the company has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated. 5. Reasons to be stated for unfavourable or qualified answers. Where, in the auditors report, the answer to any of the questions referred to in paragraph 4 is unfavourable or qualified, the auditors report shall also state the reasons for such unfavourable or qualified answer, as the case may be. Where the auditor is unable to express any opinion in answer to a particular question, his report shall indicate such fact together with the reasons why it is not possible for him to give an answer to such question. Appendix III Auditing and Assurance Standard (AAS) 28 The Auditors Report on Financial Statements Introduction 1. The purpose of this Auditing and Assurance Standard (AAS) is to establish standards on the form and content of the auditors report issued as a result of an audit performed by an auditor of the financial statements of an entity. Much of the standards laid down by this AAS can be adapted to auditors reports on financial information other than financial statements. 2. The auditor should review and assess the conclusions drawn from the audit evidence obtained as the basis for the expression of an opinion on the financial statements. 3. This review and assessment involves considering whether the financial statements have been prepared in accordance with an acceptable financial reporting framework applicable to the entity under audit. It is also necessary to consider whether the financial statements comply with the relevant statutory requirements. 4. The auditors report should contain a clear written expression of opinion on the financial statements taken as a whole. Basic Elements of the Auditors Report 5. The auditors report includes the following basic elements, ordinarily, in the following layout: (a) Title; (b) Addressee;

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(c) Opening or introductory paragraph (i) (ii) (i) (ii) (i) (ii) (f) identification of the financial statements audited; a statement of the responsibility of the entitys management and the responsibility of the auditor; a reference to the auditing standards generally accepted in India; a description of the work performed by the auditor; a reference to the financial reporting framework used to prepare the financial statements; and an expression of opinion on the financial statements;

(d) Scope paragraph (describing the nature of an audit)

(e) Opinion paragraph containing

Date of the report;

(g) Place of signature; and (h) Auditors signature. A measure of uniformity in the form and content of the auditors report is desirable because it helps to promote the readers understanding of the auditors report and to identify unusual circumstances when they occur. 6. A statute governing the entity or a regulator may require the auditor to include certain matters in the audit report or prescribe the form in which the auditor should issue his report. In such a case, the auditor should incorporate in his audit report, the matters specified by the statute or regulator and/or report in the form prescribed by them in addition to the requirements of this AAS. Title 7. The auditors report should have an appropriate title. It may be appropriate to use the term Auditors Report in the title to distinguish the auditors report from reports that might be issued by others, such as by the officers of the entity, the board of directors, or from the reports of others. Addressee 8. The auditors report should be appropriately addressed as required by the circumstances of the engagement and applicable laws and regulations. Ordinarily, the auditors report is addressed to the authority appointing the auditor. Opening or Introductory Paragraph 9. The auditors report should identify the financial statements2 of the entity that have been audited, including the date of and period covered by the financial statements. 10. The report should include a statement that the financial statements are the responsibility of the entitys management and a statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. 11. Financial statements are the representations of management. The preparation of such statements
2 The Council of the Institute has made Accounting Standard (AS) 3, Cash Flow Statements, mandatory for certain entities in respect of accounting periods commencing on or after 1.4.2001. Further, the Council has also decided that AS 3 should also be treated as a specified accounting standard for the purpose of section 211 of the Companies Act, 1956 thereby making the Cash Flow Statements a part of the Balance Sheet and Profit and Loss Account. However, irrespective of the fact that the cash flow statement is considered to be a part of the Balance Sheet and Profit and Loss Account, the opening or the introductory paragraph of the auditors report on financial statements of such companies and other entities for which AS 3 has been made mandatory, would also identify the Cash Flow Statement as a part of the financial statements audited apart from the Balance Sheet and Profit and Loss Account. Similar reporting considerations would also apply to the entities which, though not required to comply with AS 3 in view of its not being mandatory for them, voluntarily prepare the cash flow statements. Further, in the above mentioned cases, the auditors report on financial statements would also contain an expression of opinion on the true and fair view of the cash flows for the period under audit (refer to Appendix for an illustrative auditors report on the financial statements in the case of a company for which AS 3 has been made mandatory).

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requires management to make significant accounting estimates and judgments, as well as to determine the appropriate accounting principles and methods used in preparation of the financial statements. This determination will be made in the context of the financial reporting framework that management chooses, or is required to use. In contrast, the auditors responsibility is to audit these financial statements in order to express an opinion thereon. 12. An illustration of these matters in an opening (introductory) paragraph is: We have audited the attached Balance Sheet of . (Name of the entity) as at 31st March 2XXX and also the Profit and Loss Account for the year ended on that date annexed thereto. These financial statements are the responsibility of the entitys management. Our responsibility is to express an opinion on these financial statements based on our audit. Scope Paragraph 13. The auditors report should describe the scope of the audit by stating that the audit was conducted in accordance with auditing standards generally accepted in India. The reader needs this as an assurance that the audit has been carried out in accordance with established standards. 14. Scope refers to the auditors ability to perform audit procedures deemed necessary in the circumstances. Auditing and Assurance Standard (AAS) 2, Objective and Scope of the Audit of Financial Statements, with regard to the determination of the scope states (paragraph 5): The scope of an audit of financial statements will be determined by the auditor having regard to the terms of the engagement, the requirements of relevant legislation and the pronouncements of the Institute. The terms of engagement cannot, however, restrict the scope of an audit in relation to matters which are prescribed by legislation or by the pronouncements of the Institute. 15. The Auditing and Assurance Standards issued by the Institute of Chartered Accountants of India establish the auditing standards generally accepted in India. 16. The report should include a statement that the audit was planned and performed to obtain reasonable assurance whether the financial statements are free of material misstatement. 17. The auditors report should describe the audit as including: (a) examining, on a test basis, evidence to support the amounts and disclosures in financial statements; (b) assessing the accounting principles used in the preparation of the financial statements; (c) assessing the significant estimates made by management in the preparation of the financial statements; and (d) evaluating the overall financial statement presentation. 18. The report should include a statement by the auditor that the audit provides a reasonable basis for his opinion. 19. An illustration of these matters in a scope paragraph is: We conducted our audit in accordance with the auditing standards generally accepted in India. Those Standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. Opinion Paragraph 20. The opinion paragraph of the auditors report should clearly indicate the financial reporting framework used to prepare the financial statements and state the auditors opinion as to whether the financial statements give a true and fair view in accordance with that financial reporting framework

