Friday 21 January 2011
KERALA COOPERATIVE AUDIT MANUEL VOLUME I PART III CHAPTER III
BALANCE SHEET - PREPARATION OF
A. Verification of Assets and Liabilities
1. Balance Sheet :- De Paula defines balance sheet as following.-
“A Balance sheet is not a statement of assets and liabilities, as is commonly through, but merely a ‘sheet’ showing a classified summary of all the balances appearing in a set of books, after all the nominal accounts have been closed by transfer to the Profit and Loss Account-the balance sheet including in one form or another, the balance on the latter account”. It shows, in a classified form, all the balances remaining in the books, after the nominal accounts are transferred to the Trading and Profit and Loss Account and the Corresponding accounts in the ledger are closed.
The balance sheet, no doubt, includes all the assets and liabilities of the business but in many cases, it includes items on both the sides, which are strictly speaking, neither assets nor liabilities. For example, debit balance, of the profit and loss account appears on the assets side, although it is not an “asset”. Similarly statutory reserve fund and other reserves, credit balance of the profit and loss account, which appear on the liability side cannot be termed as “liabilities”. The balance sheet is expected to exhibit a true and fair view of the financial position of the society. Since the balance sheet includes other items as well, which are neither assets nor liabilities, it is necessary that these items should be correctly described so that the whole position will be clear. Therefore it is the duty of auditor to satisfy himself that the balance sheet is properly prepared according to the correct and consistent accounting principles.
2. Meaning of valuation of assets for the purpose of Balance Sheet :- A comparison of the capital at the beginning of the year and at the close of the year would undoubtedly reveal whether the business runs at a profit and conversely decrease in capital is an indication of loss. Since the surplus of assets over liabilities represents the capital of a business concern, any such increase or decrease in surplus of capital represents the profit or loss made during a year. The term valuation in connection with the Balance Sheet can be interpreted as follows:-
(i) The value may be the estimated amount that the assets would fetch, if sold or disposed of, i.e. the realisable value.
(ii) Value may mean the amount that is estimated to replace the asset i.e. the replacement value.
(iii) The amount that an asset costs, when purchased or acquired, less the provisions made for depreciation since its acquisition i.e. the written down value or going concern value.
(iv) The balance of revenue expenditure which is being written off over a period of years, i.e. ‘Deferred revenue expenditure or ‘prepaid expenses’.
3. Going concern value :- Even through all the above basis for valuation may be used in connection with different classes of assets, ordinarily only the written down or going concern value is taken into consideration. Where the asset, in which part of the capital is invested, is of a wasting nature or consumed in the course of earning income, such wastage must be made good before true profit is arrived at. For this it is necessary to estimate the working life of fixed assets like buildings, plant, machinery etc.
4. Form of Balance Sheet :- As the Balance Sheet purports to reveal the financial position of the business, it follows that it should be drawn out in some intelligible form or order.
No definite rule can be laid down as to the correct order in which the assets and liabilities shall appear in the Balance Sheet. Two methods of arrangement are employed. In the first, the assets are shown in the order of liquidity ie, cash and bank balances, which are most liquid appearing first followed by investments and other current assets, fixed assets and fictitious assets appearing last. The liabilities however, appear in the reverse order, viz, share capital and reserves appearing first and liabilities and provisions for credit balance of profit and loss account appearing last. The second method is in the reverse order of their realisability. That is, fixed assets are shown first, floating assets next and liquid assets like cash and bank balances in the last. On the liability side, liabilities are shown in the reverse order of repayment. Capital is shown first reserves next and credit balance of profit and loss account as last.
B. Verification of assets
1. (i) Fixed Assets :- Verification of fixed assets by the auditor should be made with reference to the documents relating to their acquisition. A schedule of fixed assets at the beginning of the year and acquired during the year should be obtained and checked with the fixed assets register. It should be seen that all articles scrapped, destroyed or sold have been duly brought into account and their written down values adjusted. Physical verification of plant and machinery and other fixed assets, should be carried out periodically. A certificate should also be obtained from the management that all items scrapped, destroyed or sold have been duly recorded in the books.
(ii) Floating or current assets :- Floating assets are those assets which are acquired for resale or produced for the purpose of sale and consists of cash and such assets as are held for purpose of conversion into cash in the course of regular business. Current assets are ordinarily classified under the following main heads:-
(i) Interest accrued on investment and loans.
(ii) Stock in trade in case of trading concern.
(a) Stores and spare parts
(b) Loose Tools
(c) Semi-finished goods, work in progress and finished goods in case of manufacturing concerns.
(iii) Loans outstanding and sundry debtors.
(iv) Cash and bank balances etc.
Interest accrued on investments should be shown separately in the balance sheet. While taking interest receivable, adequate provision should be made for overdue interest. Physical verification of stock in hand and also work in progress will have to be carried out. For verification of loans outstanding and sundry debtors, ledger accounts and balance confirmations will have to be seen. Cash on band should be counted and the balance at Bank confirmed by obtaining confirmation certificates from the Banks for all balances.
(iii) Wasting assets :- Wasting assets are those of a fixed nature and are gradually exhausted and used up in the course of working, such as a mine or quarry. It is difficult to assess how much a mine or a quarry has been exhausted and how much minerals remain. Therefore, the common method following in the valuation of this type of assets is to show it in the Balance Sheet at its original cost and provision made for depreciation.
2. Valuation of different types of assets
(i) Good will :- Good will is a peculiar asset. “It is a thing very easy to describe but very difficult to define” Good will is an intangible asset and will not appear in the balance sheet except in the case of purchase, when it should appear at cost. It represents the sum paid for anticipated future profits and therefore it is argued that it should be written off from profits. Since it is an intangible assets it is wise to write it down out of available profits.
