Verification of Assets and Liabilities (Part -2) - Vouching, Auditing & Secretarial practice | Auditing and Secretarial Practice - B Com PDF Download

6). Valuation of goodwill

Goodwill is the value of reputation of an organization which enables the business to earn more than the normal rate of profit. While under taking verification and valuation of goodwill an auditor should observe the following points;

1. Goodwill purchased along with running business When goodwill has been purchased along with running business from some vendors the amount of goodwill should be verified by the auditors from the purchase agreement with vendors, showing the price paid for the goodwill. Where the price paid for the goodwill is not specifically fixed, auditor should ensure that the amount of goodwill taken into account is the amount of purchase consideration, i.e, amount of purchase consideration over net assets taken over.
2. Goodwill arise by writing up the value of assets When goodwill account has been arise by a company by writing up the value of its assets or the revaluation of assets, the auditor should examine the basis on which assets have been revalued and satisfy himself that the amount of goodwill brought into account is proper.
3. Goodwill created in the books of partnership firm The amount of goodwill created in the book of partnership firm on the admission of a new partner or on the retirement or on death of an existing partner, should be verified by the auditor with the help of with the help of the partnership deed. The auditor can also verify the changes made in the goodwill account from time to time on the basis of the provisions of the partnership deed.
4. Valuation of goodwill Valuation of goodwill is a matter of financial policy, to be decided by the management of the business. The auditor can’t interfere in the valuation of goodwill, though he may give his advise on the valuation of goodwill. For the valuation of goodwill the auditor is just to see that the goodwill is shown in the balance sheet at its proper value.
5. Insist upon writing off goodwill If it appears to him that the future benefit associated with the goodwill does not exist, he should insist on writing off the goodwill.
6. Shown in the balance sheet An auditor should see that goodwill valued at cost less amount written off and shown in the balance sheet.

7). Verification and valuation of patent right 

1. Examine the schedule or list of patent right.
2. Verify the patent right with the help of certificates of patents.
3. Ensure that the patents have registered in the name of the client.
4. Patent right are developed by the research work : If the patent right are developed by concern by doing some research work, the cost of research and development should be capitalized. Similarly if the patent right have been purchased, the cost of purchases of patent should be capitalized.
5. Renewal fee should be charged to revenue.
6. Cost of patent written off An auditor should see that the cost of patent written off. If a patent becomes obsolete, the entire book value should be written off.
7. Shown in the balance sheet. See that the patents are shown in balance sheet

7). Verification of investment

1. Examine the schedule of investment : He should call for and examine the schedule of investment held by the client with reference to the relevant ledger accounts.
2. Physical verification : If investment is in the hand of the client, auditor should verify the existence of the investment by personal inspection. If it is entrust to a bank for safe custody, he should get a certificate from the bank, giving the details of the security in its hand and stating that they are free from any charge.
   • If an investment is held by a trustee on behalf of the company, the auditor should call for and examine the trust deed. If the securities are held by the client brokers, the auditor should call for securities for personal inspection.
   • If the securities deposited with bank or any other creditor as a security towards loans borrowed, an auditor should get a certificate from bank or creditor to this effect.
3. Purchase of investment : If securities are purchased during the year, he should verify the purchase by examining the certificate. If no certificate is available he should examine purchase with the help of transfer deed and broker’s bought note.
4. Transfer fee, stamp duty etc. :  He should see that transfer fee, stamp duty etc incurred on the purchase of investment are properly capitalized.
5. Sale of investment : If the securities are sold during the year, the auditor verify the sale price with the help of broker’s sold note. See that the sale is approved by board of directors. See that whether the profit or loss made on sale is properly adjusted in the accounts.
6. Registered in the name of the client :  He should ensure that the investment is registered in the name of the client and they are free from charges other than those disclosed.
7. Properly valued : Satisfy himself that investment is properly valued.
8. Shown in balance sheet :  See that the investments are shown in balance sheet at market or cost price

