Study TYBCom Accountancy Auditing-II
Study TYBCom Accountancy Auditing-II
Study TYBCom Accountancy Auditing-II
SECTION-1 (AUDITING)
INTRODUCTION TO AUDITING
STRUCTURE:
1.1 Objectives
1.4 Definition
1.14. Keywords.
1.15. Bibliography
2
1.1 OBJECTIVES
e. limitations of auditing
The term audit is derived from the Latin term ‘audire,’ which
means to hear. In early days an auditor used to listen to the accounts
read over by an accountant in order to check them
With the increase in the size of the companies and the volume of
transactions the main objective of audit shifted to ascertaining whether
the accounts were true and fair rather than true and correct. Hence the
emphasis was not on arithmetical accuracy but on a fair representation of
the financial efforts
The companies Act.1913 also prescribed for the first time the
qualification of auditors
1.4 DEFINITION
However, you should not infer that the detection of errors and
frauds is no longer an audit objective; it is indeed an audit objective
because statements of account drawn up from books containing
serious mistakes and fraudulent entries cannot be considered as a
true and fair statement. To establish whether the financial
statement show a true and fair state of affairs, the auditors must
carry out a process of examination and verification and, if errors
and frauds exist they would come to his notice in the ordinary
course of checking. But detection of errors of frauds is not the
primary aim of audit; the primary aim is the establishment of a
degree of reliability of the annual statements of account.
If there remains a deep laid fraud in the accounts, which in the
normal course of examination of accounts may not come to light, it
will not be construed as failure of audit, provided the auditor was
not negligent in the carrying out his normal work. This principle was
established as early as in 1896 in the leading case in Re-Kingston
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20 By suppressing the credit notes for returns and showing the full
payment to creditors.
22 By over casting the total of wages sheets and drawing that amount
for misappropriation.
6. When there is difference between the stock as per records and the
stock physically counted.
1. Check the opening balances from the balance sheet of the last year.
5. Ensure that the list of debtors and creditors tally with the ledger
accounts.
6. Make sure that all accounts from the ledger are taken into accounts.
8. Compare the various items from the trial balance with that of the
previous year.
9. Find out the amount of difference and see whether an item of half or
such amount is entered wrongly.
10. Check differences involving round figures as Rs. 1,000; Rs. 100 etc .
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12. Ultimately careful scrutiny is the only remedy for detection of errors.
13. See that no entry of the original book has remained unposted.
2. Vouch all the receipts from the counterfoils or carbon copies or cash
memos, sales mart reports etc.
Advantages of audit
1.10 MISCELLANEOUS
2 period
It is conducted for It is carried out on
proprietors only. behalf of any party
interested in the
matter.
3 conducted
It is wider in scope. It
It is restricted to may be carried out
balance sheet and beyond balance sheet.
profit and toss
account.
4 scope
It is voluntary. It is
Audit is legally required under certain
compulsory for circumstances.
companies.
It may be conducted at
It may be conducted at any time in case of
the end of the year. suspicion about any
5. compulsion
transaction.
prescribed. It is
presented to the client.
6 time Form of report is
prescribed. It is
presented to the
shareholders.
Even third party can
appoint an investigator.
Owners appoint the
auditors.
7. report Even an employee
preferably a chartered
The statutory auditors accountant may be
must posses proper appointed as
qualifications. investigator.
Re - investigation may
8. appointment be undertaken.
Re - audit is not
generally undertaken.
9. qualifications
10. rework
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It is concerned with
finalisation of It is concerned with
accounts. establishment of
reliability of financial
2. nature statements.
The object is to
ascertain the trading The object is to certify
results. the correctness of
financial statements.
3. objects Accounting
commences when Auditing begins when
book keeping ends. accounting
ends.
It involves various
financial statements. It It depends upon the
4. commencement
involves maintenance agreement or upon the
of books of accounts. provisions of law. It
It does not go beyond
books of accounts. goes beyond books of
accounts.
5. scope
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1. When the profit and loss shown in the profit and loss account is
true and fair, and
The accounts are said to show true and fair view when the
accounts show only the actual conditions as it is. i.e. the profit
and the net worth are shown as they are.
In order to show a true and fair view the auditor should ensure that:
12. Cut off transactions are recorded properly, so that all sales invoices
are matched with goods delivered and all purchase invoices are
matched with goods received.
14. Expected or anticipated gains are not credited to the profit and loss
account.
15. Effect of events after the balance sheet date on the value of an asset
and liability is disclosed in the accounts properly
3. Disclose all material facts: The books of accounts must disclose all
material facts regarding revenue, expenses, assets and liabilities. Material
means important and essential. The disclosure of important matters in the
accounts helps the users in taking business decisions. There should be
neither suppression of vital facts nor mis-statements.
The fact that audit is compulsory by law, in certain cases by itself should
show that there must be some positive utility in it. The chief utility of audit
lies in reliable financial statement on the basis of which the state of affairs
may be easy to understand. Apart from this abvious utility, there are other
advantage of audit. Some or all of these are of considerable value even to
those enterprises and organization where audit is not compulsory, these
advantages are given below:
(a) It safeguards the financial interest of persons who are not associated
with the management of the entity, whether they are partners or
shareholders.
(c) Audited statements of account are helpful in setting liability for taxes,
negotiating loans and for determining the purchase consideration for a
business.
(d) This are also use for settling trade disputes or higher wages or bonus
as well as claims in respect of damage suffered by property, by fire or
some other calamity.
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(e) An audit can also help in the detection of wastage and losses to show
the different ways by which these might be checked, especially those that
occur due to the absence of inadequacy of internal checks or internal
control measures.
(f) Audit ascertains whether the necessary books of accounts and allied
records have been properly kept and helps the client in making good
deficiencies or inadequacies in this respects.
(h) Audited accounts are of great help in the settlement of accounts at the
time of admission or death of partner.
Audit is classified into various types, viz., audit under statute, audit of
accounts of private firm, audit of accounts of private individuals, audit of
trust accounts. An auditor can adopt any one of the modes to conduct his
audit of an organisation, viz. continuous audit or periodical audit or interim
audit.
1.14 KEYWORDS
True and fair view: A phrase which means that the financial
statements must not contain anything which is untrue, unfair, unlawful,
immoral and unethical i.e. the financial statements must not contain
errors and fraud.
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1.15 BIBLIOGRAPHY
1.16 QUESTIONS
i) Define auditing.
f) In ancient period the audit was confined to cash audit and not
to locate fraud.
4. Fill in the blanks with the appropriate word given in the bracket:
a) when two or more errors are committed in such a way that the
result of these errors on the debits and credits is nil, they are
known as ______(error of omission/compensating error)
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2
INTRODUCTION TO AUDITING II
STRUCTURE:
2.0 Objectives
2.1 Meaning And Definition Of Errors And Frauds
2.2 Reasons And Circumstances
2.3 Types Of Errors
2.4 Types Of Frauds
2.5 Risk Of Fraud And Error In Audit
2.6 Auditor’s Duties And Responsibilities In Respect Of Fraud
2.7 Basic Principles Of Audit
2.8 Audit Types
2.9 Accounting Concept Relevant To Auditing
2.0 OBJECTIVES
DEFINITIONS :
Error refers to unintentional mis-statements or mis-
descriptions in the records or books of accounts by the books
keepers. In other words, they are unintentional mistakes arising on
account of negligence or ignorance. Errors may be basically of two
types :
(a) Principal Errors and (b) Clerical Errors
(a) principal Errors and : these errors arise generally when the
principals of accountancy are not observed while recording a
transaction. For instance a capital expenditure is recorded as
a revenue expenditure or vice versa. Such errors are difficult
to detect as the Trial Balance tallies inspite of such errors.
Basically it arises on account of ignorance of accounting
principles. Following are the examples of principles errors :
(1) Wages paid for installation of plant and machinery is
recorded as wages paid to workers
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A sixth cause may be added to those Mr.Mautz has listed and that
is more serious in nature. It is the intentional effort committed by
persons in positions of authority to :
2.3.1 Commission
It includes posting errors, casting errors and
totalling errors. For example ale to A has been recorded in B’s A/c,
it is a posting error or it is recorded in A’s A/c but the amount is
wrongly recorded. Similarly the balance of Rs.510 is carried forward
as Rs.501, and then it is a casting error. Certain errors will not
affect the trial balance for example posting in a wrong account will
not affect the trial balance but if there is a totalling error or a casting
error then the trial balance does not agree.
2.3.2 Omission
In the process of recording the accounting clerk may
omit a transaction from recording either fully or partially. If a
transaction is fully omitted, then it will be difficult to trace out, as
both the debit and the credit are missing and the trial balance will
tally inspite of these errors. However if a transaction is partly
omitted, then only one aspect of the transaction is recorded. In this
case it is easier to locate such an error.
The auditor should also consider the implications of the frauds and
errors, and frame his report appropriately. In case of a significant
fraud, the same should be disclosed in the financial statement. If
adequate is not made, there should be a suitable disclosure in his
audit report.
2. Confidentiality:
The auditor should respect the confidentiality of information
acquired in the course of his work and should not disclose any such
information to a third party without specific authority or unless there
is legal or professional duty to disclose. It is remarked that an
auditor should keep his ears and eyes open but his mouth shut.
5. Documentation:
The auditor should document matters, which are important in
providing evidence that the audit was carried out in accordance with
the basic principles.
6. Planning:
The auditor should plan his work to enable him to conduct an
effective audit in an efficient and timely manner. Plans should be
based on knowledge of client's business. They should be further
developed and revised, if required, during the course of audit.
7. Audit evidence:
The auditor should obtain sufficient appropriate audit evidence
through the performance of compliance and substantive test
procedure. It will enable him to draw reasonable conclusions there
from on which he has to base his opinion on the financial
information.
MEANING:
Audit is not legally obligatory for all types of business
organizations or institutions. On this basis audits may be of two
broad categories i.e., audit required under law and voluntary audits.
(i) Audit required under law : The organizations which require audit
under law are the following:
(a) companies governed by the Companies Act, 1956;
(b) banking companies governed by the Banking Regulation Act,
1949;
(c) electricity supply companies governed by the Electricity supply
Act, 1948;
(d) co-operative societies registered under the co-operative
Societies Act, 1912;
(e) public and charitable trusts registered under various Religious
and Endowment Acts;
(f) corporations set up under an Act of parliament or State
Legislature such as the Life Insurance Corporation of India.
(g) Specified entities under various sections of the Income-tax
Act, 1961.
INTERIM AUDIT:
An audit that is taken up between two annual audits is called an
Interim Audit. A specific date, as per the client’s requirement is
taken into account, e.g. 30th September, 31st December, etc. a trial
balance is drawn and verified with a view to prepare financial
statement. Financial statement are prepared and authenticated for
the interim audit period. Assets and liabilities are verified for interim
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CONTINUOUS AUDIT:
A continuous audit is one in which the auditor’s staff is engaged
continuously in checking the accounts of the client, during the
whole year round or when for the purpose, the staff attends at quite
frequent intervals say weekly basis during the financial period.
A continuous audit is preferred for the following reasons:
i. It makes it possible for the management to exercise a stricter
control over the accounts in as much as one is able to check
sooner the causes of any errors of frauds uncovered by such
an audit.
ii. The frequent attendance by the staff deters persons so
inclined, from committing a fraud.
iii. The accounting staff of the client is motivated to keep the books
of account up-to-day.
2.9.1 MATERIALITY:
1. Information is material if its misstatement (i.e., omission or
erroneous Statement) could influence the economic decisions
of users taken on the Basis of the financial information.
Materiality depends on the size and Nature of the item, judged
in the particular circumstances of its misstatement. Thus,
materiality provides a threshold or cut-off point rather than
being a primary qualitative characteristic which the information
must have if it is to be useful.
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3
AUDIT PLANNING
STRUCTURE:
3.0 Objectives
3.1 Meaning:
3.2 Objectives Of Planning
3.3 Factors To Be Considered
3.4 Sources Of Obtaining Information
3.5 Development Of An Overall Plan
3.6 Meaning Of Audit Programme
3.0 OBJECTIVES
3.1 MEANING
The auditor may wish to discuss elements of his overall plan and
certain audit procedures with the client to improve the efficiency of
the audit and to coordinate audit procedures with work of the
client’s personnel. The overall audit plan and the audit programme,
however, remain the auditor’s responsibility.
Discussion with Client: The Auditor can discuss his overall plan and
certain audit procedures with the client to improve the efficiency of the audit
and to coordinate audit procedures with work of the client's personnel. The
overall audit plan and the audit Programme, however, remain the Auditor's
responsibility.
Consideration of the state of the economy and its effect on the client's
business.
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(i) That the date of the voucher falls within the accounting period;
(iv) that the voucher comprised all the relevant documents which
could be expected to have been received or brought into
existence on the transactions having been entered into, i.e., the
voucher is complete in all respects; and
MEANING:
It is desirable that in respect of each audit and more particularly for bigger
audits an audit programme should be drawn up. Audit programme is
nothing but a list of examination and verification steps to be applied set
out in such a way that the inter-relationship of one step to another is
clearly shown and designed, keeping in view the assertions discernible in
the statement of account produced for audit or on the basis of an
appraisal of the accounting records of the client. In other words, an audit
programme is a detailed of the accounting records of applying the audit
procedures in the given circumstances with instructions for the
appropriate techniques to be adopted for accomplishing the audit
objectives. Businesses vary in nature, size and composition; work which
is suitable to one business may not be suitable to be rendered by the
auditor are the other factors that vary from assignment to assignment.
