8 The Company Audit II

Transcription

1 8 The Company Audit II LEARNING OBJECTIVES After studying this chapter, you will be able to understanding The general considerations in a company audit. The procedure of auditing of share capital, debentures, dividends and verification of issue of bonus shares. The presentation of financial statement, such as, balance sheet and profit and loss accounts. The previous chapter basically dealt with provisions relating to company auditor i.e. his qualifications, disqualifications, rights, duties, etc. In this Chapter, we shall concentrate on provisions relating to company accounts, some specific items of financial statements relating to companies and audit thereof. Students are also expected to know in detail the requirements of Revised Schedule VI (as applicable from for financial year and onwards) to the Act, while auditing different items contained in financial statements. 8.1 General Considerations in Company Audit These have to be determined on a consideration of : (a) objectives of audit; (b) various provisions in the Companies Act, 1956, especially those concerning accounts and audit; and (c) the scope of the report that the auditor of a company is required to make in pursuance of the provisions contained in section 227 of the Act. The objectives of an audit are : (i) Verification of statements of account so as to express an opinion; (ii) Detection of errors and frauds; and (iii) Prevention of occurrence of errors and frauds. Detection and prevention of frauds and errors were originally regarded as the main objectives

2 8.2 Auditing and Assurance of an audit. It was because the auditor, at that time, was looked upon as the watchdog over the assets that the business possessed as well as over its functioning in general. Such a concept of duties of auditors has its origin in the natural distrust that exists among human beings, especially where the course of business dealings involve several persons entrusting their monies or properties to others. So deep rooted is this belief that whenever, on a company being wound up, a fraud or error is discovered, even today there is a public outcry that the auditors should be held responsible for it. Though the broad objectives of an audit, to this day, continue to be the same as aforementioned, the emphasis has shifted from the detection of frauds and prevention of occurrence of errors to the verification of the statements of account. It is because in the context of present system of management of companies, it is of greater importance that the annual statement of account should exhibit a true and fair state of affairs of their working instead of auditor s time and energy being devoted to tracking down petty frauds and error in accounts, which the internal staff of the company can be entrusted to detect or guard against. The function of an audit primarily, therefore, has come to be regarded as verification of statements of account and expressing an opinion thereon. The expression of opinion lends credibility to financial statements. However, while conducting the audit, the auditor is expected to bear in mind the possibility of existence of a fraud or other irregularity in accounts. Nonetheless, he is not expected to conduct the audit with the objective of discovering all frauds or irregularities, for if that is to be done, the audit would take an unduly long time and the cost of it would be quite out of proportion to its benefit. Nevertheless, it is expected that the auditor would be vigilant and watchful and whenever he comes across a circumstance which arouses his suspicion, he should find out whether a fraud, or irregularity, in fact does exist and, if so, whether it is sufficiently material to necessitate qualifications of the audit report. It is generally accepted that the auditor is not an insurer and does not guarantee that the books of account truly reflect the company s affairs. Such a view is based on the decision in the famous case, London and General Bank. The auditor, thus, is principally responsible for carrying out his duties by exercising due care and skill in consonance with the professional standards. If, despite the fact, any fraud or irregularity in accounts remains undetected, he cannot be held liable for the failure to detect it. Moreover, since the management is primarily responsible for safeguarding the assets and property of the company, the auditor, while framing his audit programme, is entitled to rely upon the internal controls in this regard instituted by the management based on a proper evaluation. It would be observed that Companies Act, 1956 also does not contemplate that an auditor is responsible for the detection of errors and frauds, except when they are so material as to vitiate the opinion expressed by him that statements of account exhibit a true and fair state of affairs.