It may not be easy for the auditor to verify the correctness of Good will which is assumed to be the capital value of extra profits which an average business would earn on the capital employed. From the auditor’s point of view, he will only have to see that its value is written down annually out of profits, in accordance with the resolutions passed, by the general body or by the Managing Committee. Where the consideration paid exceeds the market value of the assets acquired the excess amount paid will have to be treated as good will.
(ii) Patents :- These types of assets are not ordinarily possessed by Co-operative Societies. However, where they have been acquired, it should be verified by the inspection of the ‘patents’ themselves. The certificate of grant of the patent obtained from proper authority should be examined. The auditor should see that the cost of each patent is written off during the course of their expected life. The auditor should be careful enough to examine the last renewal certificate and satisfy himself as to the currency of patents.
(iii) Trade marks :- Verification of trade marks can be made by inspection of the certificates of registration or of any assignment of the Trade Marks. Where the trade marks have been registered, the auditor must vouch the amounts treated as capital expenditure. Fees paid for renewal should be charged to revenue account. The entire amount shown under trade marks should be written off during the life time of the trade mark.
(iv) Copy rights :- These will be acquired only by co-operatives which undertake publication of books. The Copy right Act 1957, ensures sole right to authors of books, articles etc. When the right is purchased, the written assignment must be examined and the price paid should be vouched. As far as possible, these assets should not appear in the balance sheet for a period longer than 2 to 3 years. The valuation of copy right should have regard to the prospect of future sales.
(v) Plant and Machinery :- Purchase of new plants and machinery will be vouched during the course of audit. In addition the auditor will also see and verify the invoices and receipts, the correspondence regarding the purchases and also contracts with machinery manufacturers and engineers’ certificates. Where there are only a few machines, the auditor should personally inspect and identify them. Where the number of machines is large, he should obtain a schedule of plants and machinery. A certificate of their existence and efficient working should also be obtained from those responsible. The mode of valuation should be original cost less depreciation.
When the machines are sold or scrapped, the auditor must see that the machinery account is credited with the amount of their book value as on that date.
(vi) (a) Free hold lands :- The auditor should examine the title deeds and satisfy himself whether the society has got a clear title to the property. The last title deed should be examined to see that the property has been duly conveyed to the society. Encumbrance certificate should be obtained and verified. It should also be ascertained that extensions and alterations, if any, have been properly apportioned in between capital and Revenue expenditure. The auditor should also ensure that the property/building still continue to be in possession of the society.
The building should appear in the balance sheet at original cost. Depreciation reserve, created should be shown in the liability side.
(b) Lease hold property :- The lease should be inspected. Where the client is not the original lessee, the assignment made in his favour should be inspected. The auditor should ascertain whether conditions such as prompt payment of ground rent, maintenance of fire insurance etc., have been fulfilled. Otherwise, the lease might be forfeited. The lease hold property should appear at cost less proportionate depreciation for the period expired.
Where the lease hold property has been sublet, the counter part of the tenants agreement should be examined. The cost of lease hold property must be written off to Profit and loss account over the period of the lease, for at the end of the period of the lease, the property reverts to the lessor.
(vii) Motor Vehicles :- The auditor should verify the vehicles register or vehicles account. The auditor should also examine the registration book of each vehicle and satisfy himself whether the registration number and description recorded therein agree with the particulars shown in the vehicles register. If the Society has got a fleet of vehicles it will be necessary to keep separate account of each vehicle. The expenses under repairs etc. should be charged to revenue and only the cost of major repairs carried out be allowed to be carried over to for one or two years so as to spread over the benefit of the expenditure over the period for which it is availed of.
The auditor should examine the adequacy of depreciation provided for. In special circumstances, such as accident etc., a special depreciation will have to be charged. As regards valuation the method adopted is original cost less the aggregate depreciation. In special circumstances, such as accident, etc. special depreciation will have to be charged. (Also see para III Chapter I).
(viii) Tools, implements, furniture and fixtures, installation and fitting :- Tools, implements, furniture, fittings etc. should be dealt with as in the case of plant and machinery and adequate depreciation should be charged every year, based on the working life of different items. In the case of fittings upon lease hold premises, the entire cost should be written off during the period of the lease or their estimated working life, whichever is shorter. A list of dead stock articles and office equipments should be obtained and the total agreed with the amount appearing against the item in the balance sheet.
(ix) Library books :- Purchase of costly books especially reference books and technical books, may be capitalized and shown under the heading “Library books”. Library register should be maintained for all purchases under the item whether the expenditure is debited under revenue head or capital account. Periodical inspection and physical verification of books should be conducted. 10% depreciation per annum may be charged on Library books.
(x) Live Stock :- A register of live stock showing the particulars of acquisition, identification marks (or name), price paid, depreciation charged etc. should be maintained. The basis of valuation should be revaluation at the end of each year. In the case of animals such as working bullocks, milch cattle etc., their working or useful life and their usefulness to the society should be taken into consideration. Calves; heifers and other young animals appreciate in value as they grow up. Necessary adjustments are made on the death or disposal of any animal.
3. Verification and valuation of current assets:
(i) Investments :- Where investments are numerous, a complete schedule of all investments held, showing the nominal amount and full title of each investments, the book value and the market value thereof as at the date of balance sheet, should be obtained. The auditor should compare this schedule with the books and other records. The auditor should examine all the investments simultaneously and compare them with the schedule. He should see that the amounts and nature of investments corresponds with those shown in the schedule of investments. In case these securities have been entrusted with some bankers for safe custody the auditor should get a certificate from the bank about the nature of investments held by them and that they are free from any charge.