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and, where appropriate, whether the financial statements comply with the statutory requirements. 21. The term used to express the auditors opinion, give a true and fair view, indicates, amongst other things, that the auditor considers only those matters that are material to the financial statements. 22. Paragraph 3 of Framework of Statements on Standard Auditing Practices and Guidance Notes on Related Services, issued by the Institute of Chartered Accountants of India, discusses the financial reporting framework. The paragraph reads as under: Financial Reporting Framework Financial statements are ordinarily prepared and presented annually and are directed towards the common information needs of a wide range of users. Many of those users rely on financial statements as their major source of information because they do not have the power to obtain additional information to meet their specific information needs. Thus, financial statements need to be prepared in accordance with one, or a combination of: (a) relevant statutory requirements, e.g., the Companies Act, 1956, for companies; (b) accounting standards issued by the Institute of Chartered Accountants of India; and (c) other recognised accounting principles and practices, e.g., those recommended in the Guidance Notes issued by the Institute of Chartered Accountants of India. 23. An illustration of these matters in an opinion paragraph is: In our opinion and to the best of our information and according to the explanations given to us, the financial statements give a true and fair view in conformity with the accounting principles generally accepted in India: (a) in the case of the Balance Sheet, of the state of affairs of the (name of the entity) as at 31st March 2XXX; and (b) in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date. 24. In addition to an opinion on the true and fair view, the auditors report may need to include an opinion as to whether the financial statements comply with other requirements specified by relevant statutes or law. For example, in the case of companies incorporated under the Companies Act, 1956, section 227(2) of the said Act requires that the auditors report should state in his audit report, whether in the auditors opinion and to the best of his information and according to the explanations given to the auditor, the financial statements give the information required by the Companies Act, 1956 in the manner so required3.. Date of Report 25. The date of an auditors report on the financial statements is the date on which the auditor signs the report expressing an opinion on the financial statements. The date of report informs the reader that the auditor has considered the effect on the financial statements and on the report of the events and transactions of which the auditor became aware and that occurred up to that date. 26. Since the auditors responsibility is to report on the financial statements as prepared and presented by management, the auditor should not date the report earlier than the date on which the financial statements are signed or approved by management. Place of Signature 27. The report should name specific location, which is ordinarily the city where the audit report is signed. Auditors Signature 28. The report should be signed by the auditor in his personal name. Where the firm is appointed as the auditor, the report should be signed in the personal name of the auditor and in the name of
3 Refer to Appendix for an illustration of the opinion paragraph in the case of a company incorporated under the Companies Act, 1956. Also refer footnote 1 for applicability of AS 3 to an entity and the auditors duties and responsibilities in this regard.

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the audit firm. The partner/proprietor signing the audit report should also mention the membership number assigned by the Institute of Chartered Accountants of India. The Auditors Report 29. An unqualified opinion should be expressed when the auditor concludes that the financial statements give a true and fair view in accordance with the financial reporting framework used for the preparation and presentation of the financial statements. An unqualified opinion indicates, implicitly, that any changes in the accounting principles or in the method of their application, and the effects thereof, have been properly determined and disclosed in the financial statements. An unqualified opinion also indicates that: (a) (b) (c) 30. the financial statements have been prepared using the generally accepted accounting principles, which have been consistently applied; the financial statements comply with relevant statutory requirements and regulations; and there is adequate disclosure of all material matters relevant to the proper presentation of the financial information, subject to statutory requirements, where applicable. The following is an illustration of a complete auditors report incorporating the basic elements set forth and illustrated above. This report illustrates the expression of an unqualified opinion. Auditors Report (Appropriate Addressee) We have audited the attached Balance Sheet of ..... (Name of the entity) as at 31st March 2XXX and also the Profit and Loss Account for the year ended on that date annexed thereto4. These financial statements are the responsibility of the entitys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in India. Those Standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion and to the best of our information and according to the explanations given to us, the financial statements give a true and fair view in conformity with the accounting principles generally accepted in India5: (a) in the case of the Balance Sheet, of the state of affairs of .. (Name of the entity) as at 31st March 2XXX; and (b) in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date. For ABC and Co., Chartered Accountants Auditors Signature (Name of Member signing the Audit Report) (Designation6) (Membership Number) Place of Signature Date
4 5

Refer to footnote 1. ibid.

Partner or proprietor, as the case may be.