3 The Company Audit-II 8.3 The aforementioned shift of emphasis in the objectives of audit which also has the tacit acceptance of law has come about primarily due to the extraordinary increase that has taken place in the size of corporate organisations as well as in the volume, complexity and variety of transactions handled by them. On this account, it has become impracticable for the statutory auditor to frame a programme for carrying on a detailed audit for the detection of all frauds and irregularities. He is increasingly obliged to rely on the internal control measures. As such, he is not in a position to give a categorical assurance to the shareholders that there does not exist a fraud or irregularity in the books of account except to the limited extent that the fraud, if any, is not sufficiently material to affect true and fair position exhibited by the statements of account. The auditor, nonetheless, is required to verify the final statements of account; also to check or verify all the matters affecting them so as to ensure fully that they exhibit a true and fair state of affairs of the business of the company. For the purpose, he may either carry out a detailed examination of the books or relying on the internal control measures in operation, after testing their strength, merely test the accuracy of transaction recorded therein. It is permissible for an auditor to verify the accuracy of transactions recorded in the books of account by the application of test checks, if he is satisfied that the system of internal control, in operation, is adequate and satisfactory. One of the refined forms that test checks can take is selection of a representative sample statistically from the area of accounts which is to be test checked and checking in depth the transactions comprised in the sample. Other forms that test checks take are procedural tests. These are applied to a variety of transactions selected from areas of account provided such areas, as selected for test checking, contain a representative sample of the transactions entered into by the concern and the transactions are checked exhaustively. On this consideration, the practice of verification of transactions by application of test-checks has come to be recognised universally. As against test checking, a detailed checking of 100% of transactions would only reveal arithmetical mistakes but still fail to ensure true and fair view. In any case, detailed checking would be very time consuming and almost impracticable having regard to size of organisation spread across the globe. However, the conditions under which test checks can be substituted for detailed checking, and the extent of test checks that must be applied in each case, are matters which the auditor must decide having regard to the circumstances of each case. On this consideration, while conducting the audit of a large business house which has on its staff a qualified accountant, as internal auditor, it is nowadays sometimes possible for the statutory auditor to somewhat reduce the scope and extent of his routine checking. He, instead of going over the facts and figures as have already been examined by a competent and trustworthy internal staff, may limit his checking only to application of test-checks; if however, any significant mistakes are observed in the test period, the scope of the audit is suitably extended. A consciousness is growing in the profession that a greater co-ordination is possible between

4 8.4 Auditing and Assurance the work of the internal auditor and the statutory auditor which, if brought about, would enable the statutory auditor to make use of, to a greater extent, the detailed checking carried on by the internal auditor in the discharge of his duties and responsibilities. 8.2 Specific Provisions as Regards Accounts in the Companies Act, 1956 The provisions in the matter of books of account which a company is required to maintain are contained in section 209 of the Companies Act, They are briefly summarised below: (1) Every company shall maintain at its registered office proper books of account with regard to : (a) all sums of money received and expended by the company and the matters in respect of which the receipts and expenditure take place; (b) all sales and purchases of goods by the company; (c) the assets and liabilities of the company; and (d) in case, it is a company engaged in production, processing, manufacturing or mining activities, particulars relating to utilisation of material or labour or other items of cost, provided there is such a requirement by the Central Government in respect of the class of companies to which it belongs. N.B. - It is permissible, however, for all or any of the books of account may be kept at such place in India as the Board of directors may decide but, when a decision in this regard is taken, the company shall file with the Registrar of Companies a notice giving full address of the other place. (2) When a company has a branch office, whether in or outside India, to comply with the aforementioned provisions, the company must maintain proper books of account relating to transactions effected at the branch office, also arrange to obtain from the branch proper summarised returns, at intervals of not more than three months, for being kept at the registered office or the other place. (3) For the purposes of sub-sections (1) and (2), proper books of account shall not be deemed to be kept with respect to the matters specified therein : (a) if there are not kept such books as are necessary to give a true and fair view of the state of affairs of the company or branch office, as the case may be, and to explain its transactions; and (b) if such books are not kept on accrual basis and according to the double entry system of accounting. (4) The books of account and other books and papers shall be open to inspection by any director during business hours.

5 The Company Audit-II 8.5 (4A) The books of account together with vouchers relevant to any entry made therein for a period of not less than eight years immediately preceding the current year shall be preserved by the company in goodorder. (5) If any of the persons referred to in sub-section (6), fails to take reasonable steps to secure compliance with the requirements of law aforementioned or by a wilful act causes any default by the company, he shall be punishable for each offence with imprisonment for a term which may extend to six months or a fine which may extend to ` or with both. But he may be relieved from such a liability if he can show that he has reasonable ground to believe that a competent and responsible person was charged with the duty of seeing that these requirements were complied with and he was in a position to discharge that duty. (6) Where the company has a managing director or manager, such managing director or manager and all officers and other employees of the company; and where the company has neither a managing director nor manager, every director of the company. (7) If a person, not being a person referred to in the foregoing paragraph, who has been charged with the duty of seeing that requirements of law in regard to the books of account is complied with, makes a default in doing so, he shall, in respect of each offence, be punishable with a fine which may extend to ` 10,000. Section 541(2) (applicable to a company in the course of winding up) is also relevant. It has been provided in Section 541(2) that proper books of account shall constitute (a) such books or accounts as are necessary to exhibit and explain the transactions and financial position of the business of the company, including books containing entries made from day to day in sufficient detail of all cash received and all cash paid; and (b) where the business of the company has involved dealings in goods, statements of the annual stock takings and (except in the case of goods sold by way of ordinary retail trade) of all goods sold and purchased, showing the goods and the buyers and sellers thereof in sufficient detail to enable those goods and those buyers and sellers to be identified. Although Section 541 relates to winding up of a company yet it has the effect of further elaborating the requirements as regards maintenance of books of accounts and should be considered as a general requirement from the point of view of the company. To conclude, it can be said that its application should not be confined to winding up process only. Inspection of Books of Account, etc. of Companies - Section 209 A provides that the books of account and other books and papers of every company shall be opened to inspection during business hours: (i) by the registrar, or (ii) by such officer authorised by the Central Government, or (iii) by such officer authorized by the SEBI.