There may be instances where some of the investments have been sold subsequent to the date of the balance sheet, but prior to the date of audit. In such case the auditor should vouch the transactions.
Investments my be:-
(1) Registered debentures, stocks and shares, Government Securities.
(2) Inscribed stocks; and
(3) Bearer bonds and share warrants
(ii) Verification of Securities :- Where securities lie in the custody of the Society the auditor should examine each script carefully. The certificates, warrants or the securities themselves should be examined carefully and seen that they are in the name of the society itself and that they are complete in all aspects and are registered in the name of the Society. Where securities are lodged with any bank for sale custody, a certificate to the effect should be obtained from the bank, specifying charge if any, held by them. Immediately after verifying the security or certificates, the auditor should put his initials or ticks against the particular item in the list of investments so as to prevent its presentation once again.
In the case of bearer warrants, it should be seen that interest coupons are in order and are attached to the script itself. The numbers of such coupons should have been noted on the schedule.
(iii) Valuation of securities :- An accepted basic principle is that profits should be taken to credit, only when the goods are sold and therefore on no account should the stock be valued above cost for the purposes of Balance Sheet. On the other hand, the wise method is to value at cost price or market price whichever is lower. The fact that the market price is higher on the date of balance sheet should in no way be taken into account, but on the other hand if there is a fall in the price of goods which is lower than the cost price, then the market value should be taken as the basis of valuation.
As regards the duty of the Auditor in the valuation of assets, he need not be valuer. The actual valuation is to be done by the management, the auditor is concerned only with the correctness of valuation. He is required to ascertain that the valuation made appears to be fair and reasonable according to the accepted principles. He must make sure that no circulating asset is valued above the cost price on any account. An auditor is guilty of mis-feasance, if he fails to detect the over-valuation of important assets like work in progress when ample evidence is available for checking the accuracy of the figures given to him. (West Minister Road Construction and Engg; Co., Ltd., case)
(iv) Verification of mortgage deed and time barred cases :- While verifying the mortgage deeds care should be taken to prevent substitution of bonds. A particular bond may be produced twice before the auditor against payment of two or more of similar amounts. This kind of fraud is quite common and therefore the auditor should be careful to guard against such substitution.
During verification the auditor should locate time barred cases also and spot out cases on which immediate action is required.
4. Stock in trade:
(i) General :- As the correctness of the profit and loss account of a trading concern depends to a large extent on the accuracy of the valuation of the stock in trade at the date of the Balance sheet, the verification of this form of assets forms a very important part of the duty of the auditor. He has also to see that it is valued according to certain accepted principles of accountancy.
(ii) Verification of physical existence of stores :- The stock should be taken on the last day of any particular period. The process of verifying physically the existence of each item of stock at the close of the year or at the end of any specific period is known annual or periodical stock taking. Complete physical counting, weighing or measuring of all the stock on hand should be made as at the end of the year in the case of all societies which undertake trading or manufacturing activities.
(iii) Method of stock taking :- Stock taking means measuring or weighing and counting of goods on hand on a particular day and valuing them. It involves two things.
(i) Ascertaining the quantity of goods by means of weighing or measuring or counting as the case may be, and
(ii) Valuing them based on some accepted principles of accountancy. Verification of stocks has to be done immediately after the close of transaction of the last day of the period. One person should call out the quantities and descriptions and another should enter them on the stock sheets. Later on the price at which each item is to be valued is noted by a responsible official in the stock sheet and calculation and casting being checked by another. The completed stock sheets should be certified by the Secretary/Manager/Custodian of Stock/Directors as the case may be. While verifying the stock the following precautions are to be taken:-
(1) All goods not in the premises, but in respect of which invoices have been passed through, should be included in the stock sheets.
(2) The items of purchases which have reached the premises, but the corresponding invoices have not been passed through the books, should not be taken into stock. But it should be treated as stock in transit. If such items are taken into stock the cost of the same should be shown as purchases pending payment.
(3) Goods sold and treated as sales in the accounts but not yet delivered to the customers should be excluded from the stock list.
(4) Goods which are held on behalf of third parties, by way of consignment, or agency, should not be included in the list.
(5) Goods which have been sent out “On sale or Return” and as are not yet accepted or returned by the customers should be included in the stock.
(6) Stocks sent on consignment should be included.
(7) Unsold goods on consignment should be valued at cost price and not at selling price.
The stock sheet should contain the following columns.
(i) Serial No. and name of goods
(ii) Quantity actually verified.
(iii) Quantity as per the Stock Register.
(iv) Quantity excess or deficit.
(v) Quantity value excess or deficit.
(vi) Rate of value per unit.
(vii) The amount of value.
(iv) Checking of stock sheets/statements.-Stock statements, duly attested by the stock verification officers and finally presented to the Auditor should be compared with the balances in the stock accounts and the discrepancies noted should be got clarified.
After examining the whole system of stock taking, the auditor should check the stock sheets as follows:-
(i) Check the totals of the stock sheets.
(ii) Check calculations bearing in mind that items calculated as singles, may, in fact be doubles, dozens, or even grosses.
(iii) Compare stock sheets with those of the previous years, particularly as regards quantities and also ascertain whether any part of the stock has been held for a long time and obsolete.
(iv) Examine the Goods Inward Book for the last few weeks of the period and trace any large item into the stock and into the purchase Register.