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An illustration of auditors report on the financial statements in the case of a company incorporated under the Companies Act, 1956 to which AS 3 is applicable is given in the Appendix. Modified Reports7 31. (a) An auditors report is considered to be modified when it includes: Matters That Do Not Affect the Auditors Opinion (b) emphasis of matter

Matters That Do Affect the Auditors Opinion qualified opinion disclaimer of opinion adverse opinion

Uniformity in the form and content of each type of modified report will enhance the users understanding of such reports. Accordingly, this AAS includes suggested wordings to express an unqualified opinion as well as examples of modifying phrases for use when issuing modified reports. Matters That Do Not Affect the Auditors Opinion 32. In certain circumstances, an auditors report may be modified by adding an emphasis of matter paragraph to highlight a matter affecting the financial statements which is included in a note to the financial statements that more extensively discusses the matter. The addition of such an emphasis of matter paragraph does not affect the auditors opinion. The paragraph would preferably be included preceding the opinion paragraph and would ordinarily refer to the fact that the auditors opinion is not qualified in this respect. 33. The auditor should modify the auditors report by adding a paragraph to highlight a material matter regarding a going concern problem where the going concern question is not resolved and adequate disclosures have been made in the financial statements. 34. The auditor should consider modifying the auditors report by adding a paragraph if there is a significant uncertainty (other than going concern problem), the resolution of which is dependent upon future events and which may affect the financial statements. An uncertainty is a matter whose outcome depends on future actions or events not under the direct control of the entity but that may affect the financial statements. 35. An illustration of an emphasis of matter paragraph for a significant uncertainty in an auditors report is as follows: Without qualifying our opinion, we draw attention to Note X of Schedule to the financial statements. The entity is the defendant in a lawsuit alleging infringement of certain patent rights and claiming royalties and punitive damages. The entity has filed a counter action, and preliminary hearings and discovery proceedings on both actions are in progress. The ultimate outcome of the matter cannot presently be determined, and no provision for any liability that may result has been made in the financial statements. In our opinion .. (remaining words are the same as illustrated in the opinion paragraph paragraph 30 above). (An illustration of an emphasis of matter paragraph relating to going concern is set out in AAS 16, Going Concern.) 36. The addition of a paragraph emphasising a going concern problem or significant uncertainty is ordinarily adequate to meet the auditors reporting responsibilities regarding such matters. However, in extreme cases, such as situations involving multiple uncertainties that are significant to the financial statements, the auditor may consider it appropriate to express a disclaimer of opinion instead of adding an
7

This AAS lays down the basic principles that govern the auditors report on financial statements. The reporting requirements contained in other AASs issued by the Council of the Institute would also be applicable.

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emphasis of matter paragraph. Matters that Do Affect the Auditors Opinion 37. An auditor may not be able to express an unqualified opinion when either of the following circumstances exists and, in the auditors judgment, the effect of the matter is or may be material to the financial statements: (a) (b) there is a limitation on the scope of the auditors work; or there is a disagreement with management regarding the acceptability of the accounting policies selected, the method of their application or the adequacy of financial statement disclosures.

The circumstances described in (a) could lead to a qualified opinion or a disclaimer of opinion. The circumstances described in (b) could lead to a qualified opinion or an adverse opinion. These circumstances are discussed in paragraphs 42 - 47. 38. A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion, or limitation on scope is not so material and pervasive as to require a disclaimer of opinion. A qualified opinion should be expressed as being subject to or except for the effects of the matter to which the qualification relates. 39. A disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and is, accordingly, unable to express an opinion on the financial statements. 40. An adverse opinion should be expressed when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements. 41. Whenever the auditor expresses an opinion that is other than unqualified, a clear description of all the substantive reasons should be included in the report and, unless impracticable, a quantification of the possible effect(s), individually and in aggregate, on the financial statements should be mentioned in the auditors report. In circumstances where it is not practicable to quantify the effect of modifications made in the audit report accurately, the auditor may do so on the basis of estimates made by the management after carrying out such audit tests as are possible and clearly indicate the fact that the figures are based on management estimates. Ordinarily, this information would be set out in a separate paragraph preceding the opinion or disclaimer of opinion and may include a reference to a more extensive discussion, if any, in a note to the financial statements. Circumstances That May Result in Other Than an Unqualified Opinion Limitation on Scope 42. A limitation on the scope of the auditors work may sometimes be imposed by the entity, for example, when the terms of the engagement specify that the auditor will not carry out an audit procedure that the auditor believes is necessary. However, when the limitation in the terms of a proposed engagement is such that the auditor believes the need to express a disclaimer of opinion exists; the auditor should ordinarily not accept such a limited engagement as an audit engagement, unless required by statute. Also, a statutory auditor should not accept such an audit engagement when the limitation infringes on the auditors statutory duties. 43. A scope limitation may be imposed by circumstances, for example, when the timing of the auditors appointment is such that the auditor is unable to observe the counting of physical inventories. It may also arise when, in the opinion of the auditor, the entitys accounting records are inadequate or when the auditor is unable to carry out an audit procedure believed to be desirable. In these circumstances, the auditor would attempt to carry out reasonable alternative procedures to obtain sufficient appropriate audit evidence to support an unqualified opinion. 44. When there is a limitation on the scope of the auditors work that requires expression of a qualified opinion or a disclaimer of opinion, the auditors report should describe the limitation and