6 8.6 Auditing and Assurance Such inspection may be made without giving any previous notice to the company or any officer thereof. It shall be the duty of every director, other officer or employee of the company to produce to the person making inspection of such books of account and other books and papers of the company in his custody or control and to furnish him with any statement, information or explanation relating to the affairs of the company as the said person may require to him within such time and at such place as he may specify. Further it shall also be the duty of every director, other officer or employee of the company to give to the person making inspection under this section all assistance in connection with the inspection which the company may be reasonably expected to give. The person making the inspection is also empowered to make copies of books of account and other books and papers and put any marks of identification in token of the inspection have been made. The person making the inspection under this section shall make a report to the Central Government. Annual accounts and balance sheet : Section 210 requires that the Board shall lay before the company at every annual general meeting a balance sheet as at the end of the period and a profit and loss account for that period. In case of a company not carrying on business for profit an income and expenditure account shall be laid. The profit and loss account shall relate (a) in the case of the first annual general meeting of the company, to the period beginning with the incorporation of the company and ending with a day which shall not precede the day of the meeting by more than nine months; and (b) in the case of any subsequent annual general meeting of the company, to the period beginning with the day immediately after the period for which the account was last submitted and ending with a day which shall not precede the day of the meeting by more than six months, or in cases where an extension of time has been granted for building the meeting under the second proviso to sub-section (1) of section 166, by more than six months and the extension so granted. The period to which the account aforesaid relates is referred to in this Act as a financial year ; and it may be less or more than a calendar year, but it shall not exceed fifteen months: Provided that it may be extended to eighteen months where special permission has been granted in that behalf by the Registrar. Constitution of National Advisory Committee on Accounting Standards : Section 210A has been inserted by the Companies (Amendment) Act, 1999 which provides that the Central Government may, by notification in the Official Gazette constitute a National Advisory Committee on Accounting Standards to advise the Central Government on the formulation and laying down of accounting policies and accounting standards for adoption by companies or

7 The Company Audit-II 8.7 class of companies under this Act. A notification constituting the said committee was issued in July 2001 by the Central Government. Form and contents of balance sheet and profit and loss account : Section 211 states : (1) Every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall, subject to the provisions of this section, be in the form set out in Part I of Revised Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central Government either generally or in any particular case; and in preparing the balance sheet due regard shall be had, as far as may be, to the general instructions for preparation of balance sheet under the heading Notes at the end of that Part : Provided that nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity or to any other class of company for which a form of balance sheet has been specified in or under the Act governing such class of company. (2) Every profit and loss account of a company shall give a true and fair view of the profit or loss of the company for the financial year and shall, subject as aforesaid, the profit or loss of the company for the financial year and shall, subject as aforesaid, comply with the requirements of Part II of Revised Schedule VI, so far as they are applicable thereto : Provided that nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity, or to any other class of company for which a form of profit and loss account has been specified in or under the Act governing such class of company. (3) The Central Government may, by notification in the Official Gazette, exempt any class of companies from compliance with any of the requirements in Schedule VI if, in its opinion, it is necessary to grant the exemption in the public interest. Any such exemption may be granted either unconditionally or subject to such conditions as may be specified in the notification. (3A) Every profit and loss account and balance sheet of the company shall comply with the accounting standards. (3B) Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies shall disclose in its profit and loss account and balance sheet, the following namely : (a) the deviation from the accounting standards; (b) the reasons for such deviation; and (c) the financial effect, if any arising due to such deviation. (3C) For the purposes of this section, the expression accounting standards means the standards of accounting recommended by the Institute of Chartered Accountants of India

