Investigation of Accounting Records | Business | Auditing

In this article we will discuss about:- 1. Definition and Object of Investigation 2. Investigator’s General Duties 3. Investigation for Valuation of Shares 4. Liabilities of an Investigator.

Definition and Object of Investigation:

Investigation means any special ex­amination of or enquiry into certain portions or sections of accounts, some matters or situations and analysis of related information or evidence collected thereby for some special purpose other than confirmation of accounts. The chief object of investigation is to obtain infor­mation relating to particular activities of a business or other organisation and, as such, it may be termed ‘restricted’, or ‘specified’ audit.  

Investigator’s General Duties:

(i) Investigation is carried out for some special purpose and is usually limited in scope and falls short of com­plete audit; it is essential for an auditor on being appointed as an investigator to get written instruction in precise and unambiguous terms regarding the ob­jects and scope of his work.

(ii) The actual method of work to be followed and the extent of investiga­tion to be carried out should be deter­mined by the investigator himself hav­ing regard to the nature of business, manner of keeping accounts, system of internal check in operation and the pur­pose of investigation, unless otherwise specified by the terms of appointment.

(iii) Appropriate programme of work should be prepared.

(iv) Previous audited accounts and other relevant papers and information having direct or indirect bearing on the subject matter of investigation should be gone through.

(v) Full records of enquiries and explanations should be kept and work­ing papers preserved.

(vi) Findings and evidence should be carefully evaluated.

(vii) Finally, the report should be prepared carefully, presenting therein all essential facts lucidly and concisely, preferably accompanied by comparative statements.

Investigation for Valuation of Shares:

An auditor is sometimes appointed to ascertain proper value of shares. In­vestigation of certain portion of accounts is necessary for this purpose.

The dif­ferent points to be considered by an investigator in this connection are briefly set out below:

(i) Market Value basis:

Shares in public companies which are enlisted by and quoted in a recog­nised stock exchange are to be valued on the basis of the closing price quoted on the stock exchange as on the date of valuation. The question as to whether or not the expenses of sale of shares should be deducted from the gross value deter­mined on the basis of the quoted price is a debatable one.

The tax laws, e.g. Estate Duty Rules (since omitted) did not permit any such deduction. This is criticised as inequitable by financial and business circles, who hold that only the net value after allowing for necessary and reasonable expenses of sale should be taken into account.

Valuation of shares in unlisted public companies and in private companies offers difficulties as no quoted price is available and as there are divergent views as to the method of valuation to be adopted.

However, one of the follow­ing two methods is usually resorted to for this purpose:

(ii) Net Assets Value (NAV) basis:

(a) Ascertain the value of assets and liabilities on some rea­sonable basis. Give special atten­tion to the valuation of good­will.

(b) Deduct liabilities to debenture- holders and other outside liabilities from the total value of assets, thereby ascertaining the amount of net assets avail­able to shareholders.

(c) Find out the rights of the holders of various classes of shares including their respec­tive rights to participate in surplus profits in the event of liquidation.

(iii) Profit-earning basis:

(a) Estimate future profit on the basis of average past results subject to suitable adjustments in view of anticipated contin­gencies, if any.

(b) Deduct from the profits, esti­mated as aforesaid, amounts wanted to be transferred to reserves and sums required to pay dividend on prefer­ence shares. The resulting figure would represent the net estimated profit available for distribution among equity shareholders.

(c) Capitalise this net estimated profit at a reasonable rate of interest to represent the value of equity shares.

(iv) Miscellaneous considerations:

(a) Supply and demand in re­spect of shares.

(b) Accumulated reserves.

(c) Possibility of bonus distribu­tion.

(d) Proposed changes in the management, if any.

(v) The revenue authorities, how­ever, recognise the following two meth­ods of valuation for the purpose of assessment of wealth tax, gift tax, capital gains tax, etc., in case of unquoted shares:

(a) Break-up value method:

Under this method, which is also described as “asset backing method” or “global division method”, a company’s net worth i.e., the aggregate of paid-up capital, reserves and balance of profit and loss account is divided by the number of equity shares in order to arrive at the value per share.

(b) Capitalisation of income method:

According to this method, the entire “maintainable profit” of a company capi­talised @ 6% is divided by the number of equity shares.

Maintainable profit, in its turn, is arrived at after making the undernoted adjustments from the aver­age of the company’s book profits for the last three years:

(1) Addition of initial deprecia­tion and development rebate, if any;

(2) Deduction of tax @ prescribed percentage of the book- profit;

(3) Deduction of amounts required for payment of dividend on shares with preferential claims e.g., preference shares.

(vi) Unquoted preference shares:

Valuation thereof may be based on the paid-up value. If, however, dividends have not been paid on such shares for many years in the past, and are not likely to be paid for some years to come, a deduction of 10 to 40 per cent of the paid-up value may be allowed having regard to the merits of each case.

Liabilities of an Investigator:

An investigator is generally liable, in the following circumstances, to his employer, or authority i.e., the person or body of persons, on whose behalf inves­tigation is conducted:

(a) If the employer acts fully relying on the investigation report in good faith;

(b) If he suffers an actual loss by so acting; and

(c) If there is an actual non-disclosure of the real state of affairs on account of the neg­ligence of the investigator.

Six important Case Laws on the subject of investigators’ liabilities are enumer­ated below:

Name of case law:

1. Chief Controller of Imports, vs. D. N. Chakravarti:

An investigator was exonerated from liability as he was unknowingly guilty of a purely technical flaw in respect of the form of his certificate and as the charge of non-disclosure of real value of past imports was not proved.

2. Colmer vs. Merrett, Son & Street:

The investigator was held liable in token damages for not carrying out complete investigation and blindly accepting a certificate re: stock from the managing director of the business investigated into.

3. The Commissioner of Income Tax vs. G. M. Dandekar:

An accountant has no duty to investigate into the correctness of accounts prepared by assessees or to the income tax depart­ment.

4. Finnegan vs. Allen:

An accountant or auditor engaged to value shares is in the position of an arbitrator and is not liable for an error of judgement if he acts honestly.

5. Short & Compton vs. Bracket:

In the absence of suspicious circum­stances an investigator is entitled to assume that the figures appearing in the books of the firm investigated into are correct.

6. Registrar of Newspapers of India vs. K. Rajinder Singh:

A chartered accountant was held guilty of professional misconduct for certifying circulation of a periodical without going into most elementary details.