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indicate the possible adjustments to the financial statements that might have been determined to be necessary had the limitation not existed. 45. Illustrations of these matters are set out below : Limitation on Scope Qualified Opinion We have audited ... (remaining words are the same as illustrated in the introductory paragraph paragraph 30 above). Except as discussed in the following paragraph, we conducted our audit in accordance with .. (remaining words are the same as illustrated in the scope paragraph paragraph 30 above). We did not observe the counting of the physical inventories as at 31st March 2XXX since that date was prior to the time we were appointed as auditors of .(Name of the entity). Owing to the nature of the entitys records, we were unable to satisfy ourselves as to inventory quantities by other audit procedures. In our opinion and to the best of our information and according to the explanations given to us, subject to the effects of such adjustments, if any, as might have been determined to be necessary had we been able to satisfy ourselves as to physical inventory quantities, the financial statements give a . (remaining words are the same as illustrated in the opinion paragraph paragraph 30 above). Limitation on Scope Disclaimer of Opinion We were engaged to audit the attached Balance Sheet of ..(Name of the entity) as at 31st March 2XXX and also the Profit and Loss Account for the year ended on that date annexed thereto. These financial statements are the responsibility of the entitys management. (Omit the sentence stating the responsibility of the auditor). (The paragraph discussing the scope of the audit would either be omitted or amended according to the circumstances.) (Add a paragraph discussing the scope limitation as follows:) We were not able to observe all physical inventories and confirm accounts receivable due to limitations placed on the scope of our work by the entity. Because of the significance of the matters discussed in the preceding paragraph, we do not express an opinion on the financial statements. Disagreement with Management 46. The auditor may disagree with management about matters such as the acceptability of accounting policies selected, the method of their application, or the adequacy of disclosures in the financial statements. If such disagreements are material to the financial statements, the auditor should express a qualified or an adverse opinion. 47. Illustrations of these matters are set out below: Disagreement on Accounting Policies-Inappropriate Accounting MethodQualified Opinion We have audited ... (remaining words are the same as illustrated in the introductory paragraph paragraph 30 above). We conducted our audit in accordance with .. (remaining words are the same as illustrated in the scope paragraphparagraph 30 above). As stated in Note X of Schedule . to the financial statements, no depreciation has been provided for the period in the financial statements. This is contrary to Accounting Standard (AS) 6 on Depreciation Accounting, issued by the Institute of Chartered Accountants of India and the accounting policy being followed by the entity according to

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which depreciation is provided on straight line basis. Had this accounting policy been followed, the provision for depreciation for the period would have been Rs............. This short provisioning for depreciation has resulted into the profit for the year, fixed assets and reserves and surplus being overstated by Rs. Or As stated in Note X of Schedule .. to the financial statements, hire purchase sales have been treated as outright sales by the entity and contrary to accepted accounting practice, the entire profit thereon has been taken into account. The profit relating to installment not due as at the date of the Balance Sheet and included in profit for the year amounted to Rs.. This has resulted in the profit for the year, inventories and reserve and surplus being overstated by Rs In our opinion and to the best of our information and according to the explanations given to us, subject to the effect on the financial statements of the matter referred to in the preceding paragraph, the financial statements give a true and ... (remaining words are the same as illustrated in the opinion paragraph-paragraph 30 above). Disagreement on Accounting PoliciesInadequate Disclosure-Qualified Opinion We have audited .. (remaining words are the same as illustrated in the introductory paragraph paragraph 30 above). We conducted our audit in accordance with ..... (remaining words are the same as illustrated in the scope paragraphparagraph 30 above). On 15th January 2XXX, the .. (Name of the entity) issued debentures in the amount of Rs.XXX for the purpose of financing plant expansion. The debentures agreement restricts the payment of future cash dividends to earnings after 31st March 2XXX. In our opinion, disclosure of this information is required by ............ In our opinion and to the best of our information and according to the explanations given to us, subject to the omission of the information included in the preceding paragraph, the financial statements give a true and . (remaining words are the same as illustrated in the opinion paragraph, paragraph 30 above). Disagreement on Accounting Policies - Inadequate Disclosure - Adverse Opinion We have audited the attached Balance Sheet of . (Name of the entity), as at 31st March 2XXX, and also the Profit and Loss Account for the year ended on that date annexed thereto8. These financial statements are the responsibility of the entitys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with ... (remaining words are the same as illustrated in the scope paragraphparagraph 30 above). (Paragraph(s) discussing the disagreement). In our opinion and to the best of our information and according to the explanations given to us, because of the effects of the matters discussed in the preceding paragraph(s), the financial statements do not give a true and fair view in conformity with the accounting principles generally accepted in India9: (a) (b) in the case of the Balance Sheet, of the state of affairs of the company as at 31st March 2XXX; and in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date.

Refer to footnote 3.

9 ibid.

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Effective Date 48. This Auditing and Assurance Standard becomes operative for all audits relating to accounting periods beginning on or after 1st April 2003. Earlier application of the AAS is encouraged. Compatibility with the International Standard on Auditing (ISA) 700 The auditing standards established in this Auditing and Assurance Standard are generally consistent in all material respects with those set out in the International Standard on Auditing (ISA) 700, The Auditors Report on Financial Statements, except the following: (a) Due to the practices prevailing in India, the AAS requires the auditor to mention the Place of Signature instead of the Auditors Address in the auditors report. The place of signature is the name of specific location, which is ordinarily the city where the audit report is signed [see paragraph 27]. According to ISA 700, the expression Auditors Address means the name of a specific location, which is ordinarily the city where the auditor maintains the office that has the responsibility for the audit. The AAS requires the auditor to mention the membership number assigned by the Institute of Chartered Accountants of India [see paragraph 28]. ISA 700, however, does not contain any corresponding requirement. The AAS requires that whenever the auditor expresses an opinion that is other than unqualified, a clear description of all the substantive reasons should be included in the report and, unless impracticable, a quantification of the possible effect(s), individually and in aggregate, on the financial statements should be mentioned in the auditors report [see paragraph 41]. ISA 700 does not require the auditor to quantify the possible effect(s) in aggregate on the financial statements. Appendix Illustrative Auditors Report on the Financial Statements in the Case of a Company Incorporated Under the Companies Act, 1956 to which AS 3 is applicable10 [see paragraph 30] Auditors Report The Members of (name of the Company)11 We have audited the attached Balance Sheet of . (name of the company), as at 31st March 2XXX, and also the Profit and Loss Account and the cash flow statement for the year ended on that date annexed thereto. These financial statements are the responsibility of the companys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the auditing standards generally accepted in India. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As required by the Manufacturing and Other Companies (Auditors Report) Order, 198812 issued by the Central Government of India in terms of sub-section (4A) of section 227 of the

(b)

(c)

10

In case AS 3 is not applicable to a company and such company also does not voluntarily prepare the cash flow statement, the references to cash flow statement should be deleted from the entire report. 11 Reference may also be made to the Statement on Qualifications in Auditors Report and the Guidance Note on Section 227(3)(e) and (f) of the Companies Act, 1956 issued by the Council of the Institute of Chartered Accountants of India. 12 The Manufacturing and Other Companies (Auditors Report) Order, 1988 has since been replaced by the Companies (Auditors Report) Order, 2003 vide Department of Company Affairs Notification dated June 12, 2003.

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Companies Act, 1956, we enclose in the Annexure13 a statement on the matters specified in paragraphs 4 and 5 of the said Order. Further to our comments in the Annexure referred to above, we report that: (i) (ii) We have obtained all the information and explanations, which to the best of our knowledge and belief were necessary for the purposes of our audit; In our opinion, proper books of account as required by law have been kept by the company so far as appears from our examination of those books (and proper returns adequate for the purposes of our audit have been received from the branches not visited by us. The Branch Auditors Report(s) have been forwarded to us and have been appropriately dealt with); 14 The Balance Sheet, Profit and Loss Account and cash flow statement dealt with by this report are in agreement with the books of account (and with the audited returns from the branches);15 In our opinion, the Balance Sheet, Profit and Loss Account and cash flow statement dealt with by this report comply with the accounting standards referred to in sub-section (3C) of section 211 of the Companies Act, 1956; On the basis of written representations received from the directors, as on 31st March 2XXX and taken on record by the Board of Directors, we report that none of the directors is disqualified as on 31st March 2XXX from being appointed as a director in terms of clause (g) of sub-section (1) of section 274 of the Companies Act, 1956; In our opinion and to the best of our information and according to the explanations given to us, the said accounts give the information required by the Companies Act, 1956, in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India16: (a) in the case of the Balance Sheet, of the state of affairs of the company as at 31st March 2XXX; (b) in the case of the Profit and Loss Account, of the profit / loss17 for the year ended on that date; and (c) in the case of the cash flow statement, of the cash flows for the year ended on that date. For ABC and Co. Chartered Accountants Signature (Name of the Member Signing the Audit Report) (Designation18) Membership Number Place of Signature Date

(iii)

(iv)

(v)

(vi)

13

Alternatively, instead of giving the comments on Companies (Auditors Report) Order, 2003 in an Annexure, the comments may be contained in the body of the main report. Members attention in this regard is invited to the Statement on the Companies (Auditors Report) Order, 2003, issued by the Institute of Chartered Accountants of India. It may also be noted that requirements of the Companies (Auditors Report) Order, 2003 have not been reproduced in this illustration. 14 Wherever applicable. 15 ibid. 16 ibid. 17 Whichever is applicable. 18 Partner or Proprietor, as the case may be.

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Appendix IV Auditing and Assurance Standard (AAS) 30 External Confirmations Introduction 1. The purpose of this Auditing and Assurance Standard (AAS) is to establish standards on the auditor's use of external confirmations as a means of obtaining audit evidence. 2. The auditor should determine whether the use of external confirmations is necessary to obtain sufficient appropriate audit evidence to support certain financial statement assertions. In making this determination, the auditor should consider materiality, the assessed level of inherent and control risk, and how the evidence from other planned audit procedures will reduce audit risk to an acceptably low level for the applicable financial statement assertions. The auditor should employ external confirmation procedures in consultation with the management. 3. Auditing and Assurance Standard (AAS) 5, Audit Evidence states that the reliability of audit evidence is influenced by its source and nature. It indicates that, in general, audit evidence from external sources is more reliable than audit evidence generated internally, and that written (documentary) audit evidence is more reliable than audit evidence in oral form. Accordingly, audit evidence in the form of written responses to confirmation requests received directly by the auditor from third parties who are not related to the entity being audited, when considered individually or cumulatively with audit evidence from other procedures, may assist in reducing audit risk for the related financial statement assertions to an acceptably low level. 4. External confirmation is the process of obtaining and evaluating audit evidence through a direct communication from a third party in response to a request for information about a particular item affecting assertions made by management in the financial statements. In deciding to what extent to use external confirmations, the auditor considers the characteristics of the environment in which the entity being audited operates and the practice of potential respondents in dealing with requests for direct confirmation. 5. The process of external confirmations, ordinarily, consists of the following: Selecting the items for which confirmations are needed. Designing the form of the confirmation request. Communicating the confirmation request to the appropriate third party. Obtaining response from the third party. Evaluating the information or absence thereof. 6. External confirmations are frequently used in relation to account balances and their components, but need not be restricted to these items. For example, the auditor may request external confirmation of the terms of agreements or transactions an entity has with third parties. The confirmation request is designed to ask if any modifications have been made to the agreement, and if so, the relevant details thereof. Other examples of situations where external confirmations may be used include the following: Bank balances and other information from bankers. Accounts receivable balances. Stocks held by third parties. Property title deeds held by third parties. Investments purchased but delivery not taken. Loans from lenders. Accounts payable balances. Long outstanding share application money.