8 8.8 Auditing and Assurance constituted under the Chartered Accountants Act, 1949 (38 of 1949), as may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards established under sub-section (1) of section 210A : Provided that the standard of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the Accounting Standards until the accounting standards are prescribed by the Central Government under this sub-section. (4) The Central Government may, on the application, or with the consent of the Board of directors of the company, by order, modify in relation to that company any of the requirements of this Act as to the matters to be stated in the company s balance sheet or profit and loss account for the purpose of adapting them to the circumstances of the company. (5) The balance sheet and the profit and loss account of a company shall not be treated as not disclosing a true and fair view of the state of affairs of the company, merely by reason of the fact that they do not disclose (i) in the case of an insurance company, any matters which are not required to be disclosed by the Insurance Act, 1938 (4 of 1938); (ii) in the case of a banking company, any matters which are not required to be disclosed by the Banking Companies Act, 1949 (10 of 1949); (iii) in the case of a company engaged in the generation or supply of electricity, any matters which are not required to be disclosed by both the Indian Electricity Act, 1910 (9 of 1910), and the Electricity (Supply) Act, 1948 (54 of 1948); (iv) in the case of a company governed by any other special Act for the time being in force, any matters which are not required to be disclosed by that special Act; or (v) in the case of any company, any matters which are not required to be disclosed by virtue of the provisions contained in Revised Schedule VI or by virtue of a notification issued under sub-section (3) or an order issued under sub-section (4). (6) For the purposes of this section, except where the context otherwise requires, any reference to a balance sheet or profit and loss account shall include any notes thereon or documents annexed thereto, giving information required by this Act, and allowed by this Act to be given in the form of such notes or documents. (7) If any such person as is referred to in sub-section (6) of section 209 fails to take all reasonable steps to secure compliance by the company, as respects any accounts laid before the company, in general meeting with the provisions of this section and with the other requirements of this Act as to the matters to be stated in the accounts, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to ten thousand rupees, or with both : Provided that in any proceedings against a person in respect of an offence under this section, it shall be a defence to prove that a competent and reliable person was charged

9 The Company Audit-II 8.9 with the duty of seeing that the provisions of this section and the other requirements aforesaid were complied with and was in a position to discharge that duty. Provided further, that no person shall be sentenced to imprisonment for any such offence unless it was committed willfully. (8) If any person, not being a person referred to in sub-section (6) of section 209, having been charged by the managing director or manager, or Board of directors, as the case may be, with the duty of seeing that the provisions of this section and the other requirements aforesaid are complied with, makes default in doing so, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months or with fine which may extend to ten thousand rupees, or with both. Provided that no person shall be sentenced to imprisonment for any such of offence unless it was committed willfully. Students may note that sub-section (3A), (3B) and (3C) were added in section 211 making it mandatory on the part of the management of the company to comply with the accounting standards as specified in sub-section (3C). Hence, statutory recognition has been given to the accounting standards by the legislation. It is incumbent on the company, in case of non-compliance, to mention the fact of deviation, reason for deviation and the financial effect, if any, as well. [ Note : Recently the Ministry of Corporate Affairs through Notification No. S.O. 301(E) dated 8 th Feb, 2011 issued a notification on General Exemption under Section 211 of the Companies Act, According to this, a general exemption is issued whereby the categories of companies in column (2) of the Table below will be exempted from the disclosures given in column 3:- Class of Companies 1. Companies producing Defence Equipments including Space Research; 2. Export Oriented company (whose export is more than 20% of the turnover); 3. Shipping companies (Including Airlines); 4. Hotel companies (including Restaurants); 5. Manufacturing companies/multiproduct companies; Exemptions from para(s) of Part-II of Schedule VI. para 3(i)(a), 3(ii(a), 3(ii)(d), 4-C, 4-D (a) to (e) except (d). para 3(i)(a) 3(ii)(a), 3(ii)(b), 3(ii)(d). para 4-D (a) to (e) except (d). para 3(i)(a) and 3(ii)(d) para 3(i)(a) and 3(ii)(a). 6. Trading companies; para 3(i)(a) and 3(ii)(b).