Because of such variations, evolving one audit programme applicable to
all business under all circumstances is not practicable. However it
becomes a necessity to specify in details in the audit programme the
nature of work to be done so that no time will be wasted on matters not
pertinent to the engagement and any special matter or any specific
situation can be taken care of.
Amplification is not necessary of the above points except the one under
evidence: that is the very basis for formulation of opinion and an audit
programme is designed to provide for that by prescribing procedures and
techniques. What is best evidence for testing the accuracy of any
assertion is a matter of experts knowledge and evidence. This is the
primary taks before the auditor when he draws up the audit programme.
Transactions are varied in nature and impact; procedures to be
prescribed depend on prior knowledge of what evidence is reasonable
available in respect of each transaction
OF AUDIT PROGRAMME
3.7.1 FACTORS
a. It provides the assistant carrying out the audit with total and clear set
of instructions of the work generally to be done.
b. It is essential, particularly for major audits, to provide a total
perspective of the work to be performed.
c. Selection of assistants for the jobs on the basis of compatibility
becomes easier when the work is rationally planned, defined and
segregated.
d. Without a written and pre-determined programme, work is necessarily
to be carried out on the basis of some ‘mental’ plan. In such a
situation there is always a danger of ignoring or overlooking certain
books and records. Under a properly framed programme, the danger
is significantly less and the audit can proceed systematically.
e. The assistance, by putting their signature on programme, accepts the
responsibility for the work carried out by them individually and, if
necessary, the work done may be traced back to the assistant.
f. The principal can control the progress of the various audits in hand by
examination of audit programmes initiated by the assistants deputed
to the jobs for completed work.
g. It serves as a guide for audits to be carried out in the succeeding
year.
h. A properly drawn up audit programme serves as evidence in the
event of any charge of negligence being brought against the auditor. It
may be of considerable value in establishing that he exercised
reasonable skill and care that was expected of professional auditor.
d. A hard and fast audit programme may kill the initiative of efficient and
enterprising assistants.
3.8.1 MEANING:
The audit working papers constitute the link between the auditor’s report
and the client’s records. Documentation is one of the basic principles
listed in AAS 1. according to AAS 3 (reproduced in Appendix l),
documentation refers to working papers prepared or obtained by the
auditor and retained by him in connections with performance of his audit.
The objects of an auditor’s working papers are to record and demonstrate
the audit work from one year to another. Therefore, working papers
should provide for:
Working papers are varied in nature but the foundation of all working
paper can be traced to:
III. It acts as an evidence in the court in the court of law when a charge
of negligence is brought against the auditor.
IV. It acts as the process of planning for the auditor so that he can
estimate the time that may be required for checking the schedules.
Working papers should record the audit plan, nature, timing and extent of
auditing procedures performed, and the conclusions drawn from the
evidence obtained. The form and content of working papers are affected
by matters such as:
5. As stated in para 4, the client does not have a right to access the
working papers of the auditor. However, the auditor may, at his discretion,
in case considered appropriate by him, make portions of or extracts from
his working papers available to the client.
3.8.7 FEATURES
Working papers are the property of the auditor. The auditor may, at his
discretion may, at his discretion, make portions of or extracts from his
working papers available to his client. Audit working papers are the
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4
AUDITING TECHNIQUES AND INTERNAL
AUDIT INTRODUCTION I
STRUCTURE
4.0 Objectives
4.1 Test Checking Meaning
4.2 Features Of Test Checking
4.3 Factors To Be Considered
4.4 Advantages And Disadvantages Of Test Checking
4.5 Test Checking Vs Routing Checking
4.6 Audit Sampling
4.0 OBJECTIVES
• Know the meaning of Test Checking
• Understand the features of Test Checking
• Know the advantages and disadvantages of Test Checking
• Distinguish between test checking and routing checking
• Understand the meaning of Audit sample
system increases.
can be relied upon to a greater extent than any arbitrary technique which
lacks basis and acceptability.
2. Estimation Process: Test Checking and Sampling can never
.bring complete reliability; it cannot give accurate results. It is a
process of estimation. What error is tolerable for a particular matter
under examination is a matter of the individual's judgment in that
particular
3. Coverage of material items: Entries involving large amounts or
relating to material accounts are ..seen exhaustively and other entries
are picked up for verification from the remainder according to a certain
plan. Sometimes entries are checked for a few specified months
exhaustively and the rest go unchecked.
2. Time factor: Where the Auditor has very little time at his disposal to
check all the transactions of a medium or large sized concern.
Naive and Biased: The extent to which test checking can be resorted
to is a matter of Auditor's personal assessment. It does not ensure
selection of representative samples of adequate size and offers
opportunities for bias to enter into selection process.
SAMPLING RISK
(2) Sampling risk20 arises from the possibility that the auditor
conclusion, based on a sample, may be different from the
conclusion that would be reached if the entire population were
subjected to the same audit procedure.
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(3) The auditor is faced with sampling risk in both tests of control
and substantive procedure as follow:
(I) Risk of under reliance: The risk that, although the sample
result dose not support the auditor’s assessment of control
risk, the actual compliance rate would support such an
assessment.
(II) Risk of over reliance: The risk that, although the sample
result supports the auditor’s assessment of control risk, the
actual compliance rate would not support such as an
assessment.
(b) Substantive procedures:
(I) Risk of incorrect rejection: The risk that, although the sample
results the supports the conclusion that a recorded account
balance or class of transactions is materially misstated, in fact
it is not materially misstated.
(II) Risk of incorrect acceptance: The risk that, although the
sample result supports the conclusion that a recorded account
balance or class or transactions is not materially misstated.
(4) The risk of under reliance and the risk of incorrect rejection
affect audit efficiency as they would ordinarily lead to
additional work being performed by the auditor, or the entity,
which would establish that the initial conclusions were
incorrect. The risk of over reliance and the risk of incorrect
acceptance affect audit effectiveness and are more likely to
lead to an erroneous opinion on the financial statements than
either the risk of under reliance or the risk of incorrect
rejection.
(5) Sample size is affected by the level of sampling risk the auditor
is willing to accept from the results of the sample. The lower
the risk the auditor is willing to accept, the greater the sample
size will need to be.
Tolerable Error
sub-population.
Projection of Errors
25. The auditor projects the error results of the sample to the
population from which the sample was selected. There are several
acceptable methods of projecting error results. However, in all the
cases, the method of projection will need to be consistent with the
method jsed to select the sampling unit. When projecting error
results, the auditor needs to keep in mind the qualitative aspects of
the errors found. When the population has been divided into sub-
population, the projection of errors is done separately for each sub-
population and the results are combined.
Reassessing Sampling Risk
5
INTERNAL CONTROL
STRUCTURE
5.1 Objectives
5.2 Introduction
5.1 OBJECTIVES:
5.2 INTRODUCTION
Accounting control
Administrative control
• To ensure that all the transactions have been carried out under a
proper authority and by persons authorised for the same in the
business.
• To review the system of internal check from time to time to advice the
management on improvement of the system and to undertake special
investigation for the management.
Internal audit helps the statutory audit to a large extent. Both the
internal auditor and the statutory auditor have a common interest as far as
authenticity of the accounts are concerned. However soundness of
internal audit relieves the statutory auditor from detailed checking.
Thus, under internal check system the staff duties are so arranged
that no one person is allowed to record every aspect of the transactions
and the entire work is distributed among the various members of the staff
in such a manner that the work of one person is automatically checked by
others.
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• The work is divided among the staff and each staff is assigned a
specific task.
• No single staff shall have absolute control over recording of all the
aspects of business transactions by himself.
• The same staff shall not be allowed to have access to all books of
accounts as well as physical custody of the assets.
• The duties of the members of the staff should be changed from time
to time.
• The salesman must not receive cash on the cash memos issued by
him.
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2. The customer must present the three copies of cash memo to the
cashier at the time of making payment
3. The cashier must verify the particulars and satisfy himself regarding
the total payment with reference to rates and quantity.
5. He will retain one copy with himself and hand over the other two
copies to the customer.
At the end of the day’s working, the sales man, the cashier and the
gate keeper should prepare the summary and submit to the manager or
officer incharge. If these summaries tally, the accounts are certified as
correct.
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• There should be proper filing of mail orders received and the cash
book should be checked with these mail orders.
• The purchase department on the basis of the requisition will send out
enquiries to the various suppliers asking for quotation.
• On receiving the order the vendor shall execute the order. The
supplies will be received by the stores department.
• The goods received should be inspected with the copy of the order.
• All Purchases that are made by employee for the personal use must
be accounted for separately.
6) Separate departments should deal with cash sales and credit sales.
10) Amount due from the customer shall be written off as bad unless all
methods of recovery are exhausted.
12) The sales invoice clerk shall have no access to physical stock or
accounting records.
13) The credit note shall be prepared only after ascertaining the fact
from the despatch section and the sales department for the goods
received back from the customers. Credit notes are to be prepared
in quadruplicate. One is to be retained with the invoice department,
second copy is to be sent to despatch department, third copy to the
sales department and fourth copy to the customer.
15) The invoice can be cancelled only by the sales department. All sales
invoices must be printed and numbered in serial order.
19) A sales ledger control account shall be balanced with the control
account periodically.
23) The stock held by the agents should be verified periodically with the
statements received from the agents.
24) The goods sent on sale or return basis but unsold on the date of the
balance sheet should not be treated as sales but unsold stock.
6) Each worker is to be given a pay slip indicating the gross wages and
net wages.
9) The rosters of workers for each work should be prepared and copy of
the same be sent to the wage preparing section.
10) Late arrival of workers shall be entered in a separate register and the
same be sent to the personnel section for future reference.
13) All calculations regarding gross wages and net wages payable after
deduction are to be checked by an independent person.
14) In the wage sheet the names of workers, rates of pay, the period for
wage to be paid shall be entered by one person. The calculations
regarding gross wages payable shall be made by another person.
The deductions under various heads shall be made by a third person.
The net wages payable and the checking of the wages sheet with
reference to leave deductions etc. should be made by a senior staff
member. The wages sheet shall be signed by the authorised official.
15) If the wages are to be paid on the basis of piece wage system, the
actual work done by each worker must be maintained on a job card
to be given to each worker. These cards should be counter signed by
the foreman of the department and the store department to which the
goods produced are delivered.
16) The wage sheet shall be prepared in triplicate. One copy shall be
endorsed to pay master, the second copy to the account section and
final copy shall be retained by the wage preparing section.
records. In case he does not do so he may be held liable for all the
undetected errors and frauds. He should not show any negligence in his
duty. He should design the audit program keeping in view the weak links
of the system. He should also suggest the changes to the management
strengthening the system of internal check. It should be noted that the
existence of a sound internal check system in an organisation helps the
auditor to a great extent in audit work, but does not reduce his legal
liability at all.
implemented.
5. Nature
The auditor should take the following steps in addition to the normal
audit procedure while auditing the computerised accounts.
heat, dust etc. The auditor should ensure that proper precautions
have been taken by the client for the safe custody of such disks.
tasks assigned to them are properly carried out and avoidable wastes and
losses do not occur to eat up the fruit of the enterprises.
It is also necessary for the auditor to study the significant features of the
business carried on by the concern: the nature of its activities and various
channels of goods and materials as well as cash, both inward and
outward, : and also a comprehensive study of the entire process of
manufacturing, trading and administration. This will help him to
understand and evaluate the internal controls in the correct perspective.
ADVANTAGES
Audit Assurance: The Auditor needs reasonable assurance that the accounting
system is adequate and that all the accounting information which should be
recorded has infact been recorded. -
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Role of review: The review of Internal Controls will enable the Auditor to know –
(a) Whether errors and frauds are likely to be located in the ordinary course of
operations of the business;
(d) Whether any administrative control has a bearing on his work (e.g. when
there is a weak control over
,'g) How reliable the reports, records and the certificates to the Management can
be; (h) the extent and depth of the examination that he Auditor needs to
carry out in the different areas of accounting;
(i) What would be the appropriate audit technique and audit procedure in
the given circumstances; (/) what* are the areas where control is weak
and where it is excessive; and (k) whether some worthwhile suggestions
can be given to improve the control system.
(ii) AUDITORS DUTIES
Review: If the Auditor reviews the Internal Control System of the client, he will
be in a position to bring to the Management's notice, the weaknesses in the
system and suggest measures for improvement. During the course of his
audit, he may also ascertain how far the weaknesses have been removed.
(a) Is there an adequate Internal Control System commensurate with the size of
the Company and the nature of its business, for the purchase of Inventory and
Fixed Assets and for sale of goods and services?
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(b) Should study and evaluate the operation of those Internal Controls upon
which he wishes to rely in determining the nature, timing and exient of
other audit procedures.
3. Where the Auditor concludes that he can rely on certain Internal Controls,
his substantive procedures would normally be less extensive than would
otherwise be required. It may also differ as to their nature and timing.
Internal control can provide only reasonable, but not absolute, assurance
that the objectives stated above are achieved. This is because there are
some inherent limitations of internal controls, such as:
(b) The fact that most controls do not tend to be directed at transactions
of unusual nature;
(e) The possibility that a person responsible for exercising control could
abuse that authority, for example, a member of management
overriding a control;
The primary Internal Control measures in relation to Sales & Debtors are -
10. Listings in Sales Ledger balances shall be regularly balanced with Control
Account.