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7. The reliability of the evidence obtained by external confirmations depends, among other factors, upon the application of appropriate procedures by the auditor in designing the external confirmation request, performing the external confirmation procedures, and evaluating the results of the external confirmation procedures. Factors affecting the reliability of confirmations include the control which the auditor exercises over confirmation requests and responses, the characteristics of the respondents, and any restrictions included in the response or imposed by management. Relationship of External Confirmation Procedures to the Auditor's Assessments of Inherent Risk and Control Risk 8. Auditing and Assurance Standard (AAS) 6 (Revised), "Risk Assessments and Internal Control" discusses audit risk and the relationship between its components: inherent risk, control risk, and detection risk. It outlines the process of assessing inherent and control risk to determine the nature, timing, and extent of substantive procedures to reduce detection risk, and therefore, audit risk, to an acceptable level. 9. AAS 6 (Revised) also indicates that the nature and extent of evidence to be obtained from the performance of substantive procedures varies depending on the assessment of inherent and control risks, and that the assessed levels of inherent and control risk cannot be sufficiently low to eliminate the need to perform any substantive procedures. These substantive procedures may include the use of external confirmations for specific financial statement assertions. 10. Paragraph 48 of AAS 6 (Revised) indicates that the higher the assessment of inherent and control risk, the more audit evidence the auditor needs to obtain from the performance of substantive procedures. Consequently, as the assessed level of inherent and control risk increases, the auditor designs substantive procedures to obtain more evidence, or more persuasive evidence, about a financial statement assertion. In these situations, the use of confirmation procedures may be effective in providing sufficient appropriate audit evidence. 11. The auditor should assess whether the evidence provided by the confirmations reduces audit risks for the related assertions to an acceptably low level. In making that assessment, the auditor should consider the materiality of the account balance and the auditors assessment of the inherent and control risk. If the auditor concludes that the evidence provided by the confirmations alone is not sufficient, he should perform additional procedures. 12. The lower the assessed level of inherent and control risk, the less assurance the auditor needs from substantive procedures to form a conclusion about a financial statement assertion. For example, an entity may have a loan that it is repaying according to an agreed repayment schedule, the terms of which the auditor has confirmed in previous years. If the other work carried out by the auditor (including such tests of controls as are necessary) indicates that the terms of the loan have not changed and has lead to the level of inherent and control risk over the balance of the loan outstanding being assessed as low, the auditor might limit substantive procedures to testing details of the payments made, rather than again confirming the balance directly with the lender. 13. Unusual or complex transactions may be associated with higher levels of inherent or control risk than simple transactions. If the entity has entered into an unusual or complex transaction and the level of inherent and control risk is assessed as high, the auditor considers confirming the terms of transaction with the other parties in addition to examining documentation held by the entity. Assertions Addressed by External Confirmations 14. AAS 5, Audit Evidence, categorises the assertions contained in the financial statements as existence, rights and obligations, occurrence, completeness, valuation, measurement, and presentation and disclosure. While external confirmations may provide audit evidence regarding these assertions, the ability of an external confirmation to provide evidence relevant to a particular financial statement assertion varies. 15. External confirmation of an account receivable provides strong evidence regarding the existence of the account as at a certain date. Confirmation also provides evidence regarding the operation of cut-off procedures. However, such confirmation does not ordinarily provide all the necessary audit evidence relating to the assertion regarding valuation, since it is not practicable to ask the debtor to confirm detailed information relating to its ability to pay the account.

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16. Similarly, in the case of goods held on consignment, external confirmation is likely to provide strong evidence to support the assertions related to existence and the rights and obligations, but might not provide evidence that supports the assertions related to valuation. 17. The relevance of external confirmations to auditing a particular financial statement assertion is also affected by the objective of the auditor in selecting information for confirmation. For example, when auditing the assertion regarding the completeness of accounts payable, the auditor also needs to obtain evidence that there is no material unrecorded liability. Accordingly, sending confirmation requests to an entity's principal suppliers, asking them to provide copies of their statements of account directly to the auditor, even if the entitys records show no amount currently owing to them, will usually be more effective in detecting unrecorded liabilities than selecting accounts for confirmation based on the larger amounts recorded in the accounts payable subsidiary ledger. 18. When obtaining evidence for assertions not adequately addressed by confirmations, the auditor considers other audit procedures to complement confirmation procedures or to be used instead of confirmation procedures. Timing of External Confirmations 19. The auditor may request external confirmations either as at the date of the financial statements or as at any other selected date which is reasonably close to the date of financial statements. The date may be, alternatively, settled by the auditor in consultation with the management. Where the auditor decides to request for confirmations as at date which is other than the date of the financial statements, the auditor would need to examine the movement in the concerned account(s) that occur between the date of the confirmations and the date of the financial statements. For example, when the auditor uses confirmation as at a date prior to the balance sheet to obtain evidence to support a financial statement assertion, the auditor would obtain sufficient appropriate audit evidence that transactions relevant to the assertions in the intervening period have not been materially misstated. For practical reasons, when the level of inherent and control risk is assessed at less than high, the auditor may decide to confirm balances at a date other than the period end, for example, when the audit is to be completed within a short time after the balance sheet date. As with all types of pre-year-end work, the auditor would consider the need to obtain further audit evidence relating to the remainder of the period also. Design of the External Confirmation Request 20. The auditor should design external confirmation requests to the specific audit objective. When designing the request, the auditor considers the assertions being addressed and the factors that are likely to affect the reliability of the confirmations. Factors such as the form of the external confirmation request, prior experience on the audit or similar engagements, the nature of the information being confirmed, and the intended respondent, affect the design of the requests because these factors have a direct effect on the reliability of the evidence obtained through external confirmation procedures. The other factors which have an effect on the design of an external confirmation request include effectiveness of the internal control system of the entity, apparent possibility of disputes, inaccuracies and irregularities in the accounts, the possibility that the request will receive a consideration and the materiality of the amount involved. Nature of Information Being Confirmed 21. In designing the request, the auditor considers the type of information respondents will be able to confirm readily since this may affect the response rate and the nature of the evidence obtained. For example, certain respondents' accounting systems may facilitate the external confirmation of single transactions rather than of entire account balances. In addition, respondents may not always be able to confirm certain types of information, such as the overall accounts receivable balance, but may be able to confirm individual invoice amounts within the total balance. 22. The auditors understanding of the clients arrangements and transactions with the third parties is important in determining the information to be confirmed. The auditor should obtain an understanding of the substance of such transactions and arrangements to decide about the information to be included in the request for confirmation. The auditor also considers the possibility of oral modifications in the arrangements and transactions and, accordingly, requests the management to provide him the details thereof.