10 8.10 Auditing and Assurance Abovementioned notification along with table is given for knowledge of the Students] Balance sheet of holding company to include certain particulars as to its subsidiaries : Section 212 requires that there shall be attached to the balance sheet of a holding company having a subsidiary or subsidiaries at the end of the financial year as at which the holding company s balance sheet is made out. The Central Government hereby directs vide General Circular No: 2/2011 (issued by MCA dated ) that provisions of Section 212 shall not apply in relation to subsidiaries of those companies which fulfil the following conditions:- (i) The Board of Directors of the Company has by resolution given consent for not attaching the balance sheet of the subsidiary concerned; (ii) The company shall present in the annual report, the consolidated financial statements of holding company and all subsidiaries duly audited by its statutory auditors; (iii) The consolidated financial statement shall be prepared in strict compliance with applicable Accounting Standards and, where applicable, Listing Agreement as prescribed by the Security and Exchange Board of India; (iv) The company shall disclose in the consolidated balance sheet the following information in aggregate for each subsidiary including subsidiaries of subsidiaries:- (a) capital (b)reserves (c) total assets (d) total liabilities (e) details of investment (except in case of investment in the subsidiaries) (f) turnover (g) profit before taxation (h) provision for taxation (i) profit after taxation (j) proposed dividend; (v) The holding company shall undertake in its annual report that annual accounts of the subsidiary companies and the related detailed information shall be made available to shareholders of the holding and subsidiary companies seeking such information at any point of time. The annual accounts of the subsidiary companies shall also be kept for inspection by any shareholders in the head office of the holding company and of the subsidiary companies concerned and a note to the above effect will be included in the annual report of the holding company. The holding company shall furnish a hard copy of details of accounts of subsidiaries to any shareholder on demand; (vi) The holding as well as subsidiary companies in question shall regularly file such data to the various regulatory and Government authorities as may be required by them; (vii) The company shall give Indian rupee equivalent of the figures given in foreign currency appearing in the accounts of the subsidiary companies along with exchange rate as on closing day of the financial year; (Note: Students may note that as per section 227 of the Act, the duty of the auditor extends to expressing an opinion on balance sheet and profit and loss account and all other documents annexed thereto. Since section 212 requires that particulars of

11 The Company Audit-II 8.11 subsidiary company are required to be attached to balance sheet of holding company, the same shall not be covered by auditor s report. Also refer to section 222 which deals with construction of references to documents annexed to accounts. The Board s Report under section 217 is also attached to every balance sheet of a company. Profit and loss account to be annexed and auditor s report to be attached to balance sheet - The profit and loss account shall be annexed to the balance sheet and the auditors report including the auditors separate, special or supplementary report, if any shall be attached thereto. Board s report (Section 217): (1) There shall be attached to every balance sheet laid before a company in general meeting, a report by its Board of directors, with respect to (a) the state of company s affairs; (b) the amounts, if any, which it proposes to carry to any reserves in such balance sheet; (c) the amount, if any, which it recommends should be paid by way of dividend; (d) material changes and commitments, if any, affecting the financial position of the company which have occurred between the end of the financial year of the company to which the balance sheet relates and the date of the report; (e) the conservation of energy, technology absorption, foreign exchange earnings and outgo, in such manner as may be prescribed. (2) The Board s report shall, so far as is material for the appreciation of the state of the company s affairs by its members and will not in the Board s opinion be harmful to the business of the company or of any of its subsidiaries, deal with any changes which have occurred during the financial year (a) in the nature of the company s business; (b) in the company s subsidiaries or in the nature of the business carried on by them; and (c) generally in the classes of business in which the company has as an interest. (2A) (a) The Board s report shall also include a statement showing the name of every employee of the company who (i) if employed throughout the financial year, was in receipt of remuneration for that year which, in the aggregate, was not less than such sum as may be prescribed; or (ii) if employed for a part of the financial year, was in receipt of remuneration for any part of that year, at a rate which, in the aggregate, was not less than such sum per month as may be prescribed; or

12 8.12 Auditing and Assurance (iii) if employed throughout the financial year or part thereof, was in receipt of remuneration in that year which, in the aggregate, or as the case may be, at a rate which, in the aggregate, is in excess of that drawn by the managing director or whole-time director or manager and holds by himself or along with his spouse and dependent children, not less than two per cent, of the equity shares of the company. (b) The statement referred to in clause (a) shall also indicate, (i) whether any such employee is a relative of any director or manager of the company and if so, the name of such director, and (ii) such other particulars as may be prescribed. Explanation: Remuneration has the meaning assigned to it in the Explanation to section 198. (2AA)The board s report shall also include a Directors Responsibility Statement, indicating therein, - (i) that in the preparation of the annual accounts, the applicable accounting standards had been followed along with proper explanation relating to material departures; (ii) that the directors had selected such accounting policies and applied them consistently and made judgements and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the profit or loss of the company for that period; (iii) that the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities; (iv) that the directors had prepared the annual accounts on a going concern basis. (2B) The Board s report shall also specify the reasons for the failure, if any, to complete the buy back within the time specified in sub-section (4) of section 77A. (3) The Board shall also be bound to give the fullest information and explanations in its report aforesaid, or, in cases falling under the proviso to section 222, in an addendum to that report, on every reservation, qualification or adverse remark contained in the auditors report. (4) The Board s report and any addendum thereto shall be signed by its chairman if he is authorised in that behalf by the Board; and where he is not so authorised, shall be signed by such number of directors as are required to sign the balance sheet and the profit and loss account of the company by virtue of sub-sections (1) and (2) of section 215. (5) If any person, being a director of a company, fails to take all reasonable steps to comply with the provisions of sub-sections (1) to (3), or being, the chairman, signs the Board s

13 The Company Audit-II 8.13 report otherwise than in conformity with the provisions of sub-section (4), he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to twenty thousand rupees, or with both : Provided that no person shall be sentenced to imprisonment for any such offence unless it was committed willfully: Provided, further that in any proceedings against a person in respect of an offence under sub-section (1), it shall be a defence to prove that a competent and reliable person was charged with the duty of seeing that the provisions of that sub-section were complied with and was in a position to discharge that duty. (6) If any person, not being a director, having been charged by the Board of directors with the duty of seeing that the provisions of sub-sections (1) to (3) are complied with, makes default in doing so, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to twenty thousand rupees, or with both: Provided, that no person shall be sentenced to imprisonment for any such offence unless it was committed willfully. 8.3 Payment of Interest out of Capital during Construction Under the provisions of section 208, a company which has raised money by issue of shares to meet the cost of construction of any work or building or provision of any plant which cannot be made profitable for a long time, can pay interest on paid-up capital for a period and subject to conditions specified in sub-sections (2) to (7) of section 208. Accordingly, the payment of interest should be verified as follows: (a) Ascertain that the payment is authorised by the Articles or by a special resolution. (b) Verify that the previous sanction of the Central Government for making such payment has been obtained. (c) Confirm that the interest has been paid only for such period as has been authorised by the Central Government and does not extend beyond the half-year next following during which the construction was completed or the plant was provided. (d) Verify that the rate of interest shall, in no case exceed such rate as the Central Government may, by notification in official Gazette direct. (e) Check that the amount of interest paid has been added to the cost of assets created out of the capital. The interest paid being a part of the capital expenditure incurred in bringing into existence assets, it should be added thereto. Until so added, it must be shown as a separate item in the Balance Sheet under the head Miscellaneous Expenditure.

14 8.14 Auditing and Assurance 8.4 Special Requirements of Company Audit (i) Verification of the constitution and powers - A company can function within the limits prescribed by the documents on the basis of which it has been registered. It raises its capital from the public on certain conditions, specified in the Prospectus. Before commencing business, to purchase a property or to have subscription to its capital underwritten on this account, it is essential that the auditor, prior to starting the audit of a company, shall examine: (a) The Memorandum of Association. (b) The Articles of Association. (c) Contracts entered into with vendors and other persons relating to purchase of property, payment of commission, etc. A company cannot enter into a contract before it has been registered. What is more, a public company cannot commence business until the certificate of commencement of business has been granted to it by the Registrar of Companies. It is, therefore, the duty of the auditor to take into account, while examining the transaction entered into by the company, the dates when these were entered into for confirming the validity. With a view to carrying out the audit effectively, it is necessary that the auditor should know the authority structure of the company. Under Section 291 of the Act, the Board of Directors of a company are entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to do. However, the Board shall not exercise any power or do any act or thing which is directed or required by any legislation (including the Companies Act) or by the memorandum or articles of the company, to be exercised or done by the company, in general meeting. Section 292 specifies six types of decisions that can be taken by the Board of Directors only in Board s meetings. These relate to : (i) making calls on partly paid shares. (ii) issue of debentures, (iii) borrowing monies otherwise than on debentures, (iv) investing the funds of the company, and (v) making loans. The transaction barring the first three can be delegated to any of the following: (a) a committee of directors, (b) managing director, (c) manager, (d) any other principal officer of the company, or (e) principal officer of the branch office, in relation to the branch.