(v) Trace any large scale sales towards the end of the period into the Goods Despatched Register and make sure that the goods if undelivered, have not been included in the stock.
(vi) Where quantities can be checked easily, this should be done by deducting the total sales from the total purchases plus opening stocks.
(vii) Enquire whether any goods belonging to the Society are in the hands of the consignees, selling agents, or distributors or lying in depots or warehouses.
(viii) While examining stock sheets, it should be seen that no plant, machinery, tools, furniture and similar other capital goods are not included in the stock.
(ix) After the Trading Account is drawn up and the amount of gross profit arrived at, compare the percentage of gross profit to sales with that of the previous. If there is any marked difference, the reasons for such short fall should be enquired into.
(v) Basis of Valuation :- Stock in trade is a floating asset and hence realisable value is the basis of its valuation. “Valuation at cost or market price which ever is lower” is the accepted rule. This rule is based on the principle that no profit should be taken to credit until it is actually realised and that provision should be made for anticipated losses.
As regards the Market value, it may mean either the replacement value or realisable value. The replacement value is the amount necessary for purchasing or manufacturing the goods as on the date of the Balance sheet. The realisable value is the value that would fetch if the stock were sold on that date. Which of these two values is to be adopted is determined with reference to the class of inventory. When the market price is lower than the cost price, stock is valued at the former, ie., loss is anticipated. This method of bringing down the stock into the account at a reduced value is known as, writing down.’
(vi) Evaluation of Pipe Line stock :- Stock in trade is valued at cost or market price, whichever is less. In the case of retail stock also the same principle is followed.
Maintenance of stock register and stocking of balances in it after issue at godowns is necessary, so that when a physical verification of stock is done, it can be compared with the stock register and reasons for difference, if any, investigated. The Auditor should watch whether goods received first are issued first.
(a) Inflated price :- This method can be used only when an item is subject to natural and necessary wastage. The price of such goods is inflated to cover this wastage. This is an important point which should be noted by the Auditor while checking price fluctuation slips. Ex:-Vegetables, fruits, fish etc.
(b) Abnormal losses :- This arises due to inefficiency, negligence, mischief or bad luck etc. Such losses are avoidable to a great extent. Therefore the auditor should not allow minus fluctuation in prices of goods in such cases unless he gets satisfactory explanation for the same.
(vii) Cost :- its meaning.-The elements that constitute cost are.-
(a) the purchase price of goods, stores and in the case of purchased stock, materials used in manufacture,
(b) direct expenditure incurred in bringing stock in trade to its existing condition and location and
(c) indirect or overhead expenditure incidental to the class of stock in trade concerned.
Whereas the cost of items (a) and (b) can be worked out with substantial accuracy, the cost towards item (c) ie, indirect or overhead expenditure can only be a matter of calculation. If indirect or overhead expenditure is expressed as a percentage of actual production the amount added to the stock valuation will fluctuate from one period to another according to the volume produced. To avoid distortion of revenue results, in some cases indirect or overhead expenditure is eliminated as an element of cost when valuing stock in trade or alternately, only that part which represents fixed annual charges is excluded. In other cases, an amount is included which is based on the normal production of the unit concerned.
(viii) Method of computing cost :- The following are basis usually adopted in practice for calculating cost.
(a) Unit cost :- The total cost of stock is calculated by totalling the individual cost of each article, batch, parcel or other unit. But in some cases it is impossible to identify the stock on hand with the various consignments purchased and it will involve undue time and labour.
(b) First in and first out :- This method is adopted on the assumption that the goods are consumed as and when they arrive and those on hand represents the latest purchase.
(c) Average cost :- This basis entail averaging the book value of stock at the commencement of a period with the cost of goods added during the period after deducting consumption at the average price, the periodical tests for calculating the average being as frequent as possible having regard to the nature of the business.
(d) Standard cost :- This is a predetermined or budgeted cost per unit. It is coming more into use, particularly in manufacturing or processing industries where several operations are involved or where goods are produced on large scale.
(e) Adjusted selling price :- This method is used widely in retail business. The stock is valued at the first instance on the basis of selling price and deducting therefrom a certain percentage representing the gross profit.
(f) Base stock :- Under this method an agreed quantity of stock is valued at a fixed price each year, this price being below the original cost price of the “Base Stock”. The excess on this fixed quantity can be valued at cost price or market price whichever is less.
(ix) Market value :- The market value is interpreted by some as replacement value, ie. what it would cost to purchase similar quantities at the market price ruling on the day of the balance sheet and by some as realisable value, ie. the net amount that would be realised if sold at the price ruling on the day of balance sheet. The general practice as regards stores and raw materials is to value them at the lower cost or replacement value. In the case of finished goods it is the lowest cost or net realisable value which is generally adopted. It is an accepted principle that the assets should be valued for the balance sheet purposes on a going concern basis. So it is suggested that all inventories of stores like, raw materials processed and semi processed and finished goods, etc., should be valued at cost or at the net realisable value of the finished goods.
(x) Auditor’s duty with regard to stock in trade :- The accuracy of the balance sheet largely depends on the correct valuation of stock in trade. Since falsification of accounts is frequently effected by means of manipulation of the stock list, the auditor should be very careful in the verification and valuation of stock in trade. It is impracticable for the auditor to take, inspect or value the stock himself. He has to rely largely on the internal check in force and on the officials’ certificate. Therefore, the auditor should exercise reasonable care and skill with a view to satisfy himself as to the correctness of stock taking and valuation. The work of the auditor in most cases may be summarised as follows:-
(1) Casting and a proportion of the calculations of major item in the stock sheet should be checked.
(2) The quantities shown in the book should be compared with the actual stock verified. Differences, if any, should be enquired into.
(3) Where stock is held by agents or warehouses, their certificate should be obtained and compared.
(4) He should verify whether all goods included in the stock are also included in the purchases by examining the Goods Received Books, for the last few days of the period and testing invoices for the new period.
(5) The basis of valuation should be enquired into. It should be seen that the stock is valued at cost or market price whichever is lower on the date of the balance sheet and that the value of the finished goods is below the market price. The items of obselete and defective stock should be valued at their respective realisable value.
(6) The percentage of gross profit on turn over should be compared with that of the previous period and the causes of marked fluctuation, if any, should be enquired into.
(7) It should be seen that the stock sheets have been properly certified by some responsible official, the parties concerned in the preparation having initiated them.
The most important point to be considered by the Auditor in this matter is to ascertain whether the same basis is adopted from year to year. If consistent basis is not so adopted, the trading results shown by the accounts would become distorted. The Auditor will do well if he states in his report the extent to which he relied on the certificate of the management. Any matter which is not up to the satisfaction should be dealt with in his report.
(xi) Valuing of by-products :- In manufacturing and processing societies, which yield by-products, (for example, molasses in sugar factories, cotton waste in spinning mills, oil cakes in oil mills, broken rice in rice mills) it may not be possible to ascertain the cost of the by-products. In such cases, by-products may be valued at their current ruling prices in which case, the cost of the main product must be calculated after crediting the anticipated sale proceeds of the by-products. The selling price basis of valuation may be adopted in farming societies producing crops with an annual cycle and on the date of the balance sheet, the crops harvested may be valued on the basis of prices likely to be realised after deducting selling cost such as expenses connected with marketing etc.
5. Valuation of different classes of stock :- The method of valuation varies with the nature of the inventories.
(i) Raw materials :- Raw materials are, in general, valued at cost or the market price, whichever is less. The proportionate amount of freight and other charges paid for the same is added to the invoice price.
When the stock contains goods purchased at different prices, the average price may be taken into consideration. Consequent on the fall in the price of finished products, if any definite loss is anticipated in the succeeding year, it may be desirable that the value of raw materials should be correspondingly written down.
It is the custom in some trade to value the stocks of raw materials above cost when such stocks mature with age and increase in value, eg. wine, timber, tobacco etc. in order to cover the storage charges and interest on capital locked up in such stocks. The auditor should ascertain that the stocks are not valued at an excessive amount and that the values are properly certified and do not exceed the market value of similar stocks.
(ii) Semi-finished goods or work in progress :- Work in progress is represented by the materials and work done in respect of incompleted contractors or partly finished goods. The item should be valued at cost price i.e. raw materials consumed, wages and direct charges expended thereon up to date, with a reasonable sum for over head charges. Provision will have to be made for anticipated loss. Therefore, it is better if these items are valued at current standard cost or at the net realisable value in the form of finished products.
(iii) Finished goods :- Finished goods which have been purchased are valued at cost, i.e. invoice price. The goods which are manufactured by the concern should be valued in the same manner as semi-manufactured goods. The auditor should see that such finished goods are not valued at a price higher than the price of the similar goods prevailing in the market.
The recommendations of the council of the Institute of Chartered Accountants in England and Wales, on the treatment of stock-in-trade are given below :
“No particular basis of valuation is suitable for all types of business but, whatever the basis adopted, it should be applied consistently, and the following considerations should be borne in mind.
(a) Stock in trade is a current asset held for realisation. In the balance sheet it is, therefore, usually shown at the lower cost or market value.
(b) Profit or loss on trading is the difference between the amount for which goods are sold and their cost, including the cost of selling and delivery. The ultimate profit or loss on unsold goods is dependent upon prices ruling on the date of their disposal, but it is essential that provision should be made to cover anticipated losses.
(c) Inconsistency in method may have a very material effect on the valuation of a business based on earning capacity, though not necessarily of importance in itself at any Balance Sheet date.”
(iv) Spare parts :- Spare parts which are used for the upkeep of plant and machinery, should be valued at cost. Obselete spare parts of out-of-date plant and machinery should be written off or written down. The auditor should get a complete list of spare parts certified by the Officer in charge of the factory, as to its current use.
(v) Goods on consignment :- In respect of goods sold on consignment basis, a certificate should be obtained from the consignee in respect of the stock on hand on the date of Balance Sheet. The unsold consignment of goods mentioned above should be valued at cost price plus proportionate expense etc. The auditor should be careful to see that any balance of stock of consignment inwards is not included in the stock last.
6. Sundry Debtors :- ”Sundry debtors” include all amounts due in respect of goods sold on credit, services, rendered on in respect of other contractual obligations, but should not include any amounts which are in the nature of loans or advances which should be shown under the separate heading of “Loans and advances” or loans “or loans due from members.”
(i) Outstanding advances :- Outstanding advances are usually include in ‘Sundry Debtors’,. But many times, it is shown under a separate heading Advances should be given only for specific purposes and the director of employee to whom the advance has been given should render necessary accounts as soon as the purpose for which the advance has been given, have been served. Where advances have been made or deposits kept with suppliers against order, the advance paid should have been adjusted in the invoice, or deducted from the total amount of the Bill. Where there are long pending advances the auditor should make a note of all such cases and obtain the explanations of the management or the officers concerned. If the explanation given or the clarification furnished is considered not satisfactory, the auditor should keep such payments in his schedule of irregular payments. If the amounts involved are large and no satisfactory explanation has been offered, the auditor should examine whether a case of temporary misappropriation can be made out.
(ii) Checking of outstanding advances :- A statement of all items appearing under the heading “Sundry Debtors” “Advances outstanding” etc. should to obtained and agreed with the figures appearing in the Balance Sheet. Sundry debtors for credit sale should be distinguished from other debtors such as debtors for advances, deposits against orders or advances against purchases and advances to directors and officers. The schedules should be checked with the personal ledgers and other records and the total agreed with the amount shown against the items in the balance sheet. While checking ledger balances on the schedules, notes should be made showing the period during which the amount has been outstanding, whether it has been subsequently recovered and if not, why it has been allowed to remain outstanding and whether any action has been taken for its recovery. A list of all accounts, which are overdue, should be prepared and checked by the auditor.
(iii) Deposit with Suppliers :- As regards deposits with suppliers or for services, it should be seen that these are of a normal character, such as deposit for telephone connection, security deposit with Municipalities Electricity Board etc. In such cases, the auditor should verify the receipt issued by them and should obtain confirmation as evidence of the deposit. Where deposits of a special character or of a substantial amount are made, these should be verified according to the circumstances of each case and their adjustments watched.
7. Loans outstanding :- Loans outstanding in Co-operative Societies except those doing banking business, are generally fixed loans which are payable either in lump or in installments as may be specified. Loans advanced to members would be different according to the nature of the business operations conducted by the society and the nature of the security which, the borrower can offer.
Loans are generally classified according to the nature of securities offered by them. Loans may be grouped under two broad heads (i) secured loan and (ii) unsecured loans. All loans which are backed by material securities are considered as ‘secured loans’ and others are called unsecured loans. Even the unsecured loans are based on the credit worthiness of the borrower and backed by his capacity and willingness to repay. The method of checking loans outstanding is explained below :
The auditor should obtain a list of loans and advances outstanding on the date of the balance sheet and should check it with the loan ledgers and the total of the balance agreed with the balances appearing in thew General Ledger. In checking the balance of loans, emphasis should be given on the following points :
(i) Amount outstanding :- If the byelaws have prescribed individual maximum limits for different types of loans, the outstanding balances in any account should not exceed such maximum limits. Where special loan or loans in excess of the prescribed limits have been sanctioned to any individual or institutions, authority for the same should be verified.
(ii) Period wise classification of loans outstanding :- The auditor should examine whether the loans has become overdue and whether proper extensions has been granted. If the period of repayment has not been extended, how long the loan has been overdue and what effective steps have been taken for its recovery should also be examined.
(iii) Security for the loans :- The auditor should examine the nature and adequacy of the security and its realisability. If the loan has been sanctioned against personal security, he should ascertain sureties are alive and good, for the outstanding amount. If they are secured, he should check up whether value of the security offered adequately cover the outstanding balance and also the interest accrued and accruing and also whether it can be easily realised.
(iv) Reasons for the debts becoming irrecoverable :- The auditor should also examine the circumstances which indicate the debts becoming irrecoverable, due to death, resignation or removal from service of the borrower or his sureties, insolvency of the borrower, or attachment of the property or salary under any order or decree of a Court. Where the loan is repayable in installments he should examine whether all the previous installments have been properly paid as and when they became due.
(v) Loans to Committee members :- Along with the Balance Sheet and Profit and Loss Account, the auditor should attack a list of loans, it any, given to the members of the committee and their family members. In the case of loans issued to the members of the committee, the auditor should specially look into the nature of security offered and its adequacy, whether the purpose for which the loan was sanctioned was those contemplated in the byelaws, whether any relaxation in the repayment of instalment has been allowed etc. The byelaws of certain societies stipulate that the loans issued to the members of the committee should be ratified by the General Body. This would ensure that members of the Committee taking advantage of their position do not appropriate large funds of the Society by sanctioning to themselves disproportionate loans. The auditor should therefore ensure that such provision of the byelaws have been complied with.
(vi) Assessment of bad and doubtful debts :- The balance sheet and profit and loss account of the Society checked and certified by the Auditor should disclose fairly and accurately the financial position of the Society as on the date of balance sheet. In credit societies, loans outstanding form a major portion of the assets. Therefore examination of debts is one of the most important work of the Auditor. Outstanding loans and advances in banks and credit societies consist of current dues and overdues. An overdue account is one in which the principal outstanding or any portion thereof or any instalment which has become due has been defaulted. A bad debt is one considered to be irrecoverable. Such a debt will have to be written off against the Bad Debts Reserve or any other reserve marked for the purpose. A doubtful debt is one, the recovery of which in whole or in part is uncertain. All such debts should be carefully examined and adequate provisions made against such debts.
As suggested by Spicer and Pegler, the following points should also be considered while examining the Debtors’ ledger balances for this purpose:-
(a) The term of credit allowed by the Business:-
[The debts, the term of credit of which is not yet expired, can safely be treated as good debts, in the absence of any other circumstances contrary to such course].
(b) The settlement of accounts within the period of credit, taking advantage of cash Discount whether regular or irregular:-
[The debts which are regularly settled should be considered as good. In the case of debts which are not regularly settled, the causes for such irregularity should be examined].
(c) The age of the debt:-
[Time barred debts should be reserved in full. Long outstanding debts should be considered with their relevant circumstances to decide whether they are good/bad or doubtful.]
(d) Whether the balance has tended to increase, in spite of payments being made on account:-
[Such cases should be considered carefully and reserves should be created, if necessary.]
(e) Whether an old balance is being carried forward to be paid off in installments, new goods being supplied for cash:-
[The payment of an old balance by instalment is nearly a sign of weakness. The old balance may be treated as doubtful and necessary reserve created].
