Some of the most frequently asked exam questions on verification and valuation of assets and liabilities are as follows:
Q.1. What is meant by verification of assets and liabilities? State the object of such verification.
Ans. The verification of assets and liabilities involves the consideration of the following points:
1. That each asset/liability is correctly stated in the balance sheet.
2. That each asset/liability is correctly valued according to the generally accepted valuation principles.
3. That the assets actually exist on the date of balance sheet, and are the property of the company.
4. That the assets are free from any charge except that disclosed on the balance sheet.
5. That no liabilities on the date of balance sheet have been omitted.
The verification of assets and liabilities achieves two main objects:
1. Propriety of transactions recorded.
2. Expressing an opinion on the financial statements, i.e., whether the balance sheet reflects a true and fair view of the state of affairs of the company.
Q.2. How far is an auditor responsible for verification of assets appearing in the balance sheet?
Ans. An auditor does not discharge his duties completely when he has simply vouched the entries appearing in the various books of account relating to an asset item. To clarify, vouching confirms the purchase of an asset on a particular date but cannot, on that score, enable the auditor to be satisfied that the state of affairs remained unchanged on the date of subsequent balance sheet.
In the meantime, the value or ownership or existence of such item may have changed. It is, therefore, absolutely necessary for the auditor to verify the assets appearing in the balance sheet by inspection, certificates from authorised responsible parties (e.g., bankers, creditors, etc.) or by other available documentary evidence.
Numerous Court decisions (illustrated below) hold the view that the auditor is liable for inadequate verification of assets:
Q.3. As the auditor of a company, to what extent can you rely on the certificates given by (a) The company management, (b) The company’s internal auditor with respect to the verification of assets and liabilities?
Ans. (a) Certificates given by management:
The auditor can rely to a certain extent on such certificates as collateral evidence with respect to the verification of assets and liabilities depending on circumstances during audit. If he is satisfied that there are no irregularities after having checked the accounts of debtors, relevant items and the stock statements, he can place his reliance on the certificates issued by the management regarding the provision of doubtful debts, outstanding income and expenditure, and the stock in hand.
(b) Internal auditor’s certificate:
Large companies are usually found to have their own internal audit department carrying out continuous audit throughout the year. The statutory auditor can rely on the reports and certificates of the internal auditor after having fully satisfied himself that the internal audit was effective with respect to the verification of assets and liabilities and the pertinent points dealt with.
Q.4. How would you verify the following items included in the ‘stock-in-trade’ appearing in the balance sheet?
(a) Goods sent out on consignment.
(b) Goods sent out on sale or return.
(c) Goods sold on hire-purchase.
Ans. The verification steps should cover the following aspects:
(a) (i) Ascertaining the basis of valuation ;
(ii) If the valuation is at cost, confirming that such cost includes all expenses incurred thereon by the consignor and the consignee, and that the market value is not below cost;
(iii) Checking the stock certificate received from the consignee by reference to the entries in the ‘consignment outward account’, the proforma prices being reduced at cost.
(b) (i) If such sales are treated as ordinary sales, examining whether necessary adjustments have been made in respect of goods not approved and still in the hands of the customers [Sales Account (debit) and Customers Account (credit)] ; and
(ii) Examining further that the unapproved goods with customers are valued at lower of cost or market price.
(c) (i) Verifying the stock of such goods ; and
(ii) Making sure that the proportionate estimated profit included in the outstanding installments is deducted to arrive at the cost of such goods.
Q.5. While examining the balance sheet of a company you find that the fixed assets at the close of the year have increased by 50% as compared to the previous year. What are the possible reasons for this increase and what corresponding change would you expect to find in the other items in the balance sheet?
Ans. The possible reasons for increase in the balance sheet are as follows:
1. Additions by purchase and/or construction.
2. Receipts as a gift or donation.
3. Revaluation of any or all of the assets.
Corresponding change in other items in balance sheet are:
1. (a) Reduction in cash balance.
(b) Increase in current liabilities.
2. Credit to the Capital
Reserve Account for an estimated value.
3. (a) Credit to the Capital Reserve Account, or
(b) Increase in the Subscribed Capital through issue of fully paid bonus
Q.6. How would you verify the following liabilities:
(b) Secured Loan,
(c) Unsecured Loan,
(d) Liabilities for expenses.
Ans. (a) Debentures:
The verification steps are:
(1) To examine the Memorandum and Articles so as to ascertain the borrowing powers of the company.
(2) To check the Debenture Trust Deed its terms and conditions, and the securities offered.
(3) To confirm, wherever necessary, that the permission of the Controller of Capital Issues has been obtained.
(4) To see that — (i) Cash has been received, if debentures are issued at cash, and (ii) Entries have been made in the books of account, if debentures are issued at a premium.
(b) Secured Loan:
The verification procedures are:
(1) To examine:
The borrowing powers of the company, the Board’s resolution, the agreement or arrangement with the bank or financial institutions, the securities offered, the interests payable, and any charge created and registered.
(2) to check up the fluctuations in the exchange rates in case of loans in foreign currencies with a view to ensuring adequate disclosure of the company’s liabilities at the end of the year.
(3) to obtain confirmations about the balances of each loan from the bank or financial institutions in order to see their appropriate disclosures in the balance sheet.
(c) Unsecured Loan:
The usual verification steps are:
(1) To refer the Memorandum and the Articles of the company so as to examine the specific powers of borrowing.
(2) To examine the Board’s resolutions and the resolutions in the general meeting passed by the shareholders with a view to ascertaining the limits of borrowings by the company and by the directors.
(3) To ensure whether the borrowing limits as laid down in Section 58A of the Companies Act have been complied with.
(4) To check in particular:
(i) The receipts of loan with the cash book and bank statement;
(ii) The directors’ approval to such borrowings ; and
(iii) Whether any of the directors has guaranteed the loans.
(d) Liabilities for expenses:
The verification steps for audit should be:
(1) To scrutinize all payment vouