INCOME TAX NOTES

CA IPCC CHAPTER - 6 VERIFICATION OF ASSETS &LIABILITIES

CHAPTER - 6
VERIFICATION OF ASSETS &LIABILITIES

STATISTICS OF THE CHAPTER Tentative Weightage of Chapter: 10 to 15 Marks IMPORTANCE OF THE CHAPTER This is the most practical oriented chapter and the concepts of
this chapter will be used the most in practical life. It also clears various accounting concepts.

COVERAGE OF THE CHAPTER
(1) Reserves vs. Provisions
(2) Verification of Assets
(3) Verification of Liabilities
(4) AS 4: Subsequent Events
Ca Ipcc Chapter - Verification of asset and libilities study material



(68) What is the difference between Reserve and Provisions?

Reserve
Provisions
Meaning
Reserves are amounts appropriated out of profits which are not intended to meet any liability, contingency, commitment or diminution in the value of assets known to exist at the date of the Balance Sheet.
Provisions are amounts charged against revenue to provide for:
·  depreciation, renewal or diminution in the value of assets; or
·  a known liability; or
·  a claim which is disputed.
Nature
It is an appropriation of profits
It is a charge against profits
Source
It is created only out of profits
It can also be created in case of losses
Dividends
It may be used for distribution as dividend.
It cannot be used for distribution as dividend
Examples
Capital Redemption Reserve
Provision for tax / depreciation

► DISCLOSURE: Capital and revenue reserves must be shown separately in B/S.
Balance of P&L A/c, if in debit, should be deducted from the revenue reserve.
Additions or withdrawals from reserves, if material, should be disclosed.
When amount of reserve is invested outside business & is represented by readily realised assets, then the term ‘Reserves Fund’ should be used to describe a reserve.


(69) What is the difference between Capital Reserve & Reserve Capital?

Capital Reserve
Reserve Capital
Meaning
Capital reserve represents surplus or profit earned in respect of certain types of transactions and does not include any amount regarded as free for distribution
through the P&L A/c.
It is that portion of share capital as determined by the company, which has not been called up and can be called up only in the event of winding up.
Disclosure

It is recorded in the books of accounts and is disclosed on the liabilities side of the Balance Sheet.
It is not recorded in the books of accounts and is not disclosed in the Balance Sheet.
Creation
It is created out of profits of capital nature.
Special Resolution is needed to call up
this amount in the event of winding up.
Utilisation
It may be used for writing down losses, fictitious assets, for issuing bonus shares or for certain specified purposes as per Sec. 78 & 80.
It can be used only for the purpose of winding up.


(70) What is Verification and how does it differ from Vouching?
Meaning: Verification is a process by which auditor satisfies himself by inspection or otherwise as to the existence, ownership, valuation and accuracy of items appearing in B/S. Its difference from vouching is stated below:
Verification
Vouching
It relates to items appearing in Balance Sheet.
It relates to entries recorded in books.
It is carried out at the end of a period.
It is generally done throughout the year.
It is generally done by experienced people or senior staff.
It is generally done by junior staff.
It includes valuation.
It does not include valuation.
To confirm existence, ownership, valuation & disclosure of B/S items.
To verify completeness, accuracy and validity of transactions.


(71) Write a note on Verification of Assets.
Verification of assets is done with an objective to confirm:
1. Existence: that the assets were in existence on the date of the balance sheet
2. Authority: that assets had been acquired for purpose of business & under a proper authority
3. Ownership: that the right of ownership of assets vested in or belonged to the undertaking
4. Charge: that they were free from any lien or charge not disclosed in the balance sheet
5. Valuation: that they had been correctly valued having regard to their physical condition
6. Disclosure: that their values are correctly disclosed in the balance sheet.
Verification of assets is primarily the responsibility of management since they are expected to have a much greater intimate knowledge of assets of the entity as compared to an outsider. Auditor is expected only to do appraisal of the evidence, inspection and report on matters affecting their valuation, existence, title & disclosure. His principal function is to verify original cost of assets and confirm that such valuation is fair and reasonable.