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11. Cheque received by post are to be recorded and bearer cheques must be
stamped "A/c Payee only".
12. Record of receipts shall be duly verified with the bank pay-in-slip after deposit
and also with the Cash Book.
17. Ageing analysis shall be prepared and checked. Old balances should be
followed up.
Invoices shall be verified with rates on Purchase Orders and calculations should
be checked before posting.
Goods Received Notes lying unmatched with invoices shall be duly followed
up and liabilities for goods
DISTINGUISH BETWEEN
(1) Internal check means the (1) Internal control is the whole
arrangement of work different system of controls, financial and
employees in such a manner that otherwise, established by the
work of any person is automatically management in order to carry on
checked by another person is doing the business of the company in an
his duty. orderly manner, safeguard its
assets and secure as far as
possible the accuracy and reliability
of its records.
INTERNAL AUDIT
MEANING:
OBJECTIVES
(1) To verify the accuracy and authenticity of the financial accounting and
statistical records presented to the management.
(4) To confirm that liabilities have been incurred only for the legitimate
activities of the organization.
(7) To examine the protection afforded to assets and the uses to which
they are put.
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(10) To review the operation of the overall internal control system and to
bring material departures and non-compliances to the notice of the
appropriate level of management; the review also generally aims at
locating unnecessary and weak controls for making the entire control
system effective and economical.
As per SAP-7 The scope and objectives of internal audit vary widely and
are dependent upon the size and structure of the entity and the
requirements of its managements.
(2) The external auditor should, as part of his audit, evaluate the internal
audit function to the extent considers that it will be relevant in determining
in nature, timing and extent of his compliance and substantive
procedures. Depending upon such evaluate, the external auditor may be
adopt less extensive procedure than would otherwise be required.
(3) By its very nature, the internal audit function cannot be expected to
have the some degree of independence as is essential when the external
auditor expresses his opinion on the financial information. The report of
the external auditor is his sole responsibility, and that responsibility is not
by any means reduced because of the reliance he place’s on the internal
work.
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DISTINGUISH BETWEEN:
(2) Internal check does the (2) Internal audit does the detective
preventive job i.e. internal check is job of identifying frauds and errors
derived so that frauds and errors and rectifying them.
are prevented.
(4) All the persons in the (4) Specific persons are appointed
organization are involved to to the internal audit.
maintain the internal check system.
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6
VOUCHING
STRUCTURE :
6.0 Objetive
6.1 Vouching
6.5 Exercises
6.0 OBJECTIVES
6.1 VOUCHING
From the above it becomes clear that vouching means testing the
truth of entries appearing in the primary books of accounts. In short,
vouching means to examine the evidence in support of any transaction or
entry recorded in the books of accounts. Vouching does not merely see
that the entries and transactions are supported by proper documentary
evidence. The auditor should be satisfied that they are properly
maintained, they are supported by all evidence and they are correctly
recorded in the books of accounts.
Voucher
Examples of vouchers:
9. Account head
19. Alteration
Objectives of vouching
1. To ensure that all the transactions are properly recorded in the books
of accounts.
Auditing Techniques
7.
Meaning.
4. Client's staff should not come to know of the entries selected for test
checking.
5. Period selected for test checking should differ from book to book and
year to year.
6. He should not adopt test checking where the law requires thorough
audit.
7. A number of entries of the first and last month of the year must be
checked thoroughly.
10. Auditor should select the test independently without regard to the
suggestions of the member of the client's staff.
11. Bank statement and entries for cash withdrawal and cash deposits
should be checked in full.
The extent of the test checking will depend upon the judgment and
wishes of the auditor but it must be remembered that time unnecessarily
spent in routine checking is a waste of resources. Caution must also be
taken to see that the test checking may not become insignificant in extent
or automatic and unrepresentative. Test checking will be of no use unless
the representative items selected for checking are chosen with great
intelligence and imagination.
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1. The auditor always is under fear whether he has missed out certain
important items or that errors have remained undetected while test
checking.
2. Where the client's staff is aware that the auditor resorts to test
checking, the staff may become careless.
Auditor's Liability :
If any errors are found in the accounts the auditor cannot take the
shield against the fact that he conducted test check. The auditor should
very carefully select the items for test check and ensure on the whole that
the accounts show a true and fair view of the Profit/Loss in the case of the
Profit & Loss Account and of the state of affairs of the organisation in the
case of Balance Sheet.
SURPRISE CHECKS
during such surprise checks are selected without prior notice to the
client's staff.
USE OF TICKS
Ticks are used to keep a control on the work done by the auditor
Care should be taken to see, that the use of different ticks does
not become known to the clients staff.
on. Thus, the auditor should check the purchase transaction right from the
beginning to the end. This enables him to evaluate the accounting system
and internal controls.
4. Write short notes on (a) Test check (b) Auditing in Depth (c) Surprise
Checks (d) Use of Ticks in Auditing.
Cash sales
1. The cash sales register should be fully checked with the carbon
copies of the cash sales bill. Particular attention should be given
to first and last month of accounting year.
2. A summary of daily cash should be checked.
3. The auditor should be more careful where cash memos are
issued even where cash is not received.
4. A certain representative item should be subjected to vouching in
depth to get an idea about reliability of internal control.
5. Salesman’s summary, gatekeeper’s summary and cashier
summary should also be compared.
6. Dates of cash sales bills and the date on which the receipt are
recorded in the cash book must be the same. If the dates differ,
the same should be inquired into.
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7. Where cash sales bills are cancelled, all the copies, including
original copy dully cancelled, should be kept in record.
8. Where it is a policy of the company to allow a discount, it should
be seen that uniform policy is followed.
9. If the sales are made by the salesman, their statements should
be verified and reconciliation should be made with the record of
cash received.
10. Verify the entries in the cash book and the corresponding effect
in sales A/c in the ledger.
Sales on approval
Document to
Aspect to be verified / Auditor’s duties
be seen
Sale or return •Examine the sale or return day book for
day book the manner of accounting.
• Check actual movement of goods from
dispatch register/ goods outward book.
• Note the period of approval in the case of
different goods/ customers.
• Verify whether goods returned have been
properly reversed in the day book.
Order book or Examine this register to verify sale confirmed by
confirmation customers and goods held by customers at their
book end as sale or return stock.
Sales register Ensure that sales have been recognised
whenever- (a) approval is received from the
party: or (b) goods are appropriated by the party;
or (c) period of approval has expired and goods
have not been returned.
Stock registers • Ensure that closing stock includes goods
and lying with customers in respect of which
statements period of approval has not expired.
• Ensure that goods validly returned by
customers are duly accounted in stock.
Consignment sales
Document to Aspect to be verified/ Auditor’s duties
be seen
Consignment Ascertain and note the following terms and
agreement conditions-
• Commission due- manner of payment,
adjustment, etc.
• Risk of bad debts- in case of del—credere
commission, consignee has to bear the
risk of bad debts; else bad debts are
borne by the consignor.
• Reimbursement of consignment
expenses- eligible expenses, extent of
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reimbursement.
Goods Verify goods despatched by reference to the
outward book proforma invoice, consignment day book, goods
outward book, transport documents,
acknowledgement of the goods by the consignee
and the account sales.
Stock registers • Ensure that the stock lying with consignee
at the year end is be taken in the balance
sheet at cost on a consistent basis and
credited to the consignment a/c to arrive
at the result of consignment transactions.
• Ensure that no profit is taken for the profit
on goods remaining in the hands of the
consignee.
Account sales • Verify whether consignment sales are
accounted by crediting consignment
account and debiting the consignee’s
account.
• See whether the summery of transactions
reported i.e. sales made, expenses
incurred, commission due, remittance
made, balance stock, and amount due
from / to either party is properly disclosed
in the general ledger.
Form F For goods sold through agents In the course of
inter-state trade or commerce, verify whether
form F has been obtained under the CST Act.
Consignment • When the goods are consignment above
account cost, ensure that necessary adjustments
to remove the loading are made at the end
of the year.
• Verify whether necessary adjustments are
made at the year – end in respect off
unsold goods, commission and expenses
incurred by the consignee.
Confirmation Obtain confirmation of the account balance from
the consignee.
Sales return
1. Check the total of Sales Return Journal and find the amount
recorded in profit and loss account.
2. Check every item of sale return with the credit notes sent to
customer.
3. Check the entry in gate-keeper record for return inward
movement of goods and check the internal control. Verify the
entry in stock register.
4. Compare the extent of earlier year sales and return with that of
the current year.
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5. The sales return in the beginning of the year and of the end of
the year should be carefully scrutinized.
6. Enquiry should be made if there is a wide gap between the
original transaction and the return of goods
7. If the goods are return for unacceptable quality, enquiry about
the steps taken after the return of the goods and verify the
documentation.
Rental receipts
1. Check the nature of the agreement of know the condition on
which an asset is given on the rent
2. From the original documents, check the rates, periods, mode of
payment i.e. cash or cheque.
3. Check the outstanding rent for last year and find out which of
the receipts are for last year and how much rest still
outstanding.
4. Check the entries in the cash with pay in slips and the receipts
issued.
5. Check the outstanding rent at the end of the year and see that
provision has been made for the same. Next year’s record may
be verified to find the receipt of the same.
7. Ascertain the income for the year, still to be received and check
whether provision has been made for the same.
8. In case of interest received check the calculations.
9. For interest from bank, verify the entry in the bank statement.
For fixed deposits, check whether any F.D has matured or any
F.D. newly kept.
Royalties received
The auditor should see the relevant contract and examine the
important provisions relating to the conditions of payment of royality. In
particular, the rare of royality, mode of calculation and the due dates
should be noted. The periodical statement received from the publisher
and the calculation of the royality should be checked. If there is any
deduction on account of recoupment of royality for the past period, the
records for earlier royality receipts should be seen to ensure that the
amount of deduction is as per the contract. Royalties due but not yet
received should have been properly accounted for.
PURCHASE RETURN
Purchases Returns
(p) Arrangement for the preparation of wages and salaries bills and their
analysis.
(e) Arrangement for disbursement of wages and salaries for workers and
employees not present on the pay day.
He should also verify that the system of internal control provides for
the following matters :
(£>) Preparation of wages and salary bills by members of the staff, who
are not connected with maintaining a record of engagement of
workers, recording of their attendance or fixation of their wages.
(e) Verification of the amount of total wages paid with the amount
adjusted in costing record.
(/) Checking and authorising the overtime and piece work payment
by officers who not associated with the Wages Department.
RENT
Document to be Aspect to be verified / Auditor's Duties
Rental Agreement Examine the Rent Agreement and note aspects like - (a) period of lease;
(b) rer^ payable; (c) manner of payment; (d) amenities and other charges
Payment Vouchers
• Verify the Payment Vouchers and check whether the payments have
been made. per the terms of the agreement.
TDS File • In case of rent payments exceeding Rs. 1, 20,000 per annum, see
whether tax has! been deducted at source at the appropriate rates, and
remitted to the authorities.
General Ledger / * Ensure that any payment in the nature of Deposit / Additional Deposit
Financial has not been1
Statements
Wrongly charged to revenue.
• Where the Deposit given to the Landlord bears any interest, see
whether Interne^ Income has been recognised in the P & L Account.
• Scrutinise the Ledger and see whether proper accounting entries have
b di t fP id R t t th b i i f th /
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INSURANCE PREMIUM
Document to be Aspect to be verified / Auditor's Duties
seen
Insurance • Examine the insurance policy;/ cover note and note aspects
Policy / Cover like – (a) asset covered by the policy; (b) amount of
Note premium; (c) time period of insurance, etc.
• See whether “No Claim Bonus”, whether applicable, has
granted in the policy to the insured..
Payment • Verify the payment vouchers and trade the payment entries
vouchers into the blank statement. Compare the same with receipt
issued by the insurance company.
• Examine cases of insurance premium payments where
insurance policy is taken out by arrangement with the bank
e.g. in case of machineries and other assets obtained by
way of bank loan.
Staff insurance • where insurance premium relates to staff, examine whether the
policy records same has been properly recovered monthly / periodically from their
pay bills.
General ledger / • scrutinize the ledger and see whether proper accounting entries
financial have been passed in respect of prepaid insurance as at the
statements beginning of the year / unexpired insurance premium at the end of
the year etc.
Staff Recovery In case Mobile Phone Charges paid by the Company on behalf of their
Register staff, see whether recoveries have been made from such employees for
amounts in excess of the permissible limits.
Service Tax See whether Service Tax Input Credit has been availed by the Company on
Returns the basis of the Telephone Bills / Connections in the name of the Company.
FBI Returns See whether the liability in respect of Fringe Benefit Tax on Telephone
Expenses has been properly computed and remitted to the authorities.
General Ledger / • Verify whether year-end adjustments have been properly accounted in
Financial respect of Outstanding Telephone Expenses. • Compute the percentage of
Statements Telephone Expenditure to Total Turnover and compare ' the same with that of
previous year to ensure reasonableness.
C i E a few
Despatch Register Cross-check dit cases
f of fPostageth/ Courier Expenses with the
Despatch Register™ Outward Mail Register, to see whether any mail
Acknowledgements hff-sSa
b t th t d
6. Verify the Cashbook for the transfer of Cash under Imp rest system
to Petty Cash.