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23. Confirmation requests ordinarily include authorization of the entitys management to the respondent to disclose the information to the auditor. Respondents may be more willing to respond to a confirmation request containing management's authorization, and in some cases may be unable to respond unless the request contains such authorization. Prior Experience 24. The auditor should consider the information from audits of earlier years. This information would, normally, include the misstatements, inaccuracies or irregularities identified by the auditor or those pointed out by the third parties in the earlier years, the response rate etc. Form of Confirmation RequestUse of Positive and Negative Confirmations 25. The auditor may use positive or negative external confirmation requests or a combination of both. 26. A positive external confirmation request asks the respondent to reply to the auditor in all cases either by indicating the respondent's agreement with the given information, or by asking the respondent to fill in information. The use of a positive confirmation is preferable when individual account balances are large, or where the internal controls are weak, or where the auditor has reasons to believe that there may be a substantial number of accounts in dispute or inaccurate or irregular. A response to a positive confirmation request is ordinarily expected to provide reliable audit evidence. There is a risk, however, that a respondent may reply to the confirmation request without verifying that the information is correct. The auditor is not ordinarily able to detect whether this has occurred. The auditor may reduce this risk, however, by using positive confirmation requests that do not state the amount (or other information) on the confirmation request, but ask the respondent to fill in the amount or furnish other information. On the other hand, use of this type of "blank" confirmation request may result in lower response rates because additional effort is required of the respondents. 27. A negative external confirmation request asks the respondent to reply only in the event of disagreement with the information provided in the request. However, when no response has been received to a negative confirmation request, the auditor remains aware that there will be no explicit evidence that intended third parties have received the confirmation requests and verified that the information contained therein is correct or that the confirmation was sent by the respondent but not received by him. Accordingly, the use of negative confirmation requests ordinarily provides less reliable evidence than the use of positive confirmation requests, and the auditor considers performing other substantive procedures to supplement the use of negative confirmations. 28. Negative confirmation requests may be used to reduce audit risk to an acceptable level when: (a) the assessed level of inherent and control risk is low; (b) a large number of small balances is involved; (c) a substantial number of errors is not expected; and (d) the auditor has no reason to believe that respondents will disregard these requests. 29. A combination of positive and negative external confirmations may be used. For example, where the total accounts receivable balance comprises a small number of large balances and a large number of small balances, the auditor may decide that it is appropriate to confirm all or a sample of the large balances with positive confirmation requests and a sample of the small balances using negative confirmation requests. Characteristics of Respondents 30. The reliability of evidence provided by a confirmation is affected by the respondent's competence, independence, authority to respond, knowledge of the matter being confirmed, and objectivity. For this reason, the auditor attempts to ensure, where practicable, that the confirmation request is directed to an appropriate individual. For example, when confirming that a covenant related to an entity's long-term debt has been waived, the auditor directs the request to an official of the creditor who has knowledge about the waiver and has the authority to provide the information. 31. The auditor also assesses whether certain parties may not provide an objective or unbiased response to a confirmation request. Information about the respondent's competence, knowledge, motivation, ability or

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willingness to respond may come to the auditors attention. The auditor considers the effect of such information on designing the confirmation request and evaluating the results, including determining whether additional procedures are necessary. The auditor also considers whether there is sufficient basis for concluding that the confirmation request is being sent to a respondent from whom the auditor can expect a response that will provide sufficient appropriate evidence. For example, the auditor may encounter significant unusual year-end transactions that have a material effect on the financial statements, the transactions being with a third party that is economically dependent upon the entity. In such circumstances, the auditor considers whether the third party may be motivated to provide an inaccurate response. The External Confirmation Process 32. When performing confirmation procedures, the auditor should maintain control over the process of selecting those to whom a request will be sent, the preparation and sending of confirmation requests, and the responses to those requests. Maintaining control means maintaining direct communications between the intended recipients and the auditor to minimize the possibility that the results of the confirmation process will be biased because of the interception and alteration of confirmation requests or responses. The auditor may give a list of accounts selected for confirmation to the management for preparing requests for confirmations, which should be properly addressed and stamped, alternatively, the auditor may request the management to furnish duly authorised confirmation letters and fill in the names, addresses and other relevant details relating to the accounts selected by him. The auditor should, however, ensure that it is the auditor who sends out the confirmation requests, that the requests are properly addressed, and that it is requested that all replies and the undelivered confirmations are delivered directly to the auditor. The auditor considers whether replies have come from the purported senders. No Response to a Positive Confirmation Request 33. The auditor should perform alternative procedures where no response is received to a positive external confirmation request. The alternative audit procedures should be such as to provide the evidence about the financial statement assertions that the confirmation request was intended to provide. 34. When using a confirmation request other than a negative confirmation request, the auditor, generally, follows up with a second and sometimes third request to those parties from whom replies have not been received or, alternatively, contact the recipient of the request to elicit a response. Where the auditor is unable to obtain a response, the auditor would need to use alternative audit procedures. The nature of alternative procedures varies according to the account and assertion in question. In the examination of accounts receivable, alternative procedures may include examination of subsequent cash receipts, examination of shipping documentation or other client documentation to provide evidence for the existence assertion, and sales cut-off tests to provide evidence for the assertion related to completeness. In the examination of accounts payable, alternative procedures may include examination of subsequent cash disbursements or correspondence from third parties to provide evidence of the existence assertion, and examination of other records, such as goods received notes, to provide evidence of the assertion regarding completeness. Reliability of Responses Received 35. The auditor should consider whether there is any indication that external confirmations received may not be reliable. The auditor should also consider the authenticity of the response and perform appropriate procedures to dispel any doubts. The auditor may choose to verify the source and contents of a response in a telephone call to the purported sender. In addition, the auditor would also request the purported sender to mail the original confirmation directly to the auditor. With ever-increasing use of technology, the auditor needs to consider validating the source of replies received in electronic format (for example, fax or electronic mail). Oral confirmations should be documented in the work papers. If the information in the oral confirmations or that received though a fax is significant, the auditor requests the parties involved to submit written confirmation of the specific information directly to the auditor since in such cases it is difficult to ascertain the source of the response.

