General Considerations
In any business probably cash transactions account for the largest bulk of transactions. Cash, being a highly liquid asset, is exposed to frauds of various types. Therefore, it is essential for an auditor to satisfy himself that the cash transactions entered into by the client have been correctly recorded in the books of account and all the procedures laid down for entering into such transactions have been complied with.
To verify cash transactions, more than anything else, it is necessary that the system of accounting and internal control operating in the organisation should be reviewed; also the recording of each transaction should be checked. It should also be seen that each relevant voucher has documentary evidence which is valid and that the statement is authorised by a competent official. Further, on its inclusion in the final accounts, its nature would be truly disclosed.
- Internal Control System : It is a combination of several procedures adopted by an entity designed:
- to give protection against losses through fraud, waste, mistakes, etc.,
- to ensure that the transactions entered into shall be correctly recorded; and
- to enable the concern to take policy decision as regards planning and operation of the business at the appropriate time.
Steps involved in the verification of the system of Internal Control :
- Study the system according to which accounting routines are being carried out to ensure that these do not leave any receipt of cash, material or any other asset remaining unaccounted for, permit any payment of money being made without relevant goods or
services having been received or tendered or any property being given away without its price having been received or being accounted for. - Examine the financial power vested in different persons and the conditions under which they can exercise them.
- Confirm whether the supervision over various managerial and accounting functions, exercised by different members of the staff to whom these duties have been assigned, is adequate.
- Ascertain whether any mechanical aids are being employed to ensure proper accounting of receipts and prevention of pilferage of cash, stamps, etc.
- Observe the working of the accounting system and routine and determine, by application of procedural tests, whether checks and counter-checks envisaged by the system of internal control are being properly applied.
- Confirm that there is a system according to which the physical existence of different forms of assets is being periodically reconciled with their balances in the books of account orn stores records and discrepancies noticed are reported and adjusted; also that balance of customers, creditors, bankers and persons with whom securities are deposited are reconciled periodically. Further, that persons who are in custody of valuable assets, have furnished bonds of adequate value which would protect the company in the event of any misappropriation or misapplication thereof by such persons.
- Ascertain that the system of internal control is reviewed periodically and, where necessary, a change in procedures made to plug in any loopholes which might have been observed on such a review. Also, that policy decisions which are taken from time to time are translated into actual practice.
Students should remember that, unless the system of internal control is comprehensive it may fail to provide the protection expected of it. For example, if printed receipts with counterfoils are issued in respect of amounts collected, but there is no check against cash
being collected by unauthorised persons, there will be no certainty that all amounts collected have been accounted for.
2. Correctness of book-keeping records : The audit of cash transactions entails detailed checking of the record of transactions for verifying that entries have been made in the books of account according to the system of accounting which is being regularly followed and the books of account balance as under :
- Vouching;
- Posting;
- Casting, cross-casting and tracing; and
- Reconciliation, scrutiny, confirmation, etc.
When accounts are checked in the foregoing manner, they may disclose one or more mistakes or manipulations in the accounts of different types stated below.
- Errors of omission or commission which are accidental, e.g., failure to enter some sales invoices, mistakes made in computing amounts payable for purchase, etc.
- Cases of deliberate omission or commission:
¾ to cover up a defalcation of cash, e.g., amount received from A having been posted to the account of B and subsequently, the amount paid by B having been misappropriated; or
¾ to overstate profit or assets, e.g., no provision having been made for outstanding liabilities or the goods already sold before the close of the year having been included in closing stock;
¾ to overstate liabilities and understate assets, with a view to providing a basis for effecting fictitious payments in the former case and misappropriation of the sale proceeds in the latter case. - Errors of principle such as revenue expenditure having been charged to capital.
- Compensation errors, e.g., “Furniture Account”, having been undercast by Rs. 100 and “Repairs Account” overcast by the same amount.
3. Observance of accounting principles : It is of utmost importance that the transactions should be recorded in the books of accounts having regard to the principles of accounting. The principles include :
- Distinction being drawn between capital expenditure and revenue expenditure;
- Distinction being drawn between capital receipts and revenue receipts;
- The expenses or cost should be matched to the income or benefit;
- The expenditure and income should be treated on accrual basis;
- That the fixed assets should be depreciated on a consistent basis;
- That book debts should be valued only at realisable amounts;
- That fictitious assets are written off at the earliest; and
- Outstanding assets and liabilities have been properly adjusted.
4.Evidence of Transactions : Entries in the account books are usually made on the basis of some kind of documentary evidence. It generally exists in a variety of forms e.g., payee’s receipts, suppliers’ invoices, statements of account of parties, minutes of Board of Directors or of the shareholders, contracts, documents of title, entries in subsidiary ledger,etc. The process of verification of entries in the books of account with the documentary evidence is referred to as vouching. As stated earlier, documentary evidence is of two types : (1) Internal; and (2) External.
