IGNOU Solved Question Papers: ECO - 12 (June' 2014)

Term-End Examination: June, 2014
Time: 2 hours
Maximum Marks: 50 (Weightage 70%)
Note: Attempt any five questions. All questions carry equal marks.
1. Define auditing. State the essential qualities of an auditor. 3, 7
Ans: The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially auditor was a person appointed by the owners to check account whenever the suspected fraud, he was to hear explanation given by the person responsible for financial transactions. Emergence of joint stock companies changed the approach of auditing as ownership was pestered from management. The emphasis now is clearly on the verification of accounting date with a view on the reliability of accounting statement.
In the words of Montgomery, “Auditing is a systematic examination of the books and records of a business or other organization, in order to ascertain or verify and report upon the facts regarding its financial operation and the result thereof”. 

In the words A.W. Hanson, “An audit is an examination of such records to establish their reliability and the reliability of statement drawn from them”. 
From the above definitions it is clear that the auditor’s basic duty is to examine the accounts and its arithmetical accuracy. He must ensure than the financial statements depicts true and fair view of the state of affairs of the business. Since, Auditing is a full and critical examination of the books of accounts to find out their accuracy.
Following are the essential qualities of an auditor:
1. Professionally Competent: It is the basic quality of an auditor. He must have a complete and thorough knowledge of the accountancy. To understand the accounting details he can apply his knowledge and skill. It is only possible if he has a sound background in accountancy and he is professionally competent.
2. Honest: This is the personal quality of an auditor. He should have the high moral standard. It is his duty to report on the fact basis. The auditor must be honest and sincere with his profession. He is responsible not to sign any paper which is no correct under his observation.
3. Up to Date Knowledge: An auditor's knowledge of auditing must be up to date. He must know the techniques of auditing. He must have the knowledge of other subjects relating auditing.
4. Knowledge of Business/Mercantile Law: It is the professional quality of an auditor to aware of the mercantile law, he has a complete knowledge of Contract Act, Sales of Good Act, Agency, Negotiable instruments Act, Partnership Act etc.
5. Knowledge of Taxation Law: It is also a professional quality of an auditor. He is aware of income tax ordinance 1979, sales tax and excise act and wealth tax etc this is helpful in checking the correct return of income etc.
6. Intelligent: It is also important quality of an auditor that he should be intelligent.
7. Qualification: For a professional auditor it is necessary that he should be charted accountant. According the company's ordinance 1984 it is essential qualification for auditor.
8. Tactful: It is also the personal quality of an auditor. Technical information is required to comment and criticize the policies of management. In case of missing can collect it from the client.
2. What is internal check? State the essentials of a good internal check system. 2, 8
Ans: Internal Check (IC): The term internal check implies that the work of various members of the staff is allocated in such a way that the work done by one person is automatically checked by another. It is defined as “such an arrangement of book keeping routine where in errors and frauds are likely to be prevented or discovered by the very occupation of book keeping itself’.
Internal check is a system under which accounting methods and details of an establishment are laid out that the accounts and procedures are not under the absolute and independent control of any one person or the contrary the work of one employee is complementary to that of another.
The system of IC is based upon the principle of division of labour; where in performance of each individual is automatically checked by another. This is possible by properly allocation the work and integration of function of the employees in such a manner their work complements each others.
Essentials of effective Internal Check
1. Sufficient Staff: The primary essential of internal check is sufficient staff. The employees can be appointed according to the workload. The overloading can creates trouble for management.
2. Division of Work:  Division of work is a principle of internal check. The management can determine the total amount of work. The whole work is divided among departments. The heads of such department are responsible for completion of work according to timetable.
3. Co-Ordination: Coordination is an essential of internal check. All departmental managers are bound to coordinates with other in order to achieve organization objectives. When there is fault in one department, the work of other department suffers.
4. Rotation of Duties: Rotation of duties is an essential of internal check. The workers feel bore by doing the same work from year to year. There is a need of rotation of duties. It is in the interest of concern as well as employees.
5. Responsibility: The responsibility is an essential of internal check. The employee can enjoy recreation leave. It is necessary for mental health. He cannot commit fraud as the new employee in his place can disclose the matter. There internal check system can work in the interest of business. The weakness in of one person is disclosed due to leave.
6. Checking: The principle of internal check is to check the work of other employees. Many persons perform the work. The officers can put his signatures to verify the work done by his subordinate. In this way one work passes many hands. The chances of error and fraud are minimized due to checking and counter checking.
7. Simple: The principle of internal check is simples in working the employees can understand the working of internal check system. A person can work under the supervision of other employees. The line of authority moves from top to bottom level. All workers can understand their duties in the organization.
8. Documents Classification: The classification of documents is an essential of internal check. The business documents are prepared, collected, recorded and placed in proper files. The index is prepared to compile the data.
9. Dependent Work: Dependent work is a principle of internal check. The work of one employee is dependent upon others. One work passes in the hand of two or three persons till it is complete. Another person checks the passes done by one person. No person is all in all to start and complete the transactions.
10. Harmony: The principles of internal check are harmony among the employees and departments. The understanding is essential for business goals. The harmony is basis for successful internal check.