(f) If payments are used to be made by acceptance of bills whether any bill has been dishonoured or retired or constantly renewed:-
[Frequently dishonour or renewal of bills is certainly an evidence of weakness. Such cases should require careful consideration].
(g) Whether any cheque received on account have been dishonoured:-
[Under this circumstances, the debts should be considered doubtful and reserve created.]
(h) Whether notes appear upon the account such as “Accounts suspended”, “In solicitor’s hands”, “In insolvency:, or “In Liquidation”, “Disappeared and whereabouts unknown”, etc:-
[Notes of suspension of accounts etc, made upon the top of the account provides the best means of information to study the position of the debt].
(vii) Classification of debts into bad and doubtful :- To classify a debt as bad or doubtful, the two main considerations are (i) the security for the debt and (ii) the period for which the debt has been defaulted. For example, if the security for a particular loan is reduced to nil and the loan has been outstanding for a fairly long period, there is every probability of its becoming bad. If the security has been impaired, debt outstanding has been overdue for a period, which is not considered too long, the debt may be termed “doubtful” and classified as such.
(viii) Procedure for classification of debts into good, doubtful and bad :- A list of overdues with full particulars regarding age, security, action taken for recovery etc., should be obtained by the Auditor before he examines and classified them into good, doubtful and bad. This list should be carefully scrutinised with reference to the security available and the age of the over-dues. After careful examination of all overdues accounts in the above manner, the auditor should classify the overdues into good, doubtful and bad. In order to enable easy assessment of doubtful and bad debts by the auditors, it is necessary that all the account books and registers are maintained up to date.
(ix) Procedure for writing off of bad debts statutory provisions :- Rules 62 of the Kerala Co-operative Societies Rules 1969, reads as follows:-
(1) Such of the dues to the Society including loans and interest thereon which are found irrecoverable and duly certified as such by the auditors appointed under section 63 may be written off with the approval of the General body and sanction of the Registrar.
(2) Before sanction for the write off is accorded the opinion of the financing bank may be obtained if the Society is indebted to the Financing Bank. (Registrar’s Circular No.93/75 G3-11491/75 dated 11-11-1975.)
(x) Auditor’s responsibility for certifying bad debts :- The auditor assumes a great responsibility in certifying the loans as bad as all amounts certified by as bad would be written off. He has, therefore, to be very careful in certifying a debt or loss as bad or irrecoverable. In case of irrecoverable loans, it has to be seen that cases of the defaulters were referred to arbitration in time and awards obtained which were sent up in time for execution, but returned by the recovery officer as the Principal debtor or sureties had no assets or income which could be attached. In the case of debts, which have become time barred due to inaction or negligence on the part of the Committee/Officers, proceedings should have been instituted against persons found to be negligent.
The following additional conditions are also to be fulfilled for writing off bad debts:
(i) Sanction of the General Body should have been obtained.
(ii) Prior approval of the Registrar and the financing bank to which the society is indebted should have been obtained in writing. If the society/Bank is not affiliated to the Central Bank/State Co-operative Bank, or is affiliated but not indebted to the Central/State Co-operative Bank, prior approval of Registrar should be obtained.
(xi) Provision for bad and doubtful debts :- Before arriving at the figure of net profit, adequate provision is required to be made for all amounts required to be written off as bad debts and losses which cannot be adjusted against any fund created out of profits. A fair estimate of the likely bad debts has to be made, every year and necessary provision made for writing them off. However, no bad debt can be written off against current profits.
8. Fictitious Assets :- There are certain assets which sometimes appear in the balance sheet. They may be representing capital expenditure which may not have resulted in identifiable profit earning assets and which still remain to be written off. Common examples of factitious assets are preliminary expenditure or formation expenditure, development expenses, etc. The Auditor should check the balance carried forward from year to year and ascertain the reasons for their continuance.
9. Preparation of Financial Ratios :- A financial ratio is an arithmetical expression of the relationship between two figures produced as a result of normal accounting process. Such figures may include figures of gross profit, net profit, current assets, current liabilities, fixed assets, sales or turnover, working capital etc. The advantage of preparing financial ration is that performance and financial position can be properly judged. Ration may be based on the figures in the balance sheet, profit and loss account or in both.
The following are some of the important ratios,-
(i) Current ratio :- The current ratio is also called working capital ratio.
Current ratio = -----------------
(ii) Acid test ratio or quick ratio :- This is a part of current ratio and is found by comparing liquid resources, with current liabilities. This ratio is of great importance for banks and financial institutions, but not for ordinary trading and manufacturing concerns. This can be calculated in dividing liquid resources or quick assets by current liabilities.
(iii) Proprietary ratio :- The ratio discloses the relationship between the equity of the owners or proprietors and that of creditors. ie., the ratio of the amount invested by the owners (capital + Reserve and surplus) to the amount invested by creditors. Thus the proprietary or equity ratio is worked out by dividing capital employed by liabilities.
This ratio exhibits, the proportion between owned capital and borrowed capital. Any short fall in the volume of sales or any delay in the collection of bills may create financial difficulties for the business to discharge its obligation promptly. Hence a low proprietary ratio is viewed with much anxiety.
(iv) Capital employed ratio :- The ratio of capital to non-current or fixed assets is used to ascertain the extent to which the owners have invested their capital in fixed assets which constitute the maximum structure of the business.
(v) Stock turnover ratio :- This ratio exhibits the number of times the average stock is turned (or sold) during a given period. To ascertain the number of times the average stock is turned, the cost of goods sold is divided by the average stock.