15 The Company Audit-II 8.15 Apart from the above, a number of other functions are also carried out by the Board. A few of such functions are stated herein by way of examples : (a) Adopting of accounts before the same submitted to the auditor for their report-section 215. (b) Appointment of the first auditors and filling of casual vacancy - Section 224. (c) Investment in shares of companies within the limits specified in Section 372A. (d) Entering into contracts with persons who are directors of the company or related to or associated with the directors as are specified in Section 297 of the Act. Some of the matters which only the shareholders can sanction at a general meeting : (a) Appointment and fixation of remuneration of auditors in the annual general meeting - Section 224. (b) Declaration of dividends - Regulation 85, Table A. (c) Appointment of relatives of directors etc. to an office or place of profit in the company under Section 314 of the Act. (d) Sale, lease or a disposal of the whole of the company s undertaking or a substantial part of it and donations above a certain limits [Section 293(1)]. (ii) Matters which require sanction of the Central Government : Loans to directors by a company other than a banking or a finance company (Section 295). For verifying the foregoing transactions and others authorised by the directors or shareholders, the auditor should refer to the minutes of the meeting at which these have been considered. Further, for judging the validity or otherwise of section accorded, the relevant provision of law must be referred to. A few such instances are given below : (a) Appointment of Directors (Section 256). (b) Disqualifications of Directors (Section 274). (c) Conduct of Board Meeting (Sections ). (d) General powers of Board (Section 291). (e) Powers which the Board must exercise only at a meeting (Section 292). (f) Restriction on powers of the Board regarding disposal of the undertaking or part of it etc. (Section 293). (g) Prohibitions and restrictions regarding political contributions (Section 293A). (h) Power of Board and other persons to make contributions to the National Defence Fund, etc. (Section 293B). (i) Restriction on advancing loans to Directors, etc. (Section 295).

16 8.16 Auditing and Assurance (j) Restriction on a Director or his relative, a firm in which a director or relative is a partner; or any other partner of the firm or a private company of which such a director is a member or director to enter into a contract of sale or purchase of goods except with the sanction of the Board of Directors (Section 297). (k) Restriction on an interested director in participating in or voting at Board s proceedings (Section 300). (l) Disclosure of interest by directors (Section 299). (m) Register of contracts, Companies or firms in which directors are inspected (Section 301) (n) Remuneration of directors (Section 309). (o) Restraint on a director s holding offices or places of profit (Section 314). (p) Restraint on payment of compensation for loss of office to a director (Sections 318 to 321). (q) Restriction on loans, etc., to companies under the same management (Section 370). (r) Regulation of inter-corporate loans and investments (Section 372A). (iii) Special considerations involved in the examination of certain documents (a) Memorandum of Association - It is a charter containing particulars of business activities that the company can undertake and the powers it can exercise in regard thereto. Only on a consideration thereof it is possible for the auditor to determine whether a transaction which has been entered into by the company is intra vires, i.e. the company is authorised to enter into it. If a company enters into a transaction which is ultra vires, the shareholders, though entitled to claim the profit arising on such a transaction, may restrain the management from charging the loss, if any, has been suffered thereon, to the company. If the auditor fails to detect and report the transactions which are ultra vires the company, he would be guilty of negligence. Generally the Memorandum of Association of companies is drawn up comprehensively in order that the company may be able to enter into a wide variety of transactions which it may be required to do for carrying out one or more of its objects. Nevertheless, sometimes occasions arise when a company, inadvertently, or deliberately, enters into a transaction which is ultra vires objects to powers. In such a case, the shareholders may decide to restrain the management from charging to the company the losses suffered by the company in respect of such a transaction. (b) Articles of Association - These are rules and regulations for the internal management of the company; and they define the rights of different classes of shareholders, conditions under which calls can be made, the maximum and minimum number of directors the company can have, their qualifications, disqualifications and removal, etc. The terms and conditions of these provisions

17 The Company Audit-II 8.17 (c) have relevance to the examination of transaction, that the auditor is required to carry out. He should, therefore, study the Articles and include extracts from them in his permanent audit file. The auditor, who fails to take note of the provisions in the Articles in the verification of statements of accounts, would be guilty of professional negligence. While delivering judgment in the case, Leeds Estate Building and Investment Co. v. Shepherd, Starling J. said, It is the duty of the auditor to see that the balance sheet is a true and correct representation of the company s affairs. It was no excuse that the auditor had not seen the articles when he knew of their existence. The auditor must, therefore, acquaint himself with the provision of the Articles of the company and should apply this knowledge in the verification of the transactions of the company. Prospectus - It is a formal document which a public company must issue before it makes the allotment of shares under section 56. It must contain all the terms and conditions on which subscription to the shares is sought to be obtained from the public e.g. the company may stipulate, that it would obtain a quotation for its shares at a Stock Exchange or that it shall purchase a property which is considered valuable for the company or that it has obtained the services of technical experts whose services will be valuable for setting up the factory. In case the company fails to carry out any of these undertakings or if any statement made by it ultimately is proven to be false, the shareholder has the option to claim refund of the amount paid by him. The auditor should, therefore, study carefully all the conditions and stipulations made in the prospectus and, in case any of them has not been carried out, to draw the attention of shareholders thereto. It may be noted that the right to claim refund is restricted to such of the shareholders who subscribed for shares on the basis of prospectus. A shareholder who has purchased the shares from stock exchange or otherwise cannot claim refund. Section 60A inserted by the Companies (Amendment) Act, 2000 has introduced the concept of Shelf Prospectus. Such prospectus would enable companies engaged in financial activities to raise money by way of offer of securities more than once during its validity and, in such case, only an information memorandum stating certain material particulars. Section 60B has introduced the concept of red-herring prospectus. Accordingly, section 60B involves concept of information memorandum also. 8.5 Audit of Share Capital Almost the first function of a company is to raise capital. Excepting a private company, every other company issues a prospectus, which may be in the abridged form, or a Statement in lieu of Prospectus, before it proceeds to allotment, share capital. The object is to publicly announce the conditions on which allotment will be made, to specify the projects on which the