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10. Trace the postings from the Petty Cash Book into the Nominal
Ledger Head of Account.
11. Verify the petty cash physically available on a certain date, by way
of surprise check.
12. Examine the Suspense Vouchers / lOU's and ensure that they are
reversed within a reasonable time.
Demanded for all items of expenses incurred, except those which are
capable of independent verification. As regards traveling expenses
claimed by directors the auditor should satisfy himself that these were
incurred by them in the interest of the business and that the directors
were entitled to receive the amount from the business.
(v) Other expenses claimed, e.g., porter age, tips, conveyance, etc.
If the journey was undertaken by air, the counterfoil of the air ticket
should be attached to the voucher; this should be inspected. For travel by
rail or road, the amount of the fare claimed should be checked from some
independent source. Particulars of boarding and lodging expenses and in
the case of halting allowance the rates thereof should be verified. The
evidence in regard to sundry expenses claimed is generally not attached
to T.A. bills. So long as the amount appears to be reasonable it is usually
not questioned. All vouchers for travelling expenses should be authorised
by some responsible official. In the case of foreign travel or any
133
134
7
VERIFICATION AND VALUATION
OF ASSETS AND LIABILITIES
STRUCTURE :
7.16 Exercises
135
Spicer and Pegler have defined verification as “it implies an inquiry into
the value, ownership and title, existence and possession and the
presence of any charge on the assets”. Verification is a process by which
an auditor satisfies himself about the accuracy of the assets and liabilities
appearing in the Balance Sheet by inspection of the documentary
evidence available. Verification means proving the truth, or confirmation of
the assets and liabilities appearing in the Balance Sheet.
Of course it is not possible for the auditor to verify each and every asset.
It was held in Kingston Cotton Mills case that “it is not part of an auditor’s
duty to take stock. No one contend that it is. He must rely on other people
for the details of stock in trade in hand”.
However, as per the decision given in Mc Kesson and Robins case (1939)
the auditor must physically inspect some of the assets. Now the auditor
has to report whether the balance sheet shows true and fair view of the
state of affairs of the company. Hence, he is required to verify all the
assets and liabilities appearing in the balance sheet. In case of failure, the
auditor can be held liable for damages.
1. They exist.
1. Existence : The auditor should confirm that all the assets of the
company are physically existing on the date of balance sheet.
2. Possession : The auditor has to verify that the assets are in the
possession of the company on the date of balance sheet.
5. Record : The auditor should confirm that all the assets and liabilities
are recorded in the books of account and there is no omission of
asset or liability.
6. Audit report : Under CARO the auditor has to report whether the
manangement has conducted physical verification of fixed assets
and stock and the difference, if any, between the physical inventory
and the inventory as per the book.
7. Event after balance sheet date : The auditor should find out
whether any event after the date of balance sheet has affected any
items of assets and liabilities.
137
7. 3 SCOPE OF VERIFICATION
1. That the assets were in existence on the date of the balance sheet
2. That the assets had been acquired for the purpose of business
only
6. That the assets were properly valued and disclosed in the balance
sheet.
7. 4 OBJECTS OF VERIFICATION :
2. To know whether the balance sheet exhibits a true and fair view of
the state of affairs of the business
7. 5 ADVANTAGES OF VERIFICATION
4. It exhibits true and fair view of the state of affairs of the company.
Again, while going through the decision of Mc Kesson and Robins case in
1939, we find that the auditor should physically verify some of the assets.
If possible, title documents like negotiable instruments, shares,
debentures, securities, etc. are to be thoroughly examined on the last day
of the accounting period. He should satisfy himself that the transactions, if
140
any, having bearing on the Balance Sheet date and date of audit are
bonafide and are supported with proper evidence. The auditor is also
supposed to verify stock-in-trade with reference to the purchase book, the
stock records, the gatekeeper’s book, etc. though law does not specially
compel him to take stock-in-trade.
(i) Meaning :
The valuation of the assets is the primary duty of the officials of the
company. The auditor is required to verify whether the value ascertained
is fair one or not. For this, he may rely on the technical certificate issued
by the experts in the field.
The auditor has also to see that the principle of valuation of assets
is consistently adopted and is based on established principles of
accountancy. For the purpose of convenience, those assets are classified
as under to determine their value.
1. Fixed Assets
2. Current Assets or Floating Assets
3. Wasting Assets
4. Intangible Assets
5. Fictitious Assets.
141
(1) Cost Price (Going Concern Value ) : Under this method actual
cost of assets are reduced by the depreciation provided. Usually
this method is applied to value fixed assets.
(2) Market Value : This refers to the market value of the asset i.e. the
price at which the asset is being transacted in the market. This is
applied to value the current assets only when this is lower than
cost of the asset. Usually market value is adopted to value items
having perishable nature.
(3) Scrap Value : Assets which are useless for the enterprise may be
sold as scrap in the market. The value for which such assets can
be disposed of as scrap, is called as scrap value of assets.
(5) Realisable Value : The value that can be obtained if the asset is
sold in the market i.e. anticipated selling price. Usually, expenses
such as commission, brokerage etc. are deducted from it.
143
2. For this reason, the cash should be checked not only on the last day
of the year, but also checked again sometime after the close of the
year without giving notice of the auditor’s visit either to the client or to
his staff.
3. If there is more than one figure for cash balance e.g. when there is a
cashier, a petty cashier, a branch cashier and in addition, there are
imprest balance with employees, all of them should be checked
simultaneously, as far as practicable, so that the shortage in one
balance is not made good by transfer of amount from the other.
6. Should this not be possible, the auditor should verify the receipts and
payments of cash upto the date he counts the cash. This should be
145
done soon after the cash balances have been counted. The cash
book of the day on which the balance is verified should be signed by
the auditor to indicate the stage at which the cash balance was
checked.
7. If any cheques, or drafts are included in cash balance the total there
of should be disclosed.
5. See that entry for remittance in transit is passed by only one party and
is reversed in the next year.
1. To verify cash at bank, the auditor should examine the bank pass
book and compare it with the balance as shown by the bank column of
the cash book.
3. The auditor should get a certificate regarding the balance at the bank
directly from the bank.
4. Ensure that the balance as shown by the cash book is brought into the
balance sheet as `Cash and Bank’ and not `Balance as shown by the
pass book’.
5. The auditor should also see that the `cheque outstanding’ and
`cheques not yet collected’ are genuine and not made up in order to
conceal the deficiency. If some of these cheques are more than six
months old, he should make inquires, and have them reversed in the
books of accounts.
6. Cash in Fixed deposits with the bank can be verified by examining the
deposit receipt, or getting a certificate from the banker.
7. If there are more than one bank account such as `Dividend Account’.
“Interest Account’ etc. all such accounts should be checked and the
balances should be verified upon the same date. Information
regarding their balance should also be obtained from the bank
directly.
8. If the bank account shows an adverse balance and the client has
deposited any security for the overdraft, the auditor should enquire
from the bank the particulars of the security and the amount of the
interest charged.
147
1. The auditor should examine the Bills Receivable Book with the Bills
Receivable not matured but in hand on the date of the Balance
Sheet.
2. When any bills are in the process of collection the details of the same
have to be verified with bank certificates.
3. If the Bills Receivables in hand are many, auditor should make a list
of bills for his convenience.
4. If there are any bills that have been discounted, and still not matured,
he has to examine the details of the same very carefully and should
confirm with the bank because they are to be shown as contingent
liabilities by way of a note in the Balance Sheet.
5. While examining the Bills, the auditor has to pay special attention to
see that they are properly drawn, stamped and duly accepted.
8. In case the auditor has visited his client after the Balance Sheet date,
many of the bills due on the Balance sheet date might have matured
or honoured. Hence the auditor has to vouch such bills with Cash
Book or Pass Book and reconcile the balance.
9. If the bill has been renewed after the Balance Sheet date, then also
the value of the original bill due on Balance sheet date should be
shown as Bills Receivable and interest on renewed bills properly
accounted.
10. If the bills endorsed have been dishonoured, the original drawee is to
be debited and endorsee is to be credited.
148
1. The auditor has to examine the mortgage deed, see if the copy has
been properly executed and registered in favour of the client.
2. The auditor has to examine the title deeds deposited with the
mortage deed.
149
4. The auditor has to confirm that the property is properly insured and
insurance premiums have been paid in time.
5. The auditor has to examine the title of the Borrower to the property,
etc.
1. The auditor has to examine the nature of the goods and confirm that
the goods are really belonging to the borrower. He should see
whether the loan is granted against railway receipt, lorry receipt, dock
warrant, godown keeper’s receipt etc.
2. In case goods are stored in the godown, he has to see that the rent of
the godown is paid in full and the goods are fully insured.
4. If the goods are of perishable nature, the auditor has to examine the
turnover of the stock of the client.
1. The auditor should see that the policy has completed at least two
years.
2. The auditor should confirm that all the premiums have been properly
paid and the policy is in force by examining the latest premium receipt.
3. The auditor should ascertain that due notice of assignment has been
given to the insurance company.
4. The auditor should see that the loan has been advanced on the basis
of surrender value of the policy as certified by the insurance company.
5. The auditor has to ensure that the premium, if any, paid up by the
lender to keep the policy in force is properly debited to the Loan
Account of the borrower together with the usual interest.
4. While scrutinizing the ledger, the auditor should focus the light on
discounts, returns, cash received, rebates allowed, goods returned
etc.
5. See that the patents are properly registered in the name of the
client only.
6. See that the cost of patent is being written off over its useful period
of life.
7. In case the patent is acquired, cost paid for the same and all
relevant expenses are to be capitalized.
(vi) Copyrights
3. If the client is the owner of many copyrights, the auditor should ask
the client to prepare a schedule of copyrights and get the detailed
information to confirm that the same is shown in the Balance
Sheet.
5. If any copyrights does not command the sale of any books, then
the same should be written off in such year. The auditor has to
verify the same in detail.
154
(viii) Know-how :-
1. Know how is recorded in the books only if it has been paid for. If it
is developed in house, it cannot be capitalised. The auditor should
keep his in mind while verifying know-how.
The auditor should keep this fact in mind while computing the
tax liability for the year under audit.
(viii) Investments :
2. Add to the above list, purchase made during the year and
delete the investments sold during the year with all the above
details.
6. Compare the income received with amount due and adjust the
accrued income.
13. In case of application money paid for shares which are still to
be allotted, that fact is to be specially disclosed in the Balance
Sheet.
5. See that the premium paid and acquisition expenses of lease are
being amortised (written off) over the period of lease adopting a
suitable basis.
(x) Goodwill
2. When the company has written up the values of all its assets on a
revaluation and has raised a Goodwill Account in the books, the
Goodwill appears in the Balance Sheet. In this case, the auditor
has to see the basis of valuation and get satisfied about the same.
If he is not satisfied, the fact should be reported to the
shareholders.
2. As per the provision of the same section, all fixed assets are
required to be physically verified by the management. Therefore,
the auditor should enquire whether such physical verification was
undertaken or not. If yes, he should ask for necessary papers
pertaining to the same. If there is any discrepancy, reasons for the
same should be asked.
3. Any new purchase made during the year are to be verified with
reference to purchase invoice and other papers regarding
installation of the same.
7. Auditor should see that the entire plant and machinery stands in
the name of the client and are free from any charge or
encumbrances. If plant and machinery is mortgaged, then he has
to verify that the documents are properly executed and mention of
mortgage is made in the Balance Sheet.
159
2. The auditor has to see that all expenses incidental to the purchase
of furniture and fixtures is capitalised along with the purchase price
paid for it.
3. The auditor has to enquire whether the furniture and fixtures have
been properly insured or not.
1. The auditor has to examine the title deeds of the property owned
by the client and confirm that the same is freehold.
2. If the property has been purchased during the year, the auditor
has to examine the correspondence with the broker, or solicitor in
details.
160
5. If the title deeds are deposited with the bankers or solicitors for
safe custody, the auditor should get a certificate from them to
confirm the fact.
9. The auditor should see that separate account for land and building
is maintained. Because on land, usually no depreciation is
provided.
15000
160000
4. Many a times, vehicles are purchased by the client for the purpose
of employees who pay a certain sum of money every month from
the salaries. When all the money has been paid, the client
transfers the car in the employee’s name. The auditor should
check the relevant records for recovery made and the transfer
price.
2. The auditor should collect a list of small tools, dies, moulds, rigs,
etc. from a responsible officer and examine the same very
carefully. He should also see that such a list has been certified by
a responsible officer.
3. As regards the valuation of small tools, the auditor should see that
in the case of the concern which manufactured its own tools, the
tools are not to be valued in excess of the cost.
6. The auditor should also see whether such an asset has been
properly shown in the Balance Sheet.
163
(b) Refund of octroi paid for goods sent out later on;
(a) To verify this item the auditor should call for the bank statements
of head office and branches and reconcile them. Any cash
received by the branch or head office in the first week of the new
accounting year might have been in transit on the last day of the
previous year. For the purpose of recording such cash in the
balance sheet an entry is passed in the books as :
(e) See that the entry passed as per item no. (a) is reversed in the
next year.
166
7. Such Discount to the extent not written off should be shown under
Miscellaneous Expenditure on Asset side of the Balance Sheet.
1. That all the liabilities have been clearly stated on the liability side of
the Balance Sheet.