(vi) Debtors’ turnover ratio :- The ratio of debtors to debtor Turnover (Credit Sales) shows the average period of credit allowed. The amount due from debtors is divided by the average daily or monthly credit sales.
(vii) Creditor’s Ratio :- The ratio of creditors to credit purchase amount, shows the average period of credit availed by the institutions.
(viii) Gross profit ratio :- The Auditor can calculate the gross profit ratio by
gross profit x 100
using the method -------------------
The higher the gross profit ratio, the better is the position of the institution.
(ix) Net profit ratio or margin :- This measures the rate of net profit
Net profit x 100
earned on sales. The ratio can be calculated by ----------------------
The auditor should bear in mind the above factors in arriving at a decision as to the financial soundness of the institution . He should try these exercise and ascertain the financial soundness, working result etc., of the institution and make his observation in the auditor report accordingly.
10. Verification of cash balance :-
(i) Cash on hand :- This is the first item of work to be attended to by the Auditor while conducting mechanised checking of the accounts. In a village credit society the auditor should see wether the cash book/Day book has been written up to date/ If it is incomplete, he should see that it is brought up-to-date, and balanced. Then he may test check a few receipts and vouchers of the transactions carried out during the last four or five days. He should then verify the actual cash balance and satisfy whether it agrees with the book balance. The result of verification of the cash balance should be recorded in the cash/day book. In the case of a bigger society, it is always convenient to verify the cash balance either before the day’s business or after it is over. However, if surprise verification is necessitated in view of the peculiar conditions prevailing, he may visit the society in the course of the working hours and ask the society or any other official who maintain the “scroll” or rough chitta to close it. Therefore, if the day book is incomplete at the time of verification, the auditor can verify the cash balance with reference to the cash book/cash scroll maintained by the cashier, and sign it after recording the result.
If there is more than one balance, as will be the case where there is a cashier as well as a petty cashier, all the balances should be verified at the same into to avoid one being utilised to supplement/substitute the other.
If the person responsible for custody of cash balance fails to produce it to the auditor for verification, he has to issue a summon and take action as per provisions of the Kerala Co-operative Societies Act.
(a) Specimen form of Summons:
Issued under Section 63 of the Kerala Co-operative Societies Act 21 of 1969
Whereas I, Shri. ........................................................................... have been appointed to audit the accounts of .............................................. Society and whereas documents relating to the Society have to be scrutinised by me for the said purpose, I hereby require you, Shri. .............................................................................................. President/Secretary/Manager of the said ................................................................ ................... Society to be present with the following at ............................. a.m./p.m. on. .................................... in the office of the Society or in the premises of ............................
Given under ........................................................... my hand and seal this .................................... day of ........................................... 19............
1. Cash balance of the Society.
2. Books .................... do.
3. Records and documents of the Society.
(b) Certificate of verification
FORM OF CERTIFICATE
‘Cash balance of Rs............................/- (in words .................................... .........................) was verified by me and found to agree with the day/cash book balance as at the beginning/close of ..........................................................”.
Signature with date
(C) Auditor’s responsibility for verifying cash on hand
It may be mentioned that most of the frauds relating to the cash on hand have come to light only when the auditor visits the society and asks for the production of cash balance for verification. In addition to the auditor, other inspecting officers of the department as well as of the Financing Bank can demand production of the cash on hand for verification. If all the inspecting officers make it a point to demand production of cash balance at the time of their visits to the Societies, there would be considerably fewer cases of misappropriation. The auditor should also obtain certificate in the following form regarding cash on hand on the date of the balance sheet.
“Certified that the cash balance mentioned in the balance sheet as at the 30th June 19...... represents cash on hand in the Head Office and all the branches, of the Society/Bank situated at different centres in the area of operation of the Society/Bank and custody certificates in respect of all these cash balance have been obtained from the Manager/Accountant/Cashier/Agent, etc. of the branches concerned. The above certificate has or be got signed by the Chairman/President and the managing Director or other principal Executive Officer of the society”.
(ii) Cash at Banks :- Every co-operative society will have a Bank account. All co-operative societies are generally permitted to open accounts with District/Central Co-operative Banks of the concerned District. But in certain case, if circumstances necessitate, the societies may open account with Commercial Banks with the previous sanction of Registrar. All cash balance in excess of the limit prescribed in the byelaws has to be invariably deposited in the Bank Account. Cash in Bank on the ate of Balance Sheet can be verified by means of pass Book, bank statements and the bank balance certificate. If the balance does not agree, it will be necessary to prepare a reconciliation statement. The auditor should himself write to the Bank/Post Office for confirmation certificates of all the accounts of the society with the Bank/Post Office.
(iii) Counting of cash - Precautions :- The inspecting officers and auditors have to take certain precautions while verifying the cash balance. If different cash balances are maintained, such as cash with local branches and depots etc. all the cash balances have to be called for simultaneously and verified as there is always the danger of substitution/supplementing. When coins of different denominations are sorted out and kept in separate bags duly sealed, the bags are not to be opened except in the presence of responsible officers.
(iv) Measures to be taken for preventing temporary misappropriation :- Temporary misappropriation can be committed by deliberately delaying payment into Bank. Cash Balance can also be misappropriated temporarily by taking wrong totals and/or by wrong extraction and carrying forward the cash balance. The Auditor should enquire the reasons for payment of advances to the members of staff and directors. It should be seen that advances made are genuine and for proper reasons. Unless the cash/day book is written up to date and the exact cash balance ascertained, counting of cash will have no meaning. It is therefore, necessary for the inspecting officers to see that the Day/Cash Book is written up to date always.