18 8.18 Auditing and Assurance amount raised will be spent (when these have been decided upon in advance) and to specify limits on certain expenses incidental to raising of capital. The receipt of applications for shares and allotment of shares in pursuance thereto are two important aspects of every issue of capital in so far as these constitute the legal basis of the transactions in the matter of purchase of shares. These, therefore, should receive a careful attention of the auditor. He also must verify that each party, has performed his part of the contract, within the allotted time. The audit of share capital is necessary both on incorporation and afterwards whenever the directors decide to increase the subscribed share capital. However, except when fresh capital has been issued during the year under audit, for verification of capital it is enough if transfers of shares registered during the year are verified and the total number and value of shares held by different shareholders are reconciled with the total paid-up capital of the company General Programme for Verification of Share Capital Authorised capital - The authorised capital may be verified with reference to the amount shown in the Memorandum of Associations. Previous year audited balance sheet may also be seen. Issued capital - Verify the amount of issued capital with reference to last year audited balance sheet. Also see whether the Central Government has issued any notification for conversion of debenture or loan into equity share under section 94A. Further issue of capital - The general points are given as under: (1) Study the conditions of issue contained in the Memorandum and Articles of Association, Prospectus or Statement in lieu of Prospectus, shelf prospectus, red-herring prospectus and information memorandum, as the case may be, and see that all of them have fully been complied with. (2) Verify that the first allotment was not made until the amount of minimum subscription stated in the Prospectus had been subscribed and until then the amount received was kept deposited in a Scheduled bank as required by Section 69 of the Act. (3) Confirm that the brokerage and underwriting commission was paid only at the rates authorised by the Prospectus or the Articles of Association, having regard to the provisions contained in Section 76. (4) Ensure that legal requirements as laid down in section 81 (dealing with right shares) have been complied with. (5) Verify that preliminary contracts, if any, entered into for purchase of a property or business, for creating an organisation for management of the company, etc. have been carried out strictly according to the terms stated in the Prospectus. (6) Ensure that the company intending to offer shares to the public for subscription by the issue of a Prospectus has, before such issue, made an application to one or more recognised stock exchanges for permission for the shares intending to be so offered within the stock exchange or each stock exchange as required by the Companies

19 The Company Audit-II 8.19 (Amendment) Act, Section 73 provides that allotment made by a company would be void if the permission is not granted by stock exchange before the expiry of ten weeks from the date of the closing of the subscription list. (7) Confirm that the guidelines issued by the Securities and Exchange Board of India (SEBI) have been followed. Compliance reports submitted by lead managers and reports submitted to SEBI may be examined in this regard. (8) Ascertain that there exists an internal check on receipt of amounts alongwith the application and that the same throughout has continued to function satisfactorily. (9) Verify compliance with legal provision relating to issue of shares at premium (section 78), issue of shares at discount (section 79), and issue of sweat equity shares (section 79A) Verification of Shares Issued for Cash: Usually, there are three stages in the issue of shares for cash, viz. : (i) Receipt of applications for shares alongwith application money; (ii) Allotment of shares and receipt of allotment; and (iii) Making calls and receipt of call money. The programme of work to be carried out in respect of each of the above mentioned three stages is stated below: (1) Applications - Verify the amount received alongwith the applications for shares in the following manner: (i) Check entries in the Application and Allotment Book (or Sheets) with the original applications; (ii) Check entries in the Application and the Allotment Book as regards deposits of money, received with the applications, with those in the Cash Book; (iii) Vouch amounts refunded to the unsuccessful applicants with copies of Letters of Regret; (iv) Check the totals columns in the Application and Allotment Book and confirm the journal entry debiting Share Application Account and crediting Share Capital Account. (2) Allotment (i) Examine Director s Minutes Book to verify approval of allotments. (ii) Compare copies of letters of allotment with entries in the Application and Allotment Book. (iii) Trace entries in the Cash book into the Application and Allotment Book for the verification of amounts collected on allotment.