4. That they are shown in the Balance sheet at their actual figures.
exhibit a true and fair view of the state of affairs of the concern. So, the
auditor must take all possible steps to ensure that all liabilities are
recorded properly in the books of accounts of the business. It is advisable
that the auditor should, besides verifying the liabilities as shown in the
Balance Sheet, get a certificate from the management that all liabilities of
any nature have been included in the books of accounts and the
contingent liabilities have been shown by way of a foot-note to the
Balance Sheet or have been provided for.
ILLUSTRATIONS
(i) Share Capital : Though capital is not a liability of the company the
auditor is required to verify it so that he can report on the genuineness of
the balance sheet.
(b) He should check the Cash Book, Pass Book, Director’s Minute
Book to find out the number of shares, the various classes of
shares, the amount received thereon and the amount due from the
shareholders.
(d) In case shares are issued at a premium he should ensure that the
premium on issue should be credited to a separate account.
(h) He should ensure that all the relevant provisions of the Companies
Act are complied with.
(a) The share capital would be the same as in the previous year
unless there are some alterations or addition by way of fresh issue
or otherwise. He should ensure that the relevant legal provision
are fulfilled.
(c) In case bonus shares are issued, the auditor should check
whether the permission from concerned authorities is taken,
whether proper resolution is passed and whether the capitalization
entries are correctly passed.
(d) In case rights shares are issued the auditor should check the bank
book, bank statements. He should ensure that the required
resolutions are passed and that the permission of the concerned
authorities is taken, with particular reference to Sec. 81.
(1) He should check the Profit and Loss Appropriation account for
transfer to reserves, to see the provisions of transfer of profit to
reserve are complied with.
175
(2) He should check the board resolution for transferring the profit to
the respective reserves.
(3) He should ensure that the movement in the reserve accounts i.e.
additions to/deductions from previous year’s balance are properly
disclosed as per the requirements of the law.
(5) See that the reserves are properly disclosed in the balance sheet
as per the law.
In the case of bank overdraft, the agreement with the bank and the
security offered should be examined by the auditor.
1. The auditor should ask for a schedule of creditors and check the
same with the purchase ledger as that is already examined by
him.
6. The auditor should ask for the reason for not paying any
overdue creditors.
177
The auditor should verify the Bills Payable in the following ways:
1. The Bills Payable Book should be checked with the Bills Payable
Account.
2. The Bills Payable already paid should be checked from the Cash
Book and the returned Bills Payables should be examined.
3. To verify the Bills Payables which have not yet matured at the year
end, the auditor should examine the Bills Payable book and should
check the Cash Book of the succeeding years to see whether any
payment has been made in respect of such bills. In case of any
doubt, the auditor may ask the drawers for the confirmation of the
bill.
4. The auditor should see if any charge has been created on the
assets of the concern by accepting the bill and he should see that
the facts are disclosed in the Balance Sheet.
2. The auditor should verifty the board resolution and the entry in the
Profit and Loss Appropriation account.
(xiii) Debentures :
4. The auditor should vouch the cash received on this account with
the cash book.
6. In case the debentures have been redeemed during the year the
same is to be confirmed with the Minutes of Board of directors.
Counterfoils of the cheque books. Bank Pass book and Cash
book, returned debenture certificate etc.
1. See that the Bank Account from which dividend is paid is properly
reconciled. See that dividend account is opened for each year to
avoid mistake of one year’s dividend getting mixed up with next
year’s dividend. See that no entries remain in these Bank
Accounts reconciliation like accounts debited by bank but not
accounted in books, etc. because then the Unclaimed Dividend
shown in the books will be wrong.
3. See that a full list of shareholders who have not claimed dividend
is prepared. This is necessary firstly to prove that there are no
mistakes commited while reconciling the Bank Account and
secondly to prove the accuracy of the Member’s Register. The
auditor should compare this list with the Member’s Register to see
that unclaimed dividend for every shareholder is matching with the
number of shares held by him as per Share Register. This will also
disclose if any dividend is paid to a shareholder who has already
transferred his shares provided he has not encashed his dividend
warrant.
5. See that if the statutory time limit of 3 years is over, the money
being in Unclaimed Dividend Account is transferred to the Central
Government with details of shareholders who have not claimed the
dividend.
184
3. In case calls are in arrears from earlier years, see that reminders
have been sent to the shareholders for payment of calls. If the
Board has decided to charge interest on such calls in arrears see
that reminder contains the request to pay the calls in arrears with
interest. If any part of the calls in arrears have been received
during the year on which interest was payable see that such call
moneys are received with interest.
6. See that, if the Board has passed any Resolution forfeiting shares
on which calls are in arrears, the same is reflected properly in the
accounts by passing of necessary entries and such shares are not
185
2. Fixed deposits from director for less than six months (but
exceeding 3 months) should not exceed 10% of paid up share
capital and free reserves.
10. Return of fixed deposits should be sent to the Registrar before 30th
June. In case it is not sent, auditor should mention it in the
Auditor’s Report as per Section 45 MA of Reserve Bank of India
Act, 1934.
11. Interest accrued but not due should be provided and it should be
shown under Current Liabilities.
12. Fixed Deposits received along with accrued and due interest
would be shown under `Unsecured Loans’.
Verification goes
Vouching involves beyond vouching. It
estabilishing the seeks to establish that
arithmetical accuracy assets as stated in the
Balance Sheet of a
187
Certifies correctness of
records. It is done by the
auditor himself
assisted by senior.
It is done by the junior
3. Time staff of the auditor
under the supervision
of a senior person.
4. Utility
5. Personnel
7.12.1 EXERCISES
5. How would you verify the following – (1) Plant & Machinery (2)
Building (3_ Motor cars and Vehicles (4) Freehold Land (5)
Leasehold Land (6) Assets on Hire Purchase (7) Goodwill (8)
Patents (9) Know-how (10) Wasting Assets (11) Miscellaneous
Expenditure not written-off (12) Deferred Revenue Expenditure
(13) Fictitious Assets (14) Investments (15) Immovable Properties
(16) Investment in Partnership Firms (17) Debtors (18) Bills
Receivable (19) Loans given (20) Loans Given against security
(21) Cash (22) Bank Balance (23) Share Capital (24) Loan Taken
(25) Loans Taken against Security (26) Secured Loans from
Banks (27) Loans taken against Mortgage of Property (28)
Secured Debenture (29) Creditors (30) Bills Payable (31)
Provision for Income-Tax (32) Unclaimed Dividends (33)
Contingent Liabilities (34) Proposed Dividends (35) General
Reserves (36) Capital Reserve (37) Sinking Fund,
(1) Tangible fixed Assets (2) Wasting assets (3) Freehold Land (4)
Leashold Land (5) Building (6) Plant & Machinery (7) Goodwill (8)
Deferred Revenue Expenditure (9) Investments (10) Securities
against Loans.
189
(g) Ascertainment of the fact whether the stock is free from any
charge.
(f) Ascertain that the stock is valued on the same basis as in the
previous year.
(i) Ensure that the goods entered as sold and not delivered
are not included.
(j) Ensure that the goods bought and not entered in the
invoice book are included.
(m) See that the stock held does not include goods held
on consignment as an agent.
(n) Examine carefully the stock sheets and ensure that the
stock includes only the goods dealt with by the client and
does not include any asset purchased.
(o) Confirm that stock has been valued at cost or market price,
whichever is less.
Case 2 : Irish Woollen co. Ltd. v/s Tyson & others (1900)
It was held that there was certainly no duty on the auditor to take
stock.
It was held that the auditor is liable for damages for not detecting
the overvaluation of work-in-progress even though sufficient information
was available to him. He will be guilty of negligence if he fails to take
notice of all available evidence.
194
It was held that the auditor should verify inventory either by test or
by observation or by combination of these two methods. Auditor was held
liable for certifying a Balance Sheet in which stock-in-hand represented
was totally non-existent.
Position in India :
(a) In the case of audit of a limited company the auditor has to report
whether the company final accounts are in agreement with the
books.
Loose tools
Stock-in-trade
Work-in-progress.
(d) U/s 541(2) of the Companies Act, 1956 if proper books of account
at the time of winding up are not kept and if annual stock-taking
statement and statement of goods sold and purchased for two
years immediately preceding the starting of winding up is not kept
then the auditor shall be held liable if he fails to point out this fact
in his audit report.
(i) Meaning :
3. The auditor should ensure that the stock is valued and recorded
according to the generally accepted principles of evaluation. He
should ensure that the valuation is done in confirmation with the
guidelines issued by the ICAI.
(ii) Auditor should obtain a certificate from consignee for unsold stock.
(iii) Account sale from consignee should be checked to find out how
much quantity should remain with the consignee.
(v) Further, consignee should not be debited for goods sent to him by
consignor.
(vi) Unsold stock should be valued at lower of cost and market value.
Cost should include non-recurring expenses of consignor and
consignee. Valuation of closing stock at cos should include
loading, carriage, insurance, freight, octroi, unloading charges etc.
However, selling and distribution expenses should not be included
in cost.
200
(viii) In case goods are sent at invoice price, stock reserve should be
created for unsold stock.
7.15 VALUATION OF
1. Goods on Approval :
On the Balance Sheet date if the customer has some time left to
communicate his decision or has already communicated his unwillingness
to accept the goods then the property in the goods remains with sender
and the goods will be included in the stock of the sender. These goods
will be valued at cost. Damages, if any, caused during the course of
transit should be reduced and adjusted. Such goods cannot be valued at
a price higher than the market price.
When Goods sold are in transit and the seller has already invoiced
them and the sales invoice is recorded in his books of account, the goods
do not belong to the seller.
Till the goods are received they cannot become the property of the
purchaser. But if the risk has already commenced and if the purchaser is
responsible soon after their dispatch by the seller, the purchaser has to
pass the entry in his books. The goods would still be in transit and should
be recorded as such. Such goods should be valued at cost plus incidental
expenses incurred.
7.16 EXERCISES :
Examination of Records
(z) The auditor should carry out an examination of the relevant records
himself about the validity, accuracy and recoverability of the debtor
balances. The extent of such examination would depend on the
auditor's evaluation of the efficacy of internal controls.
(it) The auditor should check the agreement of balances as shown in the
schedules of debtors with those in the ledger accounts. He should
also check the agreement of the total of debtor balances with related
control account. Any differences in this regard should be examined.
(Hi) Verification of subsequent realizations is a widely used procedure,
even in cases where direct confirmation procedure is followed. In the
203
(d) Payments, though being received regularly are quite small in relation
to the total outstanding balance.
(e) An old bill has been partly paid (or not paid), while later bills have
been fully settled.
(/) The cheques received from the debtors have been repeatedly
dishonoured,
(z) Amounts due from employees, which have not been repaid on
termination of employment.
(z'r) The auditor employs direct confirmation procedure with the consent
of the entity under audit. There may be situations where the
management of the entity requests the auditor not to seek
confirmation from certain debtors. In such cases, the auditor should
consider whether there are valid grounds for such a request. In
appropriate cases, the auditor may also need to reconsider the
nature, timing and extent of his audit procedures including the
degree of planned reliance on management's representations.
(z'v) The debtors may be requested to confirm the balances either (a) as
at the date of the balance sheet, or (b) as at any other selected date
which is reasonably close to the date of the balance sheet. The date
should be settled by the auditor in consultation with the entity.
(v) The form of requesting confirmation from the debtors may be either
(a) the 'positive' form of request, wherein the debtor is requested to
respond whether or not he is in agreement with the balance shown,
or (b) the 'negative' from of request wherein the debtor is requested
to respond only if he disagrees with the balance shown.
(vi) The use of the positive form is preferable when individual account
balances are relatively large, or where the internal controls are
205
weak, or where the auditor has reasons to believe that there may be
a substantial number of accounts in dispute or inaccuracies or
irregularities. ,,,.,.
(vii) The negative form is useful when internal controls are considered to
be effective, or when a large number of small balances are involved,
or when the auditor has no reason to believe that the debtors are
unlikely to respond. If the negative rather than the positive form of
confirmation is used, the number of requests sent and the extent of
the other auditing procedures to be performed should normally be
greater so as to enable the auditor to obtain the same degree of
assurance with respect to the debtor balances.
(x) In appropriate cases, the debtor may sent a copy of his complete
ledger account for a specific period as shown in the entity's books.
On these considerations, some entities charge off small tools and other
similar items to Production Account as and when they are purchased
and do not place any value on the unused stock on the Balance Sheet.
Nevertheless, a record of issues and receipts of tools to workmen is
kept, as a check on the same being pilfered and a memorandum stock
account of dies and patterns is also maintained. In other concerns, the
cost of tools, dies, etc. purchased is debited to appropriate assets
account, and an inventory of the unused items at the end of the year is
prepared and valued; the sum total of opening balance and purchase
reduced by the value of closing stock, as disclosed by the inventory, is
charged off to Production Account in respect of such assets. On the
other hand, some concerns carry such assets at their book values at the
end of the first year and charge off the cost of all the purchases in the
subsequent year to the Production Account on the plea that they
represent cost of replacement.
Copyrights are also acquired by surrender of rights and they also should
be verified similarly. The auditor should obtain a schedule of trademarks
and copyrights arid verified that renewal fees have been paid and
charged to revenue. The last renewal receipt should, in each case, be
examined to ascertain that the trade mark has not lapsed. Copyrights and
trademarks are generally revalued at the cost of each financial period.
