1. Bought Ledger : The structure of every account in the Bought Ledger is : opening balance, credits on account of goods purchased and debits raised in respect of returns, allowances and discount receivable, advances paid against goods, payments and transfers. Usually, it is possible to link up each
amount on one side of the account, with one or more accounts on the other side; only the amounts which cannot be correlated require a detailed scrutiny. Generally, it should be verified that payments for goods have not been made long before they were due; nevertheless, they have been made within the
period of credit, to take advantage of the cash discount allowed by the supplier. The scrutiny of the accounts would show that payments for goods normally have been credited in the order in which their costs have been credited in the accounts. Therefore, if in any case no payment has been made against
the opening balances or against any particular item of credit, the reasons thereof should be ascertained. Likewise, credit entries which cannot be correlated with those on the debit side should be enquired into to confirm that they are not fictitious. It should be further seen whether full payments for purchases have been made at a time or in parts. In the cases where payments have been made in parts, the reasons for such a practice having been followed should be ascertained. Further, when payments to a supplier are usually made by accepting Bills of Exchange but one or more amounts have been paid in cash, the reasons therefor should be ascertained. It would be observed that in respect of goods returned back, as well as allowances allowed by the supplier, either separate payments have been received or the amounts therefor have been deducted out of subsequent payment made for goods purchased. Where this has not been done, the reasons should be ascertained. The accounts in the Bought Ledger, usually, are in credit. The composition of the balance of each
amount should be scrutinised. If it is not clear, reference should be made to the account of the party as shown in the ledger for the previous year or in the one for an earlier year. The composition of each balance will indicate the group in which the balance in the account should be included for statement in
the Balance Sheet. When the amount of the opening balance of the account of the cost of goods purchased earlier has not been paid but the goods purchased subsequent thereto have been paid, the reasons for the non-payment of the amount or amounts should be enquired into. It could be that the
liability to pay the amount is disputed or is totally denied. The auditor should examine these claims to assess the liability of the client and may then have the balances adjusted and disclosed accordingly. If the liability is totally denied, the amounts should be written back. But when it is partially admitted, these
should be reduced to the extent admitted. If the account of a supplier has been credited at the end of the year with large sums of money, the basis
of the credit should be enquired into as it might be a fictitious credit with a view to suppressing profits. If certain goods purchased from a party have been subsequently sold back to him, enquiries should be made to find out if the transactions of the purchase and sale are not mere book entries, hit by Clause (b)
of sub-section (IA) of section 227 of the Companies Act, 1956. When a balance in an account has been outstanding for payment for an inordinately long time, enquiry should be made to confirm whether the balance in fact is payable.
An account in the Bought Ledger may be in debit. The balance may represent the amount receivable on account of goods returned, rebate allowed by the supplier or advance paid against an order. The auditor should confirm that the advance against the order had been paid in pursuance of a recognised trade
practice, also that subsequently goods have been received against the advance or will be received, for such an advance may represent a disguised loan to accommodate a business associate. The book balance also may represent the cost of goods purchased wrongly debited to the account of the supplier,
instead of the Purchase Account. In each such case, it should be ascertained that the book balance is good and recoverable and if it is not considered recoverable, a provision against the same has been made. The book balances should be appropriately classified for purposes of disclosure in the Balance Sheet. If the debit balance represents a loan to a director or officer of the company, either jointly or severally with another person or it is a debit due by a firm or a private company in which the director is a partner or a member, the same should be separately disclosed in the Balance Sheet in accordance with the provisions contained in Schedule VI to the Act. The maximum account due from the directors or other officers of the company at any time during the year and debts due from companies under the same management should also be disclosed alongwith the names of companies (Part I, Schedule VI to the
Companies Act, 1956). Students may note that in view of section 296 of the Companies Act, 1956 a loan or an advance paid to a director, which from its inception was in the nature of a loan is to be regarded as a loan falling within the purview of section 295.
2. Sales Ledger : The structure of each account in the Sales Ledger is opening balance, debits representing values of goods sold, payments made for goods returned and transfers. The credits represent amounts received for goods sold, advances received against orders, discounts and allowances allowed, value of goods returned back and debts written off. If amounts on either side of each account are checked with the corresponding amounts on the other side, the discrepancy, if any, would be discovered. It should be seen that the customers’ balances are being collected promptly, otherwise the capital of the
client would locked up unproductively; also the risk of bad debts and misappropriations would be greater. Therefore, when the examination reveals such a position the auditor should bring this fact to the notice of the management.