8) Verification of cash in hand

1. Physically count the cash in hand : The auditor should actually count the cash in hand by attending the business premise on the last day of the financial year. Actual verification of cash in hand has been considered to be the most important part of an auditor’s duty. It was upheld in many cases. For instance, London oil storage company ltd v/s Secer Husluck & co. In this case it was held that the auditor has committed a breach of duty in verifying the existence of the pretty cash balance.
2. Surprise visit to business premises : To prevent manipulations & fraud the auditor can pay a surprise visit to the business premises of the client.
3. Count different kinds of cash balances simultaneously : If there are different kinds of cash balances say petty cash in hand and cash in hand, the auditor should count them simultaneously. Shortage on one account may not be made up from another account.
4. Count currency notes, coins, stamps and I.O.Us : He should count on closing date not only currency notes and coins but also the stamp and I.O.Us in hand, as they are also part of cash balance.
5. See that I.O.Us are genuine.
6. Physically count the stock of the unsold canteen tickets, lunch coupons etc as they are likely to be converted into cash.
7. Compare the cash in hand as revealed by physical counting with the cash balance as shown by the cash flow.
8. Verify cash transactions with the proper documentary evidences and correspondence.
9. Shown in the balance sheet.

9) Verification of cash at bank 

1. Compare bank balance as shown by the cash book with the bank balance as shown by the bank pass book.
2. Preparation of bank reconciliation statements If there is some difference between these two balances, he should prepare a bank reconciliation statement.
3. Obtain separate certificate for fixed deposit account, savings bank account, current account etc… He should obtain separate certificate from the bank to verify balances of the different types of bank accounts.
4. Verify all of the bank accounts individually In case there are accounts with more than one bank the auditor should verify them individually.
5. See that necessary adjustments are made in respect of interest accrued on fixed deposit.
6. See that Cheques not yet collected are genuine.
7. In case money is kept with other agencies, the nature of interest and the name of the agencies should be disclosed by the auditor in his audit report.
8. Where large amounts are held in foreign banks, the fact should be disclosed by the auditor in his audit report.
9. Shown in the balance sheet

10). Verification of bills receivable

1. Examine each bill in hand to ensure that it is properly drawn, sufficiently stamped and duly accepted by the accepter.
2. Verify the bills receivable given in the balance sheet by obtaining certified schedule of bills in hand.
3. Compare the schedule of bills in hand with bills receivable book and bills receivable account.
4. See that overdue bills are not included in the bills in hand.
5. Bills discounted should be examined by referring the cash book and pass book.
6. See that bills discounted or endorsed but not yet met are treated as a contingent liability and are indicated by way of foot note in the balance sheet.
7. See that proper provisions are made for contingent liability on bills discounted.
8. Shown in the balance sheet

11). Verification of debtors

1. Examine the schedule of debtors.
2. Verify the schedule of debtors with the help of sales ledger or debtor’s ledger.
3. Verify the sales ledger balances with the help of sales book, sales returns book, cash book etc.
4. See that the book debt shown in the balance sheet is recoverable.
5. Obtain a certificate from a responsible officer in respect of statement of book debt.
6. See that adequate provisions are made against book debt. The adequacy of the provisions for the bad & doubt full debt made by the management can be checked by the auditor by considering the following points,
   • Age of debt
   • Regular payment
   • Heavy dishonoured bills
   • Comparison of actual bad debt with budgeted bad debt
7. See that proper provision is made for discount on debtors.
8. In case, where certain amounts of debts are written off, the auditor should enquire into the details.
9. Debts due from subsidiary company should be carefully inspected by the auditor.
10. In case of debt in a foreign company, the auditor should find out, by converting the amount into home currency.
11. In case the client is a company, the auditor should see that the book debts are classified for balance sheet purpose as required by the companies Act 1956. That is book debts are classifies as follows,

• Debts considered good in respect of the company is fully secured.
• Debts considered good for which the company holds no security other than the debtor’s personal security.
• Debt considered doubt full

Further debt due by directors or officials of the company either severally or jointly with any other person shown separately.

Again debt due from other company under the same management should be disclosed with the names of the companies.

12) Verification of loans advanced

Generally loans advanced will be of the following types:-

1. Loans against the security of land & building.
2. Loans against the security of stock & shares.
3. Loans against the security of goods.
4. Loans against the security of life policies.
5. Loans against the security of guaranty of a third party.
6. Loans against the personal security of the borrower.