The auditor should seg that revaluation has been made on a fair and
reasonable basis. Where he finds that any publication has ceased to
command sale, he should have the amount of its copyright written off to
revenue.
Patent Rights
Know-how
In case any item or machinery has been scrapped, destroyed or sold the
auditor should ascertain that the profit or loss arising thereon has been
210
correctly determined which has either been disclosed in the Profit and
Loss Account or credited to the Capital Reserve. In appropriate
circumstances, a certificate should be obtained from a senior official that
this has been done.
Though it is the duty of the management to ensure that fixed assets are
in existence, the auditor also should, periodically, physically examine
various items of plant and machinery and other fixed assets, say, once in
every three or five years, depending upon the size of the concern.
Sometimes the two assets are shown together in the Balance Sheet.
Nevertheless, their ledger accounts should always be separated
particularly in view of the fact that buildings are subject to depreciation
while land in general is not.
If the values of land and buildings are not separately recorded in the
books of account, the same should be separated for purposes of
calculation the amount of deprecation. This should be done with the
assistance of a valuer, unless the same can be achieved on the basis of
some documentary evidence available in the record.
Since buildings are continually repaired and there is only a thin margin of
differentiation between the expenditure of their improvement and that on
repairs, it is necessary for the auditor to scrutinise closely the
expenditure on repairs so as to exclude from its expenditure that could
legitimately be considered to have added either to the life or the utility of
the asset. Such an expenditure should be added to their cost while the
amount incurred on current repairs is written off.
It is not customary to write up the book values of land and buildings even
though their market values have increased but, where this has been
done it will be necessary for the auditor to verify that the appreciation
adjusted has been disclosed as required by the law. On the same
consideration, no notice need be taken of any fall in the market value of
such an asset until the same has crystallized by the asset being sold.
The land holding in the case of real estate dealer will be a current asset
and not a fixed asset. The same should, therefore, be valued at cost or
market value whichever is less. The amount of profit or loss arising on
sale of plots of land by such a dealer should be verified as follows:
212
(lit) If land price lists are available, these should be compared with
actual selling prices obtained. And it should be verified that
contracts entered into in respect of sale have been duly sanctioned
by appropriate authorities.
(v) The prices obtained for various plots of land sold should be
checked with the pian map of the entire tract and any discrepancy
or unreasonable price variations should be inquired into. The sale
price of different plots of land should be verified on a reference to
certified copies of sale deeds executed.
(vi) Out of the sale proceeds, provision should be made for the
expenditure incurred on improvement of land, which so far has
been accounted for.
OUTSTANDING EXPENSES
Outstanding Expenses:
v) See that the usual outstanding expenses are paid of by the time of
audit.
vi) Make sure that provision has been made for all the usual
outstanding, e.g. last Salary, wages, rent etc
vi) Verify the service contracts made by the company and see that all
outstanding arises have been provided for
ix) See that outstanding expenses have been disclosed in the balance
sheet under liabilities.
BILLS PAYABLE:-
Bills Payable
(a) Vouch payments made to retire bills on their maturity or earlier and
confirm that the relevant bills have been duly cancelled.
(b) Trace all the entries in the Bills Payable Book into the Bills Payable
Account to confirm that the liability in respect of the bills has been
correctly recorded.
(c) Reconcile the total of the schedule of bills payable outstanding at the
end of the year with the balance in the Bills Payable Account.
(d) Obtain confirmation from the drawers or holders of the bills in respect
of amount due on the bills accepted by the client that are held by
them.
(e) Verify that the charge, if any created on any asset for the due
payment of bills has been appropriately disclosed.)
the loan, payment of interest thereon and provision of security have been
duly complied with. Further, where practicable, he should write to the
party to confirm the balance of loan outstanding at the end of the year. A
loan can be raised only by a competent authority - in the case of a
company by the Board of Directors, in that of a partnership by the
partners acting jointly and it that of proprietor concern by the proprietor
himself. In the case,of a company there may exist restrictions on the
loans being raised in the Memorandum or Articles of Association. The
right of the Board of Directors of a public company or private company
which is subsidiary of the public company, under clause (d) of sub-section
(1) of section 293 of the Companies Act to borrow money is restricted to
the aggregate of the paid up capital of the company and its free reserves.
However, the company in a general meeting can relax such a restriction
by specifying the amount upto which amounts may be borrowed by the
Board of Directors. The deed of partnership in the case of a firm may also
contain restrictions on the amount of loans that the partners can raise.
The auditor should therefore, examine the right of the borrowing authority
to confirm that the loan or loans have been raised in the proper exercise
of the authority vested in the Board of Directors or the partners as the
case may be.
CONTINGENT LIABILITIES
From the auditing point of view, different types of contingent liabilities are
divided into two broad categories, one in respect of which a provision has
been made and the other for which there is no provision. AS 4 provides
guidance in respect of circumstances when provision has to be made for
216
218
8
INTRODUCTION TO COMPANY AUDIT
STRUCTURE
8.0 Objectives
8.1 Qualification Of An Auditor
8.2 Disqualification Of Auditors
8.3 Appointment Of First Auditors
8.4 Appointment Of The Subsequent Auditor
8.5 Removal Of Auditor
8.0 OBJECTIVES
2. Section 226(4)
A person is not eligible for appointment as an auditor of any
company if he is disqualified from acting as auditor of that
company’s subsidiary or holding company or of any other
subsidiary of the same holding company and vice- versa.
3. Section 226(5)
If an auditor after his appointment, becomes subject to any of the
disqualification mentioned in section 226(3) and section 226(4), he
shall be deemed to have automatically vacated his office.
222
9
COST ACCOUNTING
STRUCTURE:
9.0 Introduction
9.1 Objectives
9.3 Definitions
9.13 Summary
9.0 OBJECTIVES
9.1 INTRODUCTION
9.3 DEFINITIONS
(a) Costing:
Systematic and useful cost data and reports are required to manage the
business to achieve its objectives.
Cement Tonne
Cable Metre
Paper Ream
226
iii) Cost account locates the specific causes for the variations in profit.
It points out the losing product or operations. It indicates reasons for
loss and suggests remedial measures in time.
v) Cost accounts give actual cost for price fixation. True demand and
supply play vital role in fixing price. But cost is an essential guide
here.
vi) It provides vital data to till in tenders. Tenders filled in with the help
of marginal costing technique are successful.
xii) Cost Accounting lays down cost centres and responsibility centres
which ensures proper organizational structure.
229
xiv) Cost of closing stock of raw materials, work in progress and finished
products are readily available in cost records.
All organizations will not get all the advantages listed above.
However, an efficiently operated costing system with full support from
management can reap most of them.
All other costing methods are either variants of these two methods or
techniques designed for particular purposes, for specific occasions and
for specific conditions.
iii) The size, lay out and organisation of the factory should be
adequately described for the benefit of those operating costing
system.
viii) The forms should be got printed. It should contain full instructions.
Persons who use them should be adequately trained to ensure
accuracy and relevance of the data written on the forms.
ix) An examiner should check and sign every entry in the forms.
xiv) The cost accounts and the Financial accounts should be interlocked.
Alternatively, result of the two sets of accounts should be reconciled.
The elements of cost are (i) Direct material (ii) Direct labour (iii)
Direct expenses and (iv) Overhead expenses.
The following chart depicts the broad headings of costs and this
acts as the basis for preparing a Cost sheet.
235
Elements of cost
Overheads
CLASSIFICATION OF COSTS
236
Examples-
v) Freight, insurance and other transport costs, import duty, octroi duty,
carriage inward, cost of storage and handling are treated as direct
costs of the materials consumed.
Example :
Examples:
Examples :
Examples :
Examples:
Rent, rates, taxes and insurance of office buildings, audit fees, directors
fees.
Examples :
Correct Sequence:
239
Direct Materials
Direct Expenses
Indirect Materials
Indirect Expenses
Works cost
Indirect Materials
Indirect Expenses
Indirect Materials
(Delivery from
Indirect Expenses
=
240
Cost of Sales
Profit
Sales
9.13. SUMMARY
a) Cost centres
b) Cost units
c) Costing methods
e) Elements of costs
242
10
COST AND COST CLASSIFICATIONS -
COST SHEET
STRUCTURE
10.0 Objectives
10.1 Introduction
10.5 Summary
10.0 OBJECTIVES
10.1 INTRODUCTION
Cost can be classified as (i) fixed (ii) variable and (iii) semi -fixed
or semi variable in terms of their variability or changes in cost behaviour
in relation to changes in output or activity or volume of production. Activity
may be indicated in any form such as units of output, hours worked,
sales, etc. The separation of costs into variable and fixed categories is
the most difficult part of the costing operation. Certain costs are easily
identifiable as variable or fixed while other costs can be segregated only
after careful consideration of their nature and an examination of their
behaviour.
i) Fixed costs:
Fixed cost is a cost which does not change in total for a given time
period despite wide fluctuations in output or volume of activity. These
costs must be met by the organisation irrespective of the volume level.
These costs are also known as capacity costs, period costs or stand - by
costs; for example, rent, property taxes, supervisor’s salary, advertising,
insurance etc.
There are certain expenses /costs which do not form a part of cost
sheet. Some of these expenses are an apportionment of profit. Examples
of these expenses are -
i) Dividend to shareholders
ii) Income Tax
iii) Interest on loan
iv) Donations paid
v) Capital expenditure
vi) Capital loss on sale of assets.
vii) Commission to Partners / Managing Director
viii) Discount on issue of shares/ debentures
ix) Underwriting commission.
x) Writing of goodwill/ bad debts
xi) Provision for Taxation, Bad Debts or any kind of Fund or
reserves.
(Production … Units )
248
Direct Materials
Raw Materials
Direct Labour
Direct Expenses
--------------- ------------
Prime cost
Factory overheads
Cost of Sales
249
Sales
i) Prime Cost
Indirect labour is that labour which does not affect the construction
or the composition of the finished product. This is the labour cost of
production related activities that cannot be associated with or
conveniently traced to specific product through physical observation. For
example, Foremen’s salary and salary of employees engaged in
maintenance or service work. Indirect expenses covers all expenditure
incurred by the manufacturer from the time of production to its completion
as delivery to customer by way of rate of product. Any cannot be allocate
but which can be apportioned to or absorbed by the cost cehtres cost
250
units are known as indirect expenses. These expenses are incurred for
the benefit of more than one product, job or activity and, therefore, must
be apportioned by appropriate bases to the various functions or products.
For example, lighting and heating, maintenance factory manager’s salary,
watch and ward department’s salary etc.
Illustration -1
Particulars Rupees
Solution :
Rs. Rs.
Materials consumed
+ Purchases 110000
113000
109000
180000
Prime cost
44000
252
2,30,000
2,30,000
Sales 2,75,000
Illustration -2
Rs.
Opening Stock:
Closing stock:
Sales 2,00,000
Solution
Ltd.
Rs. Rs.
Factory overheads :
Factory Wages 2,000
Factory expenses 4,000
Factory Rent & Rates 2,500
Depreciation 2,500
11,000 11.00
(II) WORKS COST 1,32,000 132.00
Administrative Overheads :
Office Salaries 15,000
Office Expenses 12,000 27,000 27.00
(iii) COST OF PRODUCTION 1,59,000 159.00
Illustration – 3
NRC Ltd., manufactured and sold 1000 Radio sets during the year
2009. The summarized accounts are given below :
Rs. Rs.
2,00,000 2,00,000
15,000
255
75,000 75,000
It is estimated that output and sales will be 1200 Radio Sets in the
year 2010. Prices of Materials will rise by 20% on the previous year’s
level. Wages per unit will rise by 5% Manufacturing expenses will rise in
proportion to the combined cost of materials and wages. Selling and
distribution expenses per unit will remain unchanged. Other expenses will
remain unaffected by the rise in output. Prepare cost sheet showing the
price at which the Radio Sets should be sold so as to earn a profit of 20%
on the selling price.
Solution
COST SHEET
------------------------------------------------------------------------------------------------------------
2009 2010
------------------------------------------------------------------------------------------------------------
Illustration – 4.:
A factory can produce 60,000 units per year at its 100% capacity.
The estimated cost of production are as under:-
Indirect Expenses :
The factory produces only against order and not for stock. If the
Production programme of the factory is as indicated below and the
management desires to ensure a Profit of Rs. 1,00,000 for the year, work
out the average selling price at which per unit should be quoted:
257
Solution :
-------------------------------------------------------------------------------------------------------------
Semi –variable
@ Rs.50,000 p.a.
For 9 months
Profit -- - 100000
----------------
Sales 750000
-----------------
Illustration -5
The following figures have been taken from the books of M Ltd. as on
31.12.2009
258
The Company manufactured 4000 units during the year 2009. The
company is required to quote for the price for supply of 1000 units during
the year 2010. The cost of material will increase by 15% and factory
labour will cost more by 10% in the year 2010 Prepare a statement
showing the price to be quoted to give the same percentage of net profit
on sales and was realized during 2009.
Rs. Rs.
Rs.
Materials (20 x 1000) = 20,000
+ 15% increase 3,000 23,000
Factory wages (11.25 x 1000)= 11,250
10% increase 1,125 12,375
Prime Cost 35,375
Factory Expenses (4.375 x 1000) 4,375
Works Cost 39,750
Establishment Expenses (2.50 x 1000) 2,500
Total Cost 42,250
Profit (20% on Sale i.e., 25% of Cost) 10,563
Sales 52,813
Note : Percentage of Profit on sales earned during the year 2002 is 20%
4000
= = x 100 = 20%
2000
Illustration – 6.