(72) Write a note on Valuation of Assets.
For the purpose of valuation assets may be classified into:
1. Fixed Assets: Fixed assets are included in the Balance Sheet at their cost less depreciation and impairment loss, where cost includes all expenditure necessary to bring the assets into existence and to put them in working condition.
2. Wasting Assets: It is recommended that provision for depreciation/depletion should be made for every wasting asset like mines, on the basis of estimated physical exhaustion that takes place.
Provision can be made on the basis of proportion that the quantity of output during the year bears to total quantity that mine is expected to yield during its normal working life. Unit for such a computation should be unit of refined produce. If mine is acquired on a lease, total amount paid for lease should preferably be amortised over the period of lease in proportion to output in each year or on a time basis.
3 Floating/Current Assets: They are valued either at cost or market value whichever is lower. Cost includes cost of purchase, cost of conversion and other costs incurred in the normal course of business in bringing inventories up to the present location and condition. The term market value may either refer to Net realisable value or replacement cost. AS 2 contains the provisions for valuation of Stock-in-trade. The normally accepted accounting principle for valuation of stock-in- trade is cost or net realisable value whichever is lower, except for some specified cases.
4. Intangible Assets: These are valued as per the provisions contained in AS 26.


(73) How will an auditor verify Land & Buildings?
Sometimes the two assets are shown together in the Balance Sheet but their ledger accounts should always be separate as buildings are subject to depreciation while land in general is not.
LAND should be verified as follows:
1. Inspect original title deed and ensure that it covers all lands whose cost is debited in books.
2. Certificate may be obtained from legal adviser of client confirming validity of title to land.
3. Verify that conveyance deed is duly registered as required under the Registration Act, 1908.
4. In case of mortgaged property, title deed would be in possession of mortgagee or his solicitors. A certificate to this effect should be obtained from them.
5. Examine leases granted and also verify that ground rents which were outstanding for recovery on the date of Balance Sheet have since been recovered.
6. Verify that the amount of profit/loss resulting on sale has been correctly adjusted in accounts.
7. Examine that the charge, if any, against the asset is properly disclosed.
8. Check the basis of valuation and ascertain if it has been revalued.

BUILDING should be verified as follows:
1. Examine title deed of the Building.
2. Check if building is stated at its original cost in books by referring to Conveyance Deed.
3. If it is constructed, bills or certificate from contractor or architect be seen. If construction is done by client, verify that the basis of allocation of various costs is reasonable.
4. It should be depreciated at appropriate rates.
5. Ensure that Land & Building are separated for purposes of calculating deprecation.
6. Scrutinise closely the expenditure on repairs and ensure that distinction between capital and revenue expenditure is properly made.
7. If buildings have been revalued appropriate disclosures in this regard should be made.
8. Examine that the charge, if any, against the asset is properly disclosed.
9. In case of mortgaged property, title deed would be in possession of mortgagee or his solicitors. A certificate to this effect should be obtained from them.
10. Verify that amount of profit/loss resulting on sale has been correctly adjusted in accounts.


(74) How will an auditor verify following fixed assets?
A. LEASEHOLD PROPERTY:
1. Examine lease agreement to understand its terms and conditions and ascertain that the lease has been duly registered.
2. See if all conditions prescribed by lease, whose non-compliance may result in forfeiture or cancellation of lease, are being duly complied with.
3. Examine counterpart of tenant’s agreements, if part of leasehold property has been sublet.
4. Ensure that due provisions for any claim that might arise under dilapidation clause on expiry of lease has been made.
5. Ensure that the accounting and disclosure requirements as per AS 19 have been followed.
6. Where leasehold rights have been revalued that fact should be clearly shown in Balance Sheet till the account has been completely written off.

B. PLANT & MACHINERY:
1. Examine that appropriate internal control exists over plant & machinery.
2. Examine the Plant Register or schedules containing the detail of plant & machinery.
3. Verify invoice of machinery supplied & evidence of other incidental expenses for additions made and ascertain if the purchase have been duly authorized.
4. If addition is made by the concern on its own, basis of allocation of costs should be verified.
5. Verify that amount of profit/loss resulting on sale has been correctly adjusted in accounts.
6. Ensure that physical verification of plant & machinery is done periodically for verifying the existence of assets.
7. As a measure of effective internal control, see if assets have been numbered.
8. It should be depreciated at appropriate rates. If an asset has been revalued, depreciation should be provided on revised value.
9. Examine that the charge, if any, against the asset is properly disclosed.
10. Scrutinise closely the expenditure on repairs and ensure that distinction between capital and revenue expenditure is properly made.
11. Ensure that accounting & disclosure requirements as per AS 10 have been complied with.

C. MOTOR LORRIES, VANS, ETC.:
1. Cost of these assets should be verified by reference to invoices of suppliers.
2. Their ownership should be confirmed from permit and Registration Books.
3. Verify that vehicles are covered by a comprehensive policy of insurance.
4. See if adequate depreciation has been provided in respect of each of them.
5. In case of large number of vehicles, there should be a Vehicle Register.
6. In case of second hand purchase, ensure if transfer of ownership has been duly made.
7. See if any charge on them has been properly disclosed.

D. PATENT RIGHTS:
1. If a number of patents are held, a schedule thereof should be obtained.
2. Verify ownership of patent by inspection of certificate of grant of patent or agreement
surrendering it in favour of the client.
3. Check if the rights are alive and legally enforceable and renewal fees have been paid on due dates by charging to revenue and Patent Account.
4. Ensure that patents are being shown at cost less amortisation charges. Cost includes purchase price and registration cost. If patent has been developed by client in-house, all relevant expenses incurred in creating it should be capitalized.
5. Cost of patent should be written off over the legal term of its validity or over its useful commercial life, whichever is shorter.
6. Provisions of AS-26 should be complied with.

E. TRADEMARKS AND COPYRIGHT:
1. Verify ownership of Trademarks and Copyright by inspection of certificate of grant or agreement
surrendering it in favour of the client.
2. It must also be observed that the rights are alive and legally enforceable.
3. Obtain a schedule of trademarks & copyrights.
4. Verify that renewal fees have been paid and charged to revenue. Examine last renewal receipt to ascertain that the trade mark has not lapsed.
5. Ensure that they are being shown at cost less amortisation charges till date.
7. Provisions of AS-26 should be complied with.

(75) How will an auditor verify Investments?
1. Obtain schedule of Investments in form of securities and shares with all details, like opening balance, face value, market value, rate of interest, due date of interest, etc.
2. In separate columns enter amounts of interest and dividend received during the period, interest/dividend accrued/ outstanding at close of period, etc.
3. Compare closing balance in schedule with the control account in General Ledger.
4. Ensure that the investments made are duly authorised.
5. Verify the brokers’ contract note, bill of costs, etc.
6. Special attention should be paid to investments purchased or sold cum-dividend, ex-dividend, cum-interest/ex-interest, cum rights/ex-rights or cum bonus/ex-bonus.
7. Check the stock exchange quotations if sum paid for purchases/sales are substantial.
8. Physical inspection of investments may be done at the last date of accounting year.
9. If custody of investments is not with the entity, certificate should be obtained from relevant authority to the effect of holding of investments.
10. See that the accounting & disclosure requirements as per AS-13 have been complied with.
11. Examine if expenses like, transfer fees, stamp duty etc. are included in cost of investments.
12. Ensure that dividend or interest has been appropriately accounted for.

(76) How will an auditor verify Stock-in-Trade?
1. Examination of Records: Auditor should examine stock records showing item wise, the receipts, issues and balances. He should refer to the relevant basic documents e.g., goods received notes, inspection reports, material issue notes, bin cards, etc.
Attendance at Stock-taking: Physical verification of inventories is the responsibility of the management, however, where inventories are material and auditor is placing reliance upon physical count by management, it may be appropriate for him to attend stock-taking. He should consider SA 501 while conducting physical verification.

2. Confirmations from Third Parties: Where significant stocks of entity are held by third parties, auditor should directly obtain from them written confirmation for stocks held. Arrangements should be made with entity for sending requests for confirmation to such third parties.
3. Examination of Valuation and Disclosure: Ensure that valuation of inventories is in accordance with normally accepted accounting principles and is on consistent basis.
Observe compliance with provisions of AS 2.
Examine treatment of overhead expenses as part of inventory cost.
He may call for reconciliation of total cost of production as per cost records with the financial books and review this reconciliation.
If standard rates are used, he may ensure that appropriate adjustment is made.
Ensure that inventories have been disclosed properly in financial statements.


(77) How will an auditor verify Work-in-progress?
1. Auditor may involve a technical expert in verification of work-in-progress if necessary.
2. He may advise his client that where possible work-in-progress should be reduced to minimum
before closing date.
3. Ascertain that the cost sheets are duly attested by the Works Engineer and Works Manager.
4. Test the correctness of cost as disclosed in cost records by verification of quantities & cost of materials, wages and other charges by reference to records maintained and original evidence in respect of all expenditure included in cost-sheets.
5. Compare the unit cost or job cost as shown by cost sheet with standard cost.
6. Ensure that allocation of overhead expenses is made on reasonable basis.
7. Compare cost-sheet in detail with that of previous year both in regard to composition of cost and value placed on various components. Investigate causes of material variation.


(78) How will an auditor verify the Book debts?
1) Examination of Records:
1. Evaluate internal control system and examine relevant records about validity, accuracy and recoverability of debtor balances.
2. Check if balances in schedules of debtors agree with those in ledger accounts.
3. Examine whether the age of the debts has been properly determined.
4. Ascertain amounts overdue, having regard to the credit terms of the entity.
5. See if provisions for allowances, discounts, doubtful debts have been properly made.
2) Direct Confirmation Procedure:
1. If management requests auditor not to seek confirmation from certain debtors, he should consider whether there are valid grounds for such a request.
2. While selecting the debtors to be circularized, special attention should be paid to accounts with large balances, old outstanding balances and customer accounts with credit balances.
3. Method of selection of debtors should not be revealed to entity until trial balance of debtors ledger is handed over to auditor.
4. Strict control should be maintained to ensure correctness & proper dispatch of letters.
5. Entity should be asked to reconcile any discrepancies revealed by confirmations received or by additional tests carried out by auditor.
3) Analytical Review Procedures: Analytical review procedures may often be helpful for obtaining audit evidence regarding various assertions relating to debtors:
1. comparison of closing balances of debtors with the corresponding figures for the previous year;
2. comparison of actual closing balances of debtors with corresponding budgeted figures, if available
3. comparison of significant ratios relating to debtors with similar ratios for other firms in the same industry, if available;
3) Disclosure:
1. According to Part I of Schedule VI to the Companies Act, 1956, debts outstanding for more than six months have to be shown separately.
2. All sundry debtors; loans/advances are required to be classified as under:
a. Debts considered good in respect of which the company is fully secured.
b. Debts considered good but unsecured.
c. Debts considered doubtful or bad.
3. Separate disclosure is required for debts due by directors or other officers or any of them either severally or jointly with any other person or debts due by firms or private companies in which any director is partner or a director or a member.
4. Debts due from other companies under same management should be disclosed along with name of the companies.


(79) How will an auditor verify bank balances?
1. Examine bank reconciliation statement and balance certificates received from banks.
2. Examine whether cheques issued but not presented for payment and cheques deposited but not credited in bank account, have been duly debited/credited in the subsequent period.
3. Scrutinize items outstanding for an unduly long period in the reconciliation.
4. Disclosures should be made as per recognized accounting policies & practices and relevant statutory requirements.
5. Suitable disclosures be made in relation to balances/deposits with specific charge on them.
6. Examine relevant receipts/certificates and bank advices in case of any deposit with banks.
7. Examine that remittances in transit have been credited in bank in the subsequent period.
8. Adjustments should be made for cheques which have become stale as at year end.
9. Where material amounts are held in bank accounts which are blocked, e.g., in foreign banks with exchange control restrictions examine whether suitable disclosures have been made.
10. If number of bank accounts seems to be disproportionately large in relation to its size, the auditor should exercise greater care to establish the genuineness of transactions & balances.


(80) How will an auditor verify Cash-in-hand?
1. Cash in hand includes petty cash balance, balances of stamps, cash in transit, cash at branches and cash with agents, out of which the first two are verified by actual count.
2. There should be an element of surprise while checking cash.
3. Cashier should be present while cash is being counted and he should sign the statement prepared containing details of the cash balance counted.
4. If cash balance could not be checked on Balance Sheet date, arrangements should be made for all cash balance to be banked.
5. Auditor should sign Cash Book to indicate stage at which cash balance was checked.
6. Any slip, chit for temporary advances paid to employees included as part of the cash balance should be initialed by a responsible official & debited to Appropriate Accounts.
7. The quantum of torn or mutilated currency notes should be examined in the context of the size and nature of business of the entity.
8. In case of any material differences between actual cash-in-hand and balance in books, he should seek explanations from senior officials


(81) How will an auditor verify Loans & Borrowings?
1. Examine if loans obtained are within the borrowing powers of entity.
2. See if book balances agree with statements of lenders in respect of loans and advances from banks, financial institutions and others. Examine reconciliation statements, if any.
3. Examine important terms in loan agreements.
4. Examine whether requirements of applicable statute regarding creation and registration of
charges have been complied with.
5. Where entity has accepted deposits, auditor should examine whether directives issued by Reserve Bank of India or other appropriate authority are complied with.
6. If value of security falls below the amount of loan outstanding, auditor should examine whether loan is classified as secured only to the extent of market value of security.
7. Verify if loans have been properly classified as short term and long term loans.
8. Examine hire purchase agreements and see if adequate disclosures have been made.


(82) How will an auditor verify Provisions?
The auditor should examine the reasonableness and adequacy of the amounts provided for.
PROVISIONS FOR TAXES AND DUTIES:
1. Adequacy of provision for taxation for the year should be examined by reviewing overall outstanding liability as at B/S date.
2. Examine if suitable adjustments have been made for additional demands or refunds.
3. Examine relevant orders and examine if any short provisions have been made good.
4. Auditor should qualify his report if no provision has been made for a material tax liability.
5. Examine any disputed liability and see if adequate provision or suitable disclosure is made.
6. Check the method of calculating provision.