3. State the duties of an auditor of a company with regard to: 5, 5
(a) Issue of shares at discount
Ans: Auditor’s Duty regarding issue of share at a discount
  1. The auditor should examine the Prospectus, the Articles and the Minutes of the Directors to see whether the issue of shares at a discount is duly authorized or not.
  2. He should confirm the rate of discount. Rate of discount normally does not exceed 10%.
  3. He should also confirm that at least one year has been elapsed since the date for which the company became entitled to commence business.
  4. The cash receipt on issue of shares at a discount is vouched with the entries in the Cash Book and the supporting documents.
  5. He should see that the provisions of section 79 have been complied with.
  6. The auditor should also confirm that the discount on issue of shares is properly disclosed in the company’s balance sheet.
(b) Issue of bonus shares
Ans: Auditor’s Duties regarding issue of bonus shares
  1. The auditor should examine the Articles of Association to ascertain that the issue of Bonus shares is duly authorized.
  2. It is to be noted that Bonus Shares can only be issued out of the premium received on issue of shares, heavy accumulated reserves, undistributed profits, capital redemption etc., if such an issue is permitted by Articles.
  3. He should inspect the Minute Book of Shareholders for the resolution declaring the bonus and also the Director’s Minute Book to examine the resolution under which profits have been appropriated.
  4. He should ensure that sanction of Controller of Capital Issues has been obtained.
  5. He should check the Allotment Book, Share Register and Reserve Account to ensure that proper entries have been made wherever necessary and the allotments are regular.
  6. If to increase the Share Capital, alterations are effected in the Memorandum and Articles of Association, it should be seen that the requirements of law in this respect have been duly complied with.
  7. He should vouch the entries passed in connection with the issue of Bonus Shares.
  8. Lastly, he should examine the Balance Sheet of the company to note the change made by the issue of shares.