If, during the course of examination, it is found that the opening balance in an account or an amount of sales has not been collected, while the amount of sales made subsequent thereto have been duly recovered, it could be that the customer is disputing the liability to pay the amount or that the cash
collected in payment of the amount has been misappropriated. It may also be found that the debit balance in an account has been collected in parts. It could be the result of misappropriation practised by the teeming and lading method. All these matters, when noticed, should be fully investigated. When the payments for sales to a customer have been received in parts, it would be beneficial for the client to adjust the amounts received against amounts which have been outstanding the longest. The auditor should confirm that the client is aware of it and has acted accordingly. Where it is discovered that the returns out of sales, made in the year or years, have been adjusted in the accounts during the year under audit, the justification for such a delayed adjustment should be enquired into, for it could be that the customer has been allowed to return the goods, only as a matter of favour. Likewise credit balances resulting from the allowance of discounts and rebates should be scrutinised to confirm that these have been availed of within a reasonable time. If any allowance has been adjusted against an amount recoverable for the goods sold, it should be verified that the allowance is not fictitious, for it could be one which has been adjusted by a dishonest book-keeper with a view to covering up a fraud committed by an employee, by misappropriating the cash collected from the customer.
While checking the customer’s balances, the auditor shall have an opportunity to comprehensively review all the transactions entered into with each of them. If, in the process, he finds that there are any old balances which have not been collected, the possibilities of an amount collected having been
misappropriated should be investigated. For the purpose, the auditor should obtain from the customer either confirmation of the balances or copy of his statement of account, admitting that the amount is infact payable by him. If a sale has not been recorded, though the ledger account would not contain an entry in respect thereof, it may contain an entry showing that a credit for the goods returned or an allowance has been adjusted in his account which has been paid to him in cash. This would show that the original sale has not been recorded. Such a discovery may lead to the unearthing of an organised scheme of fraud. A clever employee who has misappropriated an amount paid by a customer might attempt to adjust the debit in the customer’s account before the close of the year by paying in a bogus cheque. The cheque, no doubt, would be received back unpaid in the beginning of the next year. But the non-payment of the cheque would not be detected until the bank account is reconciled. Therefore, when the bank reconciliation statement shows that the cheque of a party has been received back unpaid, the auditor should find out whether the amount due from him has been or will be recovered.
If the amount paid by a debtor has been misappropriated, though the balance in the account would be outstanding for payment, it would not be recoverable. It is only on this consideration that there exists an audit practice according to which confirmation of balance is obtained from debtors and creditors directly at the close of each period. If the balance in an account has been settled for a smaller sum, the nature of the dispute and the amount which the client has agreed to forego should be ascertained. In case the dispute has been settled by arbitration, the award should be referred to. All transfers of balances from one account to another should be checked to confirm that these have been made under proper authority in the normal course of the business.
If the scrutiny of the account in the Sales Ledger shows that any of the book debts is not recoverable, the auditor should confirm that an adequate provision has been made against the same. To verify the adequacy of provision against bad and doubtful debts, usually the client is asked to prepare a list of debts which are irrecoverable either wholly or partially. All the balances in the list afterwards are scrutinised by the auditor to confirm that these are in fact so, also that adequate steps have been taken by the client for their recovery but without success or that they are time-barred for recovery. It is necessary to remember in this connection that debts can be written off only under the authority of a person who is empowered to give up a claim, e.g., board of directors, partners or the proprietor.
When any bad debt is written off, the client should be advised that a record thereof should be kept in the Bad Debts Register in order that if subsequently any recovery is made out of it, may be possible to identify the amount. Finally, the composition of all balances outstanding of recovery should be examined. Normally, the debit balances in an account should be the total of the amount of sales not collected. In every case, where the composition of a balance is not clear, the copy of the statement of account received from the party should be referred to . If in respect of a particular customer, copies of a number of invoices are not in record his balance should be confirmed by sending out statement of account. While checking the closing balances which are required to be included under certain specific heads of account, those required to be separately disclosed (e.g., amounts due from Directors, Managers, or
concerns in which they are interested) should be listed up separately. For the tests, which must be applied and the enquiries which should be made for ascertaining which of the customer’s balances are bad and irrecoverable, students may refer to the next chapter.
NOTE : Self-balancing and sectional balancing ledgers : When in an organisation a number of edgers are maintained, it is usual to find the system of self-balancing or sectional balancing of ledgers in operation. Sectional balancing, as any student of accountancy knows, is just the system of maintaining a total account in the general ledger in respect of each sectional ledger like debtors, creditors, nominal accounts. The self-balancing system is a further improved system which enables the preparation of independent trial balances for each of the separate ledgers by means of contraadjustment accounts. This, as part and parcel of the system of internal check, is of great assistance to the auditors for localising errors. It should however be borne in mind that the only reliable verification of balances of various adjustment accounts in the general ledger lies in the thorough verification of the various personal ledger balances. As regards the routine checking aspects, no special technique is involved. The postings to the individual ledgers and to general ledger account maintained for control purpose should be appropriately checked. Also the castings and balancing should be tested.