While verifying the loan advanced, an auditor should keep in mind the following points:-

1. Examine the schedule of loans granted.
2. Verify the loans advanced with the help of loan agreement, application of loans, acknowledgements of receipts, and loan account in the ledger.
3. Examine the authority of person granting the loans. Ensure that the loans advanced are within the powers of the person granting the loans.
4. Ascertain the worth of the securities In the case of secured loans, the auditor should ascertain the worth of securities offered and see that sufficient margin is maintained.
5. Examine the credit worthiness of the borrower In the case of unsecured loans, the auditor should examine the credit worthiness of the borrower and ascertain the possibility of their recovery.
6. See that outstanding loans are confirmed by the borrowers.
7. See that interests on loans are regularly collected.
8. See that provisions are made for doubtful loans.
9. In the case of joint stock Company, the auditor should see that the loans are properly classified.
10. See that loans to directors and officials of the company are shown separately in the balance sheet.
11.  See that the advances to subsidiary companies are shown separately in the balance sheet.
12. See that loans are shown separately in the balance sheet.

•  Loans against the security of land and building
• Examine the loans granted with the help of loan agreements.
• Examine the powers of the person granting the loan.
• Examine the memorandum and articles of association, in the case of joint stock companies.
• Inspect the minutes of meeting of the board of directors and see that loans are properly sanctioned.
• Verify the details of the loan.
• See that outstanding loans are confirmed by the borrowers.
• Examine the title deed relating to the property mortgaged. 
• Interests on loans are collected regularly.

2) Loans against the security of stock& shares 

1. Examine the loans granted with the help of loan agreements.
2. Examine the list of stocks and shares held by the company.
3. See that shares offered as security is transferred to his client.
4. Check the value and see that there is sufficient margin between the loan and the present value of the security.
5. See that shares accepted as security are fully paid up

3) Loans against the security of goods 

1. Examine the loans granted with the help of loan agreements.
2. Examine the powers of the person granting the loan.
3. Examine the godown keeper’s receipt, dock warrant if loans are advanced against the goods lying in warehouse.
4. See that godown rent is paid regularly by the borrower.
5. See that goods offered as security are fully insured.
6. See that goods offered as security are easily saleable.

4) Loans against the security of life policies 

1. Examine the loans granted with the help of loan agreements.
2. Examine the powers of the person granting the loan.
3. Enquire into the class of insurance policy.
4. Examine the last receipt for the payment of insurance premium.
5. Ascertain the surrender value of the life insurance policy.

6) Loans against the guaranty of a third party

1. Examine the loans granted with the help of loan agreements.
2. Examine the powers of the person granting the loan.
3. Examine the guaranty.
4. Enquire into the financial position of surety

5) Loans against the personal security of the borrower

1. Examine the loans granted with the help of loan agreements.
2. Examine the powers of the person granting the loan.
3. Examine the credit worthiness of the borrower.
4. Finally auditor should discourage the client granting of such loans

13). Verification and valuation of stock in trade 

The work of verification and valuation of stock in trade consist of two elements,

1. Verification of stock in trade.
2. Valuation of stock in trade.

i) Verification of stock in trade does not mean merely the checking of stock statements. It is much more than this. It includes the following,

• Verification of physical existence of stock in trade.
• Verification of ownership of stock in trade.
• Verification of guaranties in the statement of stock.
• Examine the organization’s transactions that results in stock in trade.
• Ensuring that receipts and issues are properly recorded.
• Ensure that the provision is made for obsolete stock.
• Examination of system of internal control.
• Verification of arithmetical accuracy of statement of stock.

 While verifying stock in trade, an auditor should keep in mind the following points,

1. Examine the system of internal check with regard to the verification of stock in trade.
2. Obtain copies of physical layout of all plant, giving names and descriptions of all departments where stocks are held.
3. Obtain details as to the quantity and value of stock with each department.
4. Secure a copy of stock taking instructions issued to the staff.
5. Ensure that proper and adequate records of stocks have been maintained.
6. See that goods which are not related to the business are not included in the stock.
7. See that goods sold prior to the closing date are not included in the stock.
8. See that items of capital nature are excluded from the stock.
9. He should test check physical existence at least 5 % of items.
10. See that stock held by third party is included in the stock sheet.
11. Compute Work out ratio between gross profit and sales of current year and compare it with that of the previous year.
12. Compare stock sheet of current year with that of previous year.
13. Check calculations, additions and castings in the stock sheet.
14. See that stock sheet is initiated by a responsible person.
15. See that goods taken into stock sheet are passed through the purchase book.

j) Valuation of stock in trade 

Following points are to be noted while valuing stock in trade:

1. An auditor should enquire into the basis of valuation.
2. See that basis of valuation has been consistently adopted from year to year.
3. Check the values of few items in the stock sheet with the corresponding invoice prices and current selling prices.
4. See that the totals of stock sheet are correct.
5. Compare the percentage of gross profit of current year with that of previous year.
6. See that calculations, additions and castings are correct.
7. See that stock sheet is signed by a responsible officer.