In a factory two types of T.V sets are manufactured i.e black &
white + colour. From the following particulars prepare a statement
showing cost and profit per T.V Set sold. There is no opening or closing
stock.
Solution
10.5 SUMMARY
3. What are the items of expenses which are excluded from cost sheet?
Why?
262
Particulars Rupees
Purchase of Raw materials 148000
Direct wages 132000
Rent & Rates 14000
Carriages inward 6000
Stock on 1-1-2009
Raw materials 22000
Work in progress 18000
Finished goods 30000
Stock on 31.12.2009
Raw materials 24000
Work in progress 35000
Finished goods 25000
Factory expenses 18000
Sales 420000
Selling and distribution costs amounted to 75 paisa per unit sold. 25000
units were produced during the year. You are required to prepare cost
sheet showing break –up of costs, total net profit and net profit per unit
sold.
Units produced and sold during the month 10000.Find out the
selling price per unit on the basis that Profit mark up is uniformly
made to yield a profit of 20% of the selling price. There was no
stock of work in progress at the beginning or at the end of the
period.
7. The following particulars are extracted from the works and other
relevant source in respect of a Ltd. Company?
d) The direct wages in all other shops during the last year
amounted to Rs.800000 as against Rs. 180000 of factory
overhead.
265
11
RECONCILATION OF PROFIT AS PER
COST AND FINANCIAL ACCOUNTS
STRUCTURE :
11.0 Objectives :
11.1 Introduction
11.0 OBJECTIVES :
11.1 INTRODUCTION
Expenses that are not taken into account. The under mentioned
expenses are usually not included in overheads or, for that matter in cost.
It is well known that in Cost Book Stocks are only valued at cost.
But in Financial Books stock are valued either at cost or market price,
whichever is lower.
1. Prepare a cost sheet for a particular period and find out costing
profit or loss if it is not given.
2. If financial profit or loss is not given then find out the same by
preparing Trading and Profit and loss account for a period which
corresponds to the cost sheet.
Between Financial Profit and Cost Profit For the Year ended
Rs Rs
Particulars
xxx
Less
xxx
xxx
xxx
xxx xxx
xxx
Particulars Rs Rs
Less xxx
Rs.
Solution
Trading & Profit and Loss A/c for the year ended 31/12/09
Rs Rs.
To Wages 100000
400000 400000
Solution :
-----------------------------------
Works expenses
------------------------------------
---------------------------------------
-------------------------------------------
-------------------------------------------
------------------------------------------
b) Reconciliation Statement
275
--------------------------------
--------------------------------
Illustration 3 : The Trading & Profit & Loss account of “A’ Ltd. is as
follows:-
@ of Rs Rs.1.50 each)
------------ 75000
43870
To Administrative 5340
Expenses
---------
To Depreciation
1100 56470
To Net Profit
20300
------------
56470
The profit as per cost accounts was only Rs.19,770. Reconcile the
financial and costing profits using the following information :
Solution :
----------- ------------
22770
Exp.
20300
Solution :
Dr Cr.
Rs Rs.
Fines
200 By Income not credited in
Discount
100 Cost accounts: 400
Loss on sale of Care
1950 Dividend Received 150
Income Tax
8000 Interest on Bank FD
Tr. to Reserves
1000
Dividend
4800
20186 20186
279
Illustration : 5
M/s ESVEE Ltd. has furnished you the following information from
the financial books for the year ended 31st December, 2009.
Particulars Rs.
3. Statement of Reconciliation
Solution
A) Financial Books
Rs Rs.
-------------- --------------
7,30,000 7,30,000
To Factory overheads
94,750 By Gross Profit b/d 3,02,500
To Administration c/d
1,06,000 By Interest received 250
To Selling Expenses
55,000 By Rent Provided 10,000
To Bad Debts
4,000
281
--------------- --------------
3,12,750 3,12,750
Labour 150000 15
-------------- -------------
--------------- ------------
Administration overheads
---------------
622500
--------------- -------------
Selling Expenses
607500
61500 6
282
--------------- ------------
PROFIT 48500 4
--------------- -------------
SALES 717500 70
Interest 250
----------- ------------
70250
Closing Stock
Bad Debts
----------- ------------
283
Books Recommended
EXERCISES:
Rs. Units
------------------------------------------------------------------------------------------
Materials 100000.00
Wages 50000.00
Closing stock:
Materials 3000.00
Wages 2000.00
7000.00
------------------------------------------------------------------------------------------
Rs Rs.
To Selling an Distribution
Expenses 6500.00
To Debenture
Interest 1000.00
124000.00 124000.00
The net profit shown by the cost accounts for the year is
Rs.16.270 Upon a detailed comparison of the two sets of accounts it is
found that (a) The amounts charged in the cost account in respect of
overheads charges are as follows:- Works overhead charges Rs.11,500;
Office overhead charges Rs.4590, Selling and Distribution Expenses
Rs.6,640 (b) No charge has been made in the cost account in respect of
debenture interest. You are requested to reconcile the profits shown by
the two sets of accounts.
5. During the year a company’s profit have been estimated from the
costing system to be Rs.23,063 whereas the financial accounts
prepared by the auditors disclose a profit of Rs.16,624. Given the
following information you are required to prepare a Reconciliation
statement showing clearly the reason for the difference.
286
Profit and Loss Account for the year ended March 3, 2009
Stock 2,47,179
Purchases 82,154
-----------
3,29,333
-----------
----------- -----------
3,46,500
3,46,500
9,845
Administration Gross profit
expenses
b/d 48,329
Sundry 316
Selling expenses 22,176 Income
-----------
-----------
48,645
48,645
287
Question 6 :
Stock 100000.00
Purchases 80000.00
---------------
180000.00
Less:
80000.00
Closing stock
--------------
100000.00
-------------- -------------
-------------- --------------
-------------- --------------
40000.00 40000.00
Question 7:
Rs.
Question 8 ;
Rs Rs.
------------
8,70,000
290
12
STRUCTURE :
12.0 Objective
12.0 OBJECTIVES
12.1 INTRODUCTION
Materials and labour are the two major elements of costs. Hence,
the ascertainment and control of these costs are important aspects.
Proper accounting and control over material purchase, consumption and
inventories are important aspects of effective management. Labour is also
an essential factor of production. Therefore, it is necessary to use
different methods of time keeping, time booking, wage payments and pay
roll accounting and treatment of idle time and overtime in cost accounts.
Factory overheads are opening costs of a business enterprise which
cannot be traced directly to a particular unit of output. It is the aggregate
of indirect materials. Labour and expenses.
293
PURCHASE OF MATERIALS
a) Purchase Requisition:
b) Purchase order:-
i) Receipts of materials.
vii) Ensure that the stock neither exceed maximum level or go below the
minimum level.
MATERIAL REQUISITON
Code No. Description Quantity Weight Bin Card No. Stores Ledger Folio Rate Amount
Rs.
a) FIFO Method :- The first in first out method is used when the
materials received but are to be issued first. The price of the earliest lot/
quantity is taken first and then for the next lot. The value of closing stock
confirms more or less, to the current market price. This method is suitable
for falling price.
I) BIN CARD :
BIN CARD
Date Initials
STORES LEDGER
Unit ….
G.R. No. Qty. Rate Req. No. Qty Amt. Qty. Rate Amt.
LABOUR CONTROL :
TIME CARD
Department ……………..
Total Wages
Time keeper
Foreman
Job card is issued to each worker for job at the beginning of each
day or week depending upon the number of job he has to work on. It
gives complete record of the time spent by each worker on different jobs
during a particular period. The specimen job card is given below :
JOB CARD
On Off
Foreman ……..
Overtime……..
304
Idle time is a period or duration for which workers are paid but they
have not worked for production in the factory. When workers are paid on
time basis, some difference between the time for which they actually
spend upon production is bound to arise. Idle time does not include
holidays, leave etc. It may be normal in nature or abnormal. Normal idle
time is that idle time which is unavoidable; it is of normal nature and is
inherent in a production or work environment. Normal idle time is caused
due to the movement of workers. Abnormal idle time is that time which is
not caused by the usual routine of production. The time wasted by the
workers may represent abnormal idle time. The loss incurred by abnormal
conditions cannot be considered as part of the cost of the product and
should be transferred to the Costing Profit and Loss A/c. For example
time lost due to break down of machinery, lack of materials, strikes, lock
out etc.
305
12.12 OVERTIME
Overtime is the time put in by the workers and work done by them
beyond normal hours of work. It is an extra time over and above the
schedule hours of work.
CLASSIFICATION OF OVERHEADS
iii) Semi- variable overheads are the expenses which are partly fixed
and partly variable.
307
(HP hours)
6 What are the reasons for booking workers on idle time in a factory?
Balance Sheets
12000 17000
The Following is a summary of the Profit and Loss A/c for the year 1975.
Rs. Rs.
42400 43000
---------- ------------
59400 59400
No plant and machinery was sold during 1975. The net profit
Rs.16400 is the amount after charging Rs.15000 for depreciation of Plant
and Machinery and after writing off preliminary expenses Rs.1200.
i) The net increase in Working Capital during the year 1975 and
7. The Balance Sheets of XYZ Ltd. As on 31st March, 1974 and 31st
March, 1975 are given below
312
Balance Sheet
The whole Share capital of the company was issued for cash
Depreciation on Plant and machinery written. Off during the year to 31st
March 1975 amounted to Rs.28000 During the same year company paid
a Dividend of Rs.15000
i) the net increase in the Working Capital during the year ended 31st
March, 1975 and
Balance Sheets
16900 12100
Land which had cost Rs.10000 was sold for Rs.25000 Some of
the marketable securities were sold at a loss of Rs.3000. difference
between the figures to trade investments represents amount written off in
respect of worthless investments. A divided of Rs. 25000 was paid. An old
machinery which had cost Rs.10000 (accumulated depreciation thereon
Rs.8000) was sold for Rs.6000
(Ans. Increase in W.C Rs. 9200; Funds from operations Rs.58800, Total
of Sources & Applications Rs.129800 and Rs.120600 respectively)
314
12. Below are given the Balance Sheets as on December, 31, 1969
and December, 31 1970 for Ashoka Co. Sales for the year 1969 were
Rs.2,10,000. Net income after taxes was Rs.7000. In arriving at the Net
Profit, items deducted from sales included among others. Cost of goods
sold Rs.165000; depreciation Rs.5000 wages and salaries Rs.20000.
There was a gain of Rs.1000 on the sale of a truck. The truck had cost
Rs.600, depreciation of Rs.4000 had been accumulated for it and it was
sold for Rs.3000. This was the only asset written off during the year. The
company declared and paid Rs.6000 in dividends during the year.
Balance Sheets
Assets
11000
Liabilities
----------- ----------
316
13
METHODS OF COSTING
STRUCTURE :
13.0 Objectives
13.1 Introduction
13.8 Exercises
13.0 OBJECTIVES
(a) Define unit or batch costing and determine the cost of production of
each batch or unit.
.
317
31.1 INTRODUCTION
this method of costing. In batch costing the cost unit is a batch of specific
quantity of identical products.
Illustration – 1 :
SMP Ltd. manufactures papers. The following details are given for the current year
Solution :
(Rs.) (Rs.)
Direct materials –
Direct Labour
Unskilled 20,000 50
Factory overheads :
Illustration – 2 :
Labour is paid at
the rate of Rs.2 per
hour. The other
details are :-
Month
Rs,15000 5000
321
PGG Ltd.
Cost - - - -
--------------
Profit Rs.15,000
--------------
Workding :-
Rate 2 2 2
Rs. = 3 2 3
Illustration – 3 :
Wages :-
Variable :-
Fixed :- Rs. 20,000 for 10,000 working Hours. Determine the cost of Job
No. 101 and price for the job to give a profit of 25 per cent on the Selling
Price.
324
Solution :
Amount Rs.
-----------------------
Materials 4020
Dept. B – 40 x 2 = 80
Dept A – 60 x 1 Rs. 60
Dept B – 40 x 2 Rs. 80
--------
--------
Workding :-
325
2) Fixed overhead Rate = Rs. 20000 for 10000 hours = Rs. 2 per hour
Illustration – 4 :
----------
Total 5000
---------
---------------------
---------------------
326
From the following information, compute the cost of Job No. 123
Solution :
Amount Rs.
50
Direct Labour :-
Prime cost 60
Factory overheads :-
Working :
2000
Fixed overhead rate to make ready = = Rs.2
1000
(i) The work is done at a site which is generally away from the
contractor’s premises.
(c) Contractee : The person for whom the job is being done is the
contractee.
(1) Materials :-
(2) Labour :
(4) Sub-Contracting :
Total
330
Cash received
Work Certified
Since the cash received from the contractee is normally less than work
certified, this method is suitable for conservatism principles.
Illustration – 5 :
Rs.
Solution :
Contract Account
Rs. Rs.
To Depreciation on 3,000
Plant
2,12,000 2,12,000
Note :- Since the contract has been completed less than 25% no profit will
be taken to Profit & Loss Account. Hence, the balance of contract
account will be taken as work in progress.
Illustration – 6 :
Rs.