4. How would you value the following? 5, 5
(a) Live stock
Ans: Live Stock: The auditor should check the live Stock Register and note down carefully the particulars like breed, year of purchases, purchase price, depreciation etc., for various categories of animals. He should also see whether any identification number is given to identify the animals. In case the animals are purchased at the age of maturity the cost to be shown in balance sheet (BS) will include Purchase Price plus freight. If the animal is reared from its conception and then brought to Maturity the cost includes cost of calving, cost of fodder etc., consumed till maturity and the suitable share of overheads. The auditor should See that the cost up to the maturity stage of animal has been written off once the earning capacity of the animals starts declining over the remaining life.
(b) Patents
Ans: Patents: Patent rights should be verified with the certificates granting such rights. If a patent is purchased, he should verify the assignment deed. He should see whether the deed is registered in the name of his client and patents are the property of the client. The auditor should also examine whether fees paid to purchase patents are treated as capital expenditure. If renewal fees is paid, it should be treated as revenue expenditure. If the client has number of patents he should get the list of patents with details such as the date of acquisition, the period of which its acquired etc. Patents are written off over the period of which they are acquired. Hence, they are shown in the BS at cost less written off amount.
5. State the rights and duties of a company auditor. 5, 5
Ans: Rights and Powers of Company Auditors: According to Section 227(7) of the Companies Act, a company auditor has the following rights:
  1. Right of Access Books of Accounts and vouchers of the company.
  2. Right to Obtain Information and Explanations which he may think necessary for the performance of his duties.
  3. Right to Receive Notices and Other Communication Relating to General Meetings and to attend them
  4. The auditor of the company has the right to visit the branch office or offices of the company.
  5. The company auditor is required to make a report to the members of the company on the accounts examined by him of the final accounts and the related documents which are laid down before the company in the general meeting.
  6. Right to sign the Audit Report.
  7. Right to Being Indemnified out of the assets of the company against any liability incurred by him in defending himself against any civil and criminal proceedings by the company.
  8. The company auditor has the full right to seek the opinion of the experts and to take their legal and technical advice so as to discharge his duties efficiently.
  9. Right to Receive Remuneration provided he has completed the work which he has undertaken to do so.
Duties of a Company Auditor:
1. Duties towards the shareholders:
  1. Report shareholders about true and fair state of affairs of the company;
  2. State that balance sheet and profit and loss a/c give all information required by law;
  3. State that balance sheet and profit and loss a/c agree with the books of account;
  4. State that balance sheet and profit and loss a/c agree with accounting standards;
  5. State that he has obtained all the necessary information ;
  6. State whether the company has maintained all books as required by law;
  7. State the reasons of qualification in his report;
  8. State that he has received the audit report on the branch accounts audited by other auditor and how he has dealt with the same in preparing his report;
2. Duties towards Company:
  1. The auditor is required to certify profits or losses, assets & Liabilities and dividend paid etc in the prospectus.
  2. The auditor has to certify the statutory report.
  3. The auditor is required to report about whether the company has followed all rules and guideline of RBI in regard to public deposits or not.
  4. It is duty of auditor to sign on his report.
  5. If the company wants itself to be declared insolvent, it is duty of auditor to prepare profit and loss a/c for the current period.
3. Duties towards government:
  1. CARO − 2003: The auditor has to report para-wise that the company has fulfilled all the requirements of CARO − 2003.
  2. It is duty of auditor to assist the investigation ordered by the CG u/s 237.
4. Duties towards General Public:
  1. His office is of confidence and faith. He must be reliable in all respects.
  2. He should reveal all material information regarding the state of affairs of the company to the company as well as to the general public.
  3. While issuing prospectus u/s 56, he should see that the prospectus does not include any misleading information or material.
6. Define management audit. State its objectives and limitations. 2, 4, 4
Ans: Management Audit: Management audit is a method of independent and systematic evaluation of the management activities at .all levels of management to ascertain the functions, efficiency and achievement of' the management (i.e. policies) as compared to standards set by the company.
According to L. R. Howard, "Management audit is an investigation of business from the highest level downward in order to ascertain whether sound management prevails throughout, thus facilitating the most effective relationship with outside world and smooth running of internal organization."
As per Taylor and Perry; "Management auditing is a method to evaluate the efficiency of management at all levels throughout the organization, or more specifically, it comprises the investigation of a business by an independent body from the highest executive level downwards, in order to ascertain whether sound management prevails through and to report as to its efficiency or otherwise with recommendations to ensure its effectiveness where such is not the case."
Need and Objectives of management audit
Management audit is the total audit of the management i.e. reviews how the policies of the management have been implemented and its efficiency to execute the policy. Therefore, the scope is much greater than financial audit, as it examines the all aspects of the management. Management audit has some objectives. These are discussed below:
(i) Verifying the efficiency: Management audit aims at to assess the efficiency at all levels of management and implementation of policies.
(ii) Gives suggestion for increase in efficiency: Management audit highlights the inefficiencies in different areas of management and gives his valuable suggestions and means to improve the efficiencies.
(iii) Asses the effectiveness of Planning and policies: Management audit examine and evaluates the plans and policies and judge whether planning and policies are properly implemented.
(iv) Helps to increase profitability: Management audit helps the management to increase profitability by giving remedies to maximize the organization's resources in an efficient way.
(v) Helps to co-ordinate activities: Management audit detects the interrelationship among the activities, evaluates the authority and responsibility and gives valuable suggestions for improvement of co- ordination among the activities and the employees. .
  1. The management audit is audit of the management, by the management, and for the management. The management auditors are selected by the management itself. Such auditors may or may not be able to handle the job assigned to them.
  2. The management auditors are generally familiar with the organization and the staff and employees. The personal aspects cannot be overlooked in such audits. They are more likely to take the facts for granted and may not probe into depth to investigate the matter any further.
  3. Time and cost constraints may limit the scope, operation and extent of such audits.
  4. The management audit team as selected by the management may not look, act and work as a team. Conflicting interests, attitude and inclination may jeopardize the entire objective of the audit.