3. General Ledger : The general ledger contains all the balances which are ultimately included in the Profit and Loss Account and the Balance sheet. Its examination, therefore, is undertaken last of all. It should be carried out with great deal of care inasmuch as it is the final review of balances which, on
inclusion in Final Accounts, cumulatively reflect the financial position of the concern. Entries in the General Ledger usually are posted in a summary form from the Cash Book, Journal, and from other subsidiary books like Purchases Book, Sales Book, etc. As such before starting its examination, it should be confirmed that all the postings in various accounts have been verified, totals have been checked and the final balances have been linked. It should also be ascertained that balances in all the income and expense accounts have been adjusted: 1. according to standard accounting practices, and 2. on a consideration of the legal provisions which are applicable to the concern. Each ledger balance finally should be examined on a consideration of its position in the Final Accounts to see how the financial position of the concern would be affected by the inaccuracy in the balance. Wherever practicable, the balances in the General Ledger should be traced simultaneously on to the trial balance, the groupings schedules and the Final Accounts. At the same time, by way of a comparison, the corresponding balances in the previous year’s Final Accounts also should be referred to. It should be confirmed that the accounts have been kept according to accepted accounting principles and the Balance Sheet and the Profit and Loss Account have been drawn up on the same basis as in
the previous year.
Students’ attention in this connection is invited to Clause 3 (xv) of Part II of Schedule VI to the Companies Act. It requires that for any item shown in the Profit and Loss Account, affected by any change in the basis of accounting, the amount involved should be disclosed. Consistency is also one of the fundamental accounting assumptions as stated in AS-1 on “Disclosure of Accounting Policies”. Usually, the accounts of a commercial concern are kept on the mercantile basis. It demands that all the liabilities in respect of goods purchased or expenses incurred before the close of the year that were
outstanding for payment should be provided for; amounts paid as advances should be included as an asset, the proportion of expense relevant to the period that extends beyond the close of the year should be excluded by the amount being debited to the prepaid Expenses Account. Further, on the same
consideration, the income which had accrued before the close of the year, but had not been collected should be taken credit for and correspondingly, income relating to the period, following the close of the year, which has been received in advance should be adjusted as a liability. Thus, unless accounts are
adjusted in this manner, neither the Trading and Profit and Loss Account nor the Balance Sheet would disclose a true and fair state of the business.
The valuation of assets and verification of liabilities are other important steps in the ascertainment of profit earned by the business inasmuch as only under or overvaluation thereof would either depress or boost up profits Conventionally, current assets are valued at their cost or net realisable value whichever is lower, fixed assets are valued at cost reduced by the amount of depreciation that they have suffered, calculated on any accepted basis, and followed consistently.
4. Main Journal : Both the closing and adjusting entries as well as other entries which cannot be accommodated in any other Journal are recorded in the Main Journal. The evidence in support of entries in this Journal usually exists in a large variety of forms. It may consist of correspondence, contracts, minutes of Board of Directors or the shareholders, statements of account, etc. All the statements attached to support adjusting entries, since these would be prepared by the internal staff, should be verified very carefully, and where possible, some independent evidences in confirmation thereof should be obtained. The correcting entries will contain references to vouchers which have already been checked by the auditor. He ordinarily, therefore, will have a record thereof in his audit notes. It should be referred to while verifying them. One form of adjusting entries is the one recorded to provide for expenses accrued till the date of the Balance Sheet but not paid, e.g., those in respect of rent, electricity, income-tax, etc. as well as for taking credit for the income accrued but not received, e.g., interest accrued which is not matured for receipt, lease rent accrued which is not due for payment, etc. In all such cases, it is possible that by the time that audit is undertaken, some of the liabilities, a provision for which has been made, may have been paid off; also that the amounts adjusted as not recoverable may have been collected.
As a result, in actual practice, it may be found that amount paid or received were larger than those adjusted. But so long as these were estimated on a reasonable basis, it is not necessary for the auditor to reopen accounts to adjust the difference between the amounts of income or expense estimated and
those collected or paid. The opening entries should be verified by reference to the balance sheet or other similar documents for the previous year. The auditor should specially note that neither any accounting principles nor practices followed in the past have been contravened or altered during the year under audit. If a departure has been made, its effects should be disclosed on the face of the Profit and Loss Account. For example, when the basis of valuation of closing stock or that for providing depreciation on fixed assets has been altered, their effect on profit should disclosed.