Life of the plant purchased is 5 years and the scrap value is nil.
Prepare Contract account, and show the amount of profit which would be
taken on contract on a conservative basis.
Solution :
Contract Account
Rs. Rs.
89,000
7,68,000 7,68,000
7,50,000
12,00,000
335
(ii) Since contract is complete more than 50% but less than 75% half
of the estimated profit should be taken to Profit and Loss Account
which will further be reduced to the proportion of cash received to
work certified.
Cash received
Cash received
Work certified
1 x 6,00,000
2 x 7,50,000
100
80
Materials :
Labour :
Direct Expenses :
Manufacturing Overheads :
Abnormal losses are not included in the cost of normal output. The
average cost of the lost units is charged to an abnormal loss
account which is credited with the scrap and transfered to profit
and loss account. The value of abnormal loss is determined as
under :
Abnormal Gain :
Abnormal gain arises when the actual loss is less than the normal
loss expected. When the loss is less than expected, the result is abnormal
gain. The value of abnormal gain is calculated in a similar manner to an
abnormal loss and such value is debited to the concerned Process
Account and Credited to a separate account called Abnormal Gain
Account. The amount of scrap which would otherwise have been realized
had there been normal loss and no abnormal gain is debited to the
abnormal gain account. The balance of abnormal gain account is finally
transferred to the Profit and Loss Account.
Joint Products :
By Products :
Illustration – 7 :
I II III
Solution :
Process I Account
Unit Unit
Rs. Rs.
Process II Account
Unit Unit
Rs. Rs.
342
head
Rs. Rs.
To Production
Overhead
Head
2,820 28.20
Rs. Rs.
---------- -----------
- -
--------- -----------
Illustration – 8 :
I II III
The actual output and normal loss of the respective process were.
Solution :
Process I Account
Rs. Rs.
To Production
Overhead 22,500
Process II Accounts
Rs. Rs.
Overhead 36,800
Working :
= 3,600 Units
= --------------------- = Rs .--------------
3,600 3,600
= Rs. 5025
= Rs. 10,050
346
To Production
Overhead
450 12,101
Working :
= 3,400 – 850
= 2,550 Units
2,550 2,550
By Cash –
Process III 700 2,800
By Abnormal
Gain
150 600
Illustration – 9 :
Rupes
Depreciation 26,000
Solution :
Passenger KM
Rs. Rs.
----------- ----------
------------ ------------
------------ ------------
75
100
75
= ----- (4 x 40 x 50 x 2 x 30)
= 100
= 0.75 (480000)
= 3,60,000
Illustraction – 10 :
Power is used only in winter and the charges are Rs. 20/- for a room,
when occupied.
- There are 100 rooms in the hotel out of which 80% of the rooms are
generally occupied in summer and 30% in winter. The period of
summer and winter may be considered to be of 6 months in each
case. A month may be assumed of 30 days.
Solution
Rs.
( Per Annum )
Linen 6,000
Sundries 16,000
--------------
353
Total 5,37,000
-------------
-------------
------------
------------
1155750
19800
Working :
Total 19800
Lighting
Power
-----------
TotaL 36600
-----------
13.8 EXERCISES
Labour is paid at the rate of Rs. 20 per hour. The other details are :-
Rs.
7. A work order for 5000 units of a commodity has to pass through four
different machines of which the machine hour rates are :-
No.3 Rs.40.00
After the work order had been executed, Materials worth Rs. 4,000 were
returned to stores. Office overheads are to be estimated @ 60% of the
356
8. Job No. X-10 has incurred the following costs by ABC Co. Ltd.
Variable overhead –
Fixed overheads –
Your are required to calculate the cost of job No. X-10 and
estimate the percentage of profit obtained if the Price quoted to
the customer was Rs. 372.
Overhead expenses –
Casting cost come to Rs. 250 per operation and the input of mild
steel in this case was 1000 kgs. 30 kg. of the metal is tested out
and the value creditable is Rs.1 per kg. Also 2 kgs were lost in the
process of melting and moulding. Actually 105 castings are made
out of which 3 were defective and were rejected on inspection.
10. ABC Contractor were engaged on one contract during the year
2009. The contract price was Rs. 2,00,000. The trial balance
extracted from the books on 31st December 2009 stood as
follows :
Rs. Rs.
Buildings 27,000
Contract Account
358
Materials 37,000
Plant 20,000
Wages 50,000
----------- ---------------
1,44,000 1,44,000
------------- -------------
& loss account the estimated profit on the basis of cash received.
Actual expenditure for the year 2008 and 2009 was as follows :
Rs. Rs.
Particulars Process
A B C
(% of input)
(5000 units )
14. A Transport company has been given a 40 k.m. long route to run a
bus. The bus costs Rs. 500,000 and has been insured @ 4 per cent
per annum. Annual taxes payable amount to Rs. 3000. Garage Rent
is Rs. 200 p.m. Annual Reparis will be Rs. 4000 and the bus will be
used for 5 years.
The drivers salary will be Rs. 300 p.m. and conductors salary will be
Rs. 2400 p.m. Cost of Printing tickets will be Rs. 1000 p.m,
Manager’s salary will be Rs. 4000 per month.
361
Fuel cost will be Rs. 60 per 100 k.m. The bus will make 3 round
trips carrying an average of 30 passengers on each trip. Assuming
25% profit on taking, calculate the bus fare to be charged from each
passenger. The bus runs on an average 25 days in a month.
15. The following cost data pertaining to the year 2009 has been
collected from the books of BEES Ltd. Prepare a cost sheet showing
the cost of generation of Power per unit of KWTS.
Rs.
Coal consumed per Kwts is 1.5 and cost of coal delivered to the power
station is Rs. 33.06 per metric tonne. Depreciation rate chargeable is 4%
p.a. and interest on capital is to be taken at 7%.
362
14
ELEMENTARY PRINCIPLES AND
TECHNIQUES OF MARGINAL AND
STANDARD COSTING
STRUCTURE :
14.0 Objectives
14.1 Introduction
14.13 Exercise
14.0 OBJECTIVES :
This units covers two techniques viz : (1) Marginal Costing and (2)
Standard Costing
• Classify various costs into the three groups : Fixed, Variable and
Semi-Variable
• Divide the Semi-Variable costs into (a) Fixed Costs and (b)
Variable Costs.
363
14.1 INTRODUCTION
Rs. Rs.
Material 50 50000
Wages 30 30000
Rent 3000
Total 100000
In the above chart you will notice that Material and Wages
increase or decrease directly in proportion to the level of production i.e. if
1500 units are manufactured raw material cost will be Rs. 50 x 1500 = Rs.
75000 and wages will be Rs. 30 x 1500 = Rs. 45000. However, the other
components of costviz Supervisors Salary, Rent and Expenses will
remain the same. Take, for instance, Rent-whether you manufacture 1
unit or 1500 units, in the same space taken on rent, the rental expenses
will not change. If the Rent is Rs. 5000 per month, even if you
manufacture only one unit of the product, the Landlord is not going to
reduce the rent. Marginal cost refers to the portion of cost of a product
which increases or decreases in proportion to the increase or decrease in
quantity produced. Marginal cost is also referred to as variable cost. In the
following sections we will see how to use this idea to analyze the cost of a
product and ascertain the profit at various level of production.
364
Assume that you are a manufacturer and you just receive a big
enquiry for 40000 meters of tape. You decide to submit your most
attractive quotation and started to work out the probable cost of 400000
meters of tape. You will base your calculation on what the cost ought to
be under given conditions of output, facilities and efficiency. The basis
used by you can be referred to as Standard costs.
In the ensuing sections you will learn to identify the standard cost
components, relate them to the matieral cost, labour cost or overheads as
the case may be, derive the standard total cost of the product and arrive
at the difference between standard cost and actual cost and also analyse
and quantify the costs contributing to the difference.
Sales …………………..
__________ __________
__________
Marginal Contribution
366
Illustration 1.
ABC Co. Ltd. has its plant capacity of 20000 units per month. The
variable cost per unit is as follows :-
Rs.
Total 6.00
Fixed overheads are Rs. 25000 per month or Rs. 1.25 per unit at
normal capacity Fixed selling and distribution overheads are Rs. 5000 per
month. Actual Production, Sales and Inventory units were as follows :-
Uints Produced
Units sold
Solution
INCOME STATEMENT
Rs Rs.
Sales 210000
-----------
-----------
132000
----------
(100*6)
Factory 25000
The break – even point can be defined as the point of sales levels
at which profits are Zero and there is no loss. In other words, Break –
Even Point is that point at which total costs are equal to total sales
revenue. At break even point profit being zero, contribution is equal to
fixed costs. If the actual volume of sales is higher than break even volume
there will be a profit. Beyond the break even point, all the marginal
contribution represents profit.
Break even point establishes the output level which evenly breaks
the costs and revenues.
OR = ---------------------------------------------
Sales
OR = ---------------------------------------------
Sales
Illustration 2
From the following particulars calculate break even point for a) unit
and b) Sales value.
Total Sales
Output
Solution :-
370
Fixed Costs
2000 2000
10-2 8
Fixed Cost
P.V.Ratio
Sales 50000
BEP = 0.8
(a) The marginal costing method requires that all costs should be
divided into fixed and variable components. It is not easy to
divide all Semi-variable costs into fixed and variable costs.
(b) Marginal cost is not full cost. Hence, it cannot be used for
fixation of price in normal course of time. It is useful for short-
term management decisions only.
371
Illustration 3
The Golden Snow company manufactures and sells 10000 jars direct to
consumer under the brand name `Golden’ per month @ Rs. 12.50 Per
Jar. The company’s normal production capacity is 20000 Jars per month.
An analysis of cost for 10000 jars show the following :-
----------
46450
Selling 79550
---------
Total 126000
-----------
The Company has received an offer for the export under a different brand
name of 120000 jars of snow at 10000 jars per month at Rs. 7.50 per. jar
State whether the order should be accepted or not?
372
Solution :-
Marginal Cost
20000
Thus, it would be clear from the above cost analysis that the
marginal cost per Jar is Rs. 4645 as against the export Price of Rs. 7.50.
There is a net loss of Rs. 1000 at 50% capacity. The export order would
bring additional contribution of Rs. 28550 which would result in net profit
of Rs. 27550. Hence, it is advisable to accept the export order.
Illustration 4
You are required to find out (a) Break even point (b) The number
of buckets to be sold to get a Profit of Rs. 14000 and (c) If the Company
can manufacture 600 buckets more per year with an additional fixed cost
of Rs. 2000, what should be the Selling Price to maintain the profit per
bucket as stated above?
Solution :
40 40
14000
Profit Per bucket on of the sale of 1600 buckets= -------- Rs. 8.75
1600
374
= 115250
115250
2200
Illustration 5 :-
Solution :
(160000*11)
1905000
---------- ------------
Factory 360000
Selling 270000
-----------
630000
------------
20000*1905000
170000
Illustration 6 :
Solution :-
8250
2.75
= 300
= (AP*AQ) – (SP*SQ)
= (2.75*2500)-(2.50*2400)
= (AH* AR – SH * SR)
period were more or less than the standard labour hour required to
complete the work. It is calculated as follows.
= (AR – SR) * AH
Illustration 7 :
The standard time rate for unit component “X” are given below :-
Solution :-
(AH * AR – SH * SR)
-1100
= Rs. 58,900-60,000
(AR – SR) * AH
-3100
= Rs. (15500-15000)*4
Illustration : 8
Solution :
=Rs. 16000*2-30000
=Rs. 32000-30000
= 47000 – 16000*3
= 47000-4800
= Rs. 500(A)
387
Illustration 9
Production units
Fixed overheads
Solution
Workings
= 31000 – (33000*1)
388
= 31000 – 30000
= 31000-3000
= 1000 (A)
= Rs.1.50 (22000-20000)
= Rs. 1.50*2000
Illustration 10
Standards :-
Actuals :-
Output 210000
Calculate :-
389
Solution :-
= (280000*0.9-300000*1)
= Rs. 252000-300000
= Rs.48000 (F)
= 280000(0.9-1.00)
= 280000*0.10
= Rs. 28000 F)
= 1(280000-300000
Working
252000
280000
Illustration 11.
Wages paid for 18000 hours @ Rs. 0.40 each = Rs. 7200
Calculate
= Rs. (16500*2.40-16000*2.500)
= Rs.39600-4000
= Rs.400 (F)
= 16500 (2.40-2.50)
= 2.50 (16500-16000)
= Rs.2.50*500
= Rs.1250 (A)
cost
= Rs. 7200-8000
= 18000 (0.40-0.50)
= Rs,1800 (F)
* SR
= (18000-16000)*0.50
= 2000*0.50
Illustration 12.
Solution :
Working
3600
4800
4800
1000
3600
1000
- 7650
1500
- 6300
9000
6300
1500
393
= Rs.6300-1500*3.6
= 6300-5400
= 7650(0.70-0.75)
= 7650*0.05
= 0.75 (7650-4.8*1500)
= 0.75(7650-7200)
= Rs. 0.75(450)
14.13 EXERCISES
Variable Cost :
----------
Fixed Costs
----------
---------
Profit 21400
Q.8 The following data are obtained form the records of a Factory
-------- ---------
----------
395
Calculate :
Q.9 The Standard quantity and Standard price of raw material required
for one unit of Product A are given below :-
Dept. A Dept. B