PROVISION FOR GRATUITY:
1. Examine if the entity is required to pay gratuity to its employees by virtue of provisions of the Payment of Gratuity Act, 1972 and/or in terms of agreement with employees.
2. Ascertain if provision for accruing gratuity liability has been made.
3. Examine the adequacy of gratuity provision with reference to actuarial certificate.
4. If no actuarial certificate has been obtained, examine if method followed for calculating the accruing liability for gratuity is rational.

PROVISION FOR BONUS:
1. Examine if liability is provided for in accordance with Payment of Bonus Act, 1965 and/or agreement with employees or award of competent authority.
2. Specifically examine if bonus actually paid is in excess of amount required to be paid as per provisions of applicable law/agreement/award.


(83) How will an auditor verify Contingent Liabilities?
As per AS 29, contingent liability is:
possible obligation as a result of past event;
existence of which will be confirmed only by occurrence or non-occurrence of future event &
future event not wholly within the control of the enterprise.
Contingent liabilities are continuously assessed and if it becomes probable that an outflow of future economic benefit will be required to settle obligation which is previously assessed as contingent liabilities, a provision is recognized.
The following general procedures may be useful in verifying contingent liabilities.
1. Review of minutes of meetings of board of directors, committees of board of directors/other similar body.
2. Review of contracts, agreements and arrangements.
3. Review of list of pending legal cases, correspondence relating to taxes, duties, etc.
4. Review of terms and conditions of grants and subsidies availed under various schemes.
5. Review of records relating to contingent liabilities maintained by the entity.
6. Enquiry of and discussions with, the management and senior officials of the entity.
7. Representations from the management.
8. Verify that proper disclosure as required by AS 29 is made in financial statement.


(84) Write a note on events occurring after the balance sheet date / subsequent events.
As per AS 4, events occurring after B/S date are those significant events, both favourable and unfavourable, that occur between B/S date and date on which financial statements are approved by Board of Directors in case of a company and in case of any other entity by the corresponding approving authority. Some of such events may require adjustments to assets and liabilities as at the balance sheet date or may require disclosure. These are classified as under:
1. Adjusting events are those significant events occurring after B/S date that provide additional information materially affecting determination of amounts relating to conditions existing at B/S date, e.g., an adjustment for loss on B/R confirmed by insolvency of customer which occurs after B/S date.
2. Non-adjusting events are those events which do not relate to conditions existing at B/S date, e.g., decline in market value of investments. Disclosure of such events is made if they represent unusual changes affecting existence of enterprise at B/S date. For e.g., destruction of a major production plant by a fire after B/S date will not require any adjustment in B/S, but they may be disclosed in report of approving authority. If disclosure of events occurring after B/S is required, the auditor should see that the following information has been provided:
a. the nature of the events; and
b. an estimate of the financial effect or a statement that such an estimate cannot be made.
3. Certain events which take place after B/S date are required to be disclosed in financial statements because of statutory requirements or because of their special nature. E.g., dividend proposed or declared after B/S for period covered by financial statements.

Practical Questions - Chapter 6: Verification of Assets & Liabilities Q1. State your opinion/comment on the following:
(a) Fixed assets have been revalued and the resulting surplus has been adjusted against the b/f
losses.

(b) B Ltd. acquired a car for Rs. 6.5 lacs on hire purchase basis. The interest payable as well as penalty for late payment of installments was added to the cost of the car. During the year the company paid Rs. 1.5 lacs as installments for the year and provided depreciation on the said amount paid.

(c) Inventories of a car manufacturing company include the value of items required for manufacture of a model which was removed from production 5 years back, at cost.

(d) A machine was purchased by 2 companies jointly. The price was shared equally. It was agreed that they would use the machinery equally and show in their balance sheets, 50% of the value of machinery and charge 50% of depreciation in their books.

(e) M/s Bonafide Ltd. has taken a Group Gratuity Policy from Insurance Company. During accounting year 2004-05 it received a communication from the said Insurance Company informing that premium amount for the accounting year 2003-04 was less charged by Rs. 75 lacs on account of arithmetical error on the part of Insurance Company. M/s Bonafide Ltd. paid the said sum of Rs. 75 lacs during the accounting year 2004-05 by debiting the same to Prior period expenses.

Q2. State whether the following statements are true or false:
(a) Management Certificate obtained by auditor is enough for verification of inventories.
(b) The responsibility for properly determining the quantity and value of inventories rests with the management of the entity.
(c) Interest accrued but not due on secured loans is required to be shown under appropriate sub-heads under the head secured loans.