7. Explain the methods of verification of cash in hand and cash at bank. 5, 5
Ans: Verification of Cash in Hand
(i) Visit the auditee’s premises and physically count, whole of the cash at a time and compare it with the balance shown on Cash Book.
(ii) He should not accept IOU’s as cash.
(iii) If cash could not be counted on last day of the year he may visit as per his convenience and count the cash and check the cash book from the end of the last year to the date as and when cash is counted to verify the correctness of each balance at the end of last year.
Petty Cash
(i) Count the cash physically on the closing date of the year and compare it with the balance shown on Petty Cash Book.
(ii) If not possible, visit on any day and count the cash balance at the time of balance on main Cash Book simultaneously and check the accounts from the year end to the date of counting.
(iii) See whether it is shown properly on Balance Sheet including Cash in hand.
Verification of Cash at Bank
(i) Compare the balance as shown in the Pass Book with balance of Cash shown in the bank column of Cash Book.
(ii) Prepare Bank Reconciliation Statement to ascertain the reasons behind the difference between Pass book balance and Cash book balance.
(iii) Obtain a balance certificate from the bank in case of suspicion of presentation of fictitious pass book and compare the balance with Cash book.
(iv) Obtain separate certificates for different accounts or deposits with the bank for proper verification of different balances.
(v) See that “The charges not yet collected” are genuine and not made up in order to conceal the deficiency.
(iv) If actual cash counting is not possible ask the auditee to deposit whole of the cash in hand at the close of the year into bank, then the Closing Cash Balance gets automatically checked.
(v) Whatever it may be, auditor should pay surprise visit to auditee and count the cash to prevent the cashier to borrow money and make up the deficiency which was due to embezzlement in the past.
(vi) Get certificates from the auditors of the branches about the cash balance in hand and their correctness.
(vii) Check the documentary evidences in reference to the cash in transit.
(viii) See that the cash at bank is properly shown on the Balance Sheet.

8. What are the provisions with regard to unclaimed dividends? What are the duties of an auditor in this regard? 5, 5
Ans: Unclaimed dividend: The dividend declared at an Annual General Meeting is required to be paid within 30 days from the date of declaration. Where a dividend has been declared by a company but has not been paid or claimed within thirty days from the date of the declaration to any shareholder entitled to the payment of the dividend, the company shall, within seven days from the date of expiry of the said period of thirty days, transfer the total amount of dividend which remains unpaid or unclaimed to a special account to be opened by the company called the Unpaid Dividend Account.
Further, any money transferred to the Unpaid Dividend Account of a company which remains unpaid or unclaimed for a period of seven years from the date of such transfer shall be transferred by the company along with interest accrued, if any, thereon to the Investor Education and Protection Fund established under the companies Act.

9. Write short notes on the following: 5, 5
(a) Limitations of cost audit
Ans: It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.
Following are the disadvantages of cost audit
  1. Holding a Cost Audit can be expensive. This is because a company will often bring in an independent auditor who are normally charging higher price.
  2. A Cost Audit can be a long process which will likely involve more time. This extra time and effort can impact an employee's day to day routine work.
  3. If a Cost Audit is carried out in order to find fraudulent activity it can take a long time by which time people stealing could have covered their tracks.
  4. Cost Audits involve a large amount of estimation and so there is the possibility that figures will be incorrect and if record keeping from the company is not good to start with then inaccuracies will be arises.
(b) Audit note book
Ans: The audit clerk maintains the audit notebook.  He keeps therein a record of his observations during the course of any audit work as also the points to be discussed with his senior clerk or the auditor.  It is a written record of the queries made by him and the replies thereto.  It is part of permanent record of the audit office, which is used by the auditor while preparing his report. Some of the important matters recorded in the Audit Note Book are as follows:
  1. Name of the business.
  2. Instructions from the management having relevance to the audit.
  3. List of book of account maintained by the enterprise.
  4. Accounting methods followed in the enterprise, and their defects.
  5. Any irregularities in the observance of laws and notifications applicable to the enterprise.
  6. List of missing vouchers and receipts.
  7. Matters requiring explanation or clarification.
It should be noted that an audit notebook is meant to record only important and strategic items.  Matters, which are, or can be sorted out on the spot, or those of a trivial nature, need not be entered therein.