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Causes and Frequency of Exceptions 36. When the auditor forms a conclusion that the confirmation process and alternative procedures have not provided sufficient appropriate audit evidence regarding an assertion, the auditor should undertake additional procedures to obtain sufficient appropriate audit evidence. In forming the conclusion, the auditor considers the: (a) reliability of the confirmations and alternative procedures; (b) nature of any exceptions, including the implications, both quantitative and qualitative of those exceptions; and (c) evidence provided by other procedures. Based on this evaluation, the auditor would determine whether additional audit procedures are needed to obtain sufficient appropriate audit evidence. 37. Any discrepancies revealed by the external confirmations received or by the additional procedures carried out by the auditor might have a bearing on the assertions and the accounts within the given assertion not selected for external confirmation. The auditor, in such a case, should request the management to verify and reconcile the discrepancies. The auditor should also consider what further tests can be carried out to satisfy himself as to the correctness of related assertion. 38. The auditor should also consider the causes and frequency of exceptions reported by respondents. An exception might indicate a misstatement in the entity's records, in which case, the auditor determines the reasons for the misstatement and assesses whether it has a material effect on the financial statements. If an exception indicates a misstatement, the auditor would reconsider the nature, timing and extent of audit procedures necessary to provide the evidence required. If the responses received indicate a pattern of misstatements, the auditor should reconsider his assessment of inherent and control risk and also consider the effect on his audit procedures. Evaluating the Results of the Confirmation Process 39. The auditor should evaluate whether the results of the external confirmation process together with the results from any other procedures performed, provide sufficient appropriate audit evidence regarding the financial statement assertion being audited. In conducting this evaluation, the auditor considers the guidance provided by AAS 15, "Audit Sampling. Management Requests 40. When the auditor seeks to confirm certain balances or other information, and management requests the auditor not to do so, the auditor should consider whether there are valid grounds for such a request and obtain evidence to support the validity of management's requests. The auditor should also ask the management to submit its request in a written form, detailing therein the reasons for such request. The management, for example, might make such a request on the grounds that due to a dispute with the particular debtor, the request for confirmation might aggravate the sensitive negotiations between the entity and the debtor. The auditor, in such a case, would examine any available evidence to support managements request, say, examining the correspondence between the management and the debtor. If the auditor agrees to management's request not to seek external confirmation regarding a particular matter, the auditor should document the reasons for acceding to the managements request and should apply alternative procedures to obtain sufficient appropriate evidence regarding that matter. 41. If the auditor does not accept the validity of management's request and is prevented from carrying out the confirmations, there has been a limitation on the scope of the auditor's work and the auditor should consider the possible impact on the auditor's report. The auditor should, however, in this case also, document the request made by the management along with the reasons given by the management therefor as well as his own reasons for not acceding to the managements request. 42. When considering the reasons provided by management, the auditor would apply professional skepticism and consider whether the request has any implications regarding management's integrity. The

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auditor would also consider whether management's request might indicate the possible existence of fraud or error. If the auditor believes that fraud or error exists, the auditor would consider the requirements of AAS 4, The Auditors Responsibility to Consider Fraud and Error in an Audit of Financial Statements". The auditor would also need to consider whether the alternative procedures will provide sufficient appropriate evidence regarding that matter. Effective Date 43. This Auditing and Assurance Standard is effective for audits related to accounting periods beginning on or after 1st April, 2003. Compatibility with International Standard on Auditing (ISA) 505 The auditing standards established in this AAS are generally consistent in all material respects with the International Standard on Auditing (ISA) 505, External Confirmations, except the following: (a) The AAS requires the auditor to obtain an understanding of the substance of transactions and agreement with the third parties to decide about the information to be included in the request for confirmation (see paragraph 22). ISA 505 does not contain any requirements in this regard. (b) The AAS requires the auditor to consider the information from audits of earlier years (see paragraph 24). This requirement is not present in ISA 505. (c) The AAS requires the auditor to request the management to verify and reconcile the discrepancies revealed by the external confirmations received or by the additional procedures carried out by the auditor. The AAS further requires the auditor to consider what further tests can be carried out to satisfy him self as to the correctness of related assertions (see paragraph 37). This requirement is not present in ISA 505.