Documents which are part of the records of the concern, and have been prepared in the normal processes of accounting constitutes internal evidence, e.g., counterfoils of receipts, carbon copies of cash memos or invoices, wages books, etc. On the other hand, a document issued by a person with whom some business transaction had been entered into or who paid or was advanced an amount constitutes external evidence, e.g., a payee’s receipt, an invoice for purchases, a court decree, a lease agreement, a bank statement, etc. because these documents are issued by persons not belonging to the concern. External evidence, in respect of certain transactions,
sometimes may have to be obtained directly by the auditors, e.g., certificate as regards bank balances, or confirmation balances of debtors and creditors, etc.
The auditor, obviously, should endeavour in the course of his examination to get as much external evidence as possible since such evidence ordinarily provides confirmation. When, however, it is not possible to obtain external evidence and he is obliged to accept internal evidence, he should first satisfy himself on a careful consideration of the position whether the evidence which has
been produced to him, can be reasonably assumed to have come into existence in the normal course of working of the business and that there exists a system of internal check which would act as a safeguard against its being altered subsequently.
External evidence should be preferred, since the likelihood of its being duplicated or fabricated is much less. This is because it requires collusion with an outsider which, normally is not practicable. However, every evidence ‘whether internal or external’ should be subjected to appropriate scrutiny and corroboration should be obtained, if possible. The auditor will always keep in mind the circumstances of the case and see whether the evidence is prima facie authentic and correct.
Note : Students should observe carefully in the course of their practical training, the various forms in which documentary evidence usually exists in support of different types of transactions and also the sources from which further evidence can be mustered because it is more re-assuring to verify a transaction from two or more sources which are mutually independent.
5. Validity of Transactions : It is also the function of audit to establish that payments have been made validly to persons who are shown to be recipients. For example, it must be verified that salaries to partners were paid according to a provision contained in the partnership deed and the directors fees were paid according to the provisions in that regard in the Articles of Association or
the resolution passed by members of the company at a general meeting. For checking the validity of a transaction, it is usually necessary to refer to documentary evidence. It may exist in any of the following forms.
- The legal provisions, if any, having bearing on the accounts of the entity under audit.
- The rules or regulations governing the internal working of the organisation, e.g., the Articles of Association, Partnership Deed, Trust Deed, etc.
- Minutes of the proceedings of a meeting of members of the company , that of the directors or that of the Managing committee
- Copy of an agreement, e.g., Managing Director’s agreement, Lease Deed, vendor’s agreement, agency agreement, contract with an employee, etc.
An auditor should have a clear and precise knowledge of legal provisions under which the concern was registered or is functioning, as well as those which constitutes the basis of various transactions entered into, more particularly the provisions as regards maintenance and audit of its accounts. He should also study the rules, if any, framed for regulating the internal management of the entity; these may be embodied in some of the documents mentioned above. If he has any doubt on any legal point, by way of guidance, he should call for legal opinion. However, unless he is convinced of the reasonableness of the legal opinion, he should not act on it. In the case of
Republic of Bolivia Exploration Syndicate Ltd. [1914], it was held that auditors are prima facie responsible for ultra vires payments made on the faith of their balance sheet but whether, and to what extent, they are considered responsible for not having discovered them in their audit would depend upon the circumstances of each case. An auditor is responsible for detecting payments that are ultra vires the company (Leed Estate Building & Investment Society v. Shepherd).
6. Disclosure in the Final Accounts : The object of audit ultimately is that the statements of account prepared from books of account which have been checked should present a true and fair picture of the financial position of the entity. This particular objective should be kept in view while checking the grouping of accounts. The auditor must see that not only items of a like nature be grouped together but also the description of each account truly reflects the nature of the amounts accumulated therein. Unless this is verified, the classification of income and expenditure and that of assets and liabilities would be misleading. For example if director’s fee and salaries to staff
have been added together or advances to directors have been covered up by being amalgamated with book debts, the nature of these payments would be obscured. Fundamentally, care should be taken to ensure that no material fact is suppressed or stated in a manner that it may mislead any one. If it is found that owing to costing or managerial requirements, certain items of expenditure or
receipts have not been classified by the company in the way as would meet the requirements of the Companies Act, 1956 the client’s staff at the end of the year should be required to re-classify them. Nevertheless such a re-classification of expenditure should be checked by the assistant of the auditor to confirm that it has been correctly made and that no item requiring re-classification has been left out. In the case of a company, Schedule IV to the Companies Act, 1956 has laid down requirements in regard to the disclosure.