Methods of valuation of stock in trade 

• Actual cost price method
• Simple average cost method
• Weighted average cost method
• FIFO
• LIFO
• Base stock method
• Standard cost method
• Market price method
• Net realized value method

 Valuation of different items of stock in trade

1. Raw materials are valued at cost price plus proportionate freight and import duty.
2. Work in progress: cost price of raw materials plus proportionate amount of manufacturing expenses plus a percentage to cover the establishment charges relating to manufacture.
3. Finished goods: principal of “cost price or market price whichever is lower” is applied.
4. Spare parts: cost price
5. Stores articles: cost price
6. Stock of special trade: cost price plus interest at remarkable rate plus expenses of maintaining stock. 

Verification and Valuation of liabilities 

1. See that the liabilities are neither deliberately omitted nor under stated nor overvalued.
2. See that the liabilities are shown in balance sheet at their correct amount.
3. Obtain a certificate from responsible officer as to the correctness of the amount of different liabilities

1) Verification of sundry creditors 

While verifying sundry creditors an auditor should bare in mind the following points:

1. Obtain a list of creditors. He should get a schedule or list of creditors from the management and verify whether the schedule contains all the details about creditors.
2. Check the schedule of creditors with the balance in the creditor’s ledger.
3. Obtain statement of account from creditors.
4. Check the purchase book and purchase return book with the help of invoices and credit notes.
5. Check the postings from subsidiary books to the creditors account in the ledger.
6. Examine the purchase invoices to ensure that these are related to current year.
7. Compare the percentage of gross profit of current year with that of the previous year.
8. Special attention to the entries made either at the beginning of the year or at the end of the year.
9. Check the provisions for the discount on creditors with the help of reference to the creditor’s ledger. If the credited amount is unpaid for a long period, enquire the reasons.
10. See that creditor’s amount shown in the balance sheet are correct.

2) Verification of bills payable 

1. Obtain a schedule of bills payable
2. Check the total of schedule of bills payable with the bills payable book and the bills payable account.
3. Verify the payments made to the bills payable with the entries in the cash book.
4. Verify the bills payable returned under rebate.
5. Satisfy himself with the genuineness of bills payable.
6. See that the bills payable which have been paid are not shown as outstanding.
7. Check the bills payable paid after the balance sheet date but before the date of the audit with the entries made in the cash book.
8. See that the bills payable amount shown in the balance sheet are correct.

3). Verification of bank overdraft

1. Examine the overdraft agreement with the bank.
2. Check the cash book with the bank pass book.
3. Obtain a certificate from the bank and verify the correctness.
4. Verify the outstanding interest, if any.
5. If bank overdraft is secured, see that the assets charged against such loans are clearly stated in the balance sheet.

4). Verification of loans &advances borrowed 

1. Examine the loan agreement.
2. Examine the loans and advances with the help of the correspondence and relevant documents.
3. Ensure that loans and advances are taken for the use in the business.
4. Check the amount of loans and advances with the confirmation letters received from lenders.
5. If the loans are secured examine the amount of secured loans, nature and value of securities.
6. See that interest on loan is paid or not.
7. See that loans are separately shown in the balance sheet as secured and unsecured.

5). Verification of debentures 

1. Examine the memorandum and articles of association to ensure that the borrowing limit is not exceeded.
2. Examine the debenture account to verify the debentures issued.
3. Examine the debenture trust deed to verify amount of debenture issued and securities offered.
4. if debentures are issued at premium or discount, see that premium and discount are properly dealt with in the books of account.
5. If debentures are to be redeemed after some years, he should see that arrangements are made for the same.
6. See that debentures shown in the balance sheet are correct.

6). Outstanding expenses 

1. Verify the outstanding expenses with the help of statement of outstanding expenses certified by a responsible officer.
2. Compare the outstanding expenses of current year with those of previous year to see whether there is any material difference.
3. See that outstanding expenses have been subsequently paid.
4. Verify the item of expenses such as salaries, wages, rent etc which remain outstanding.
5. See that outstanding expenses are clearly shown in the balance sheet.

7). Income received in advance 

1. Verify the item of incomes which are normally received in advance with the help of list of incomes received in advance certified by a responsible official.
2. See that these are fully disclosed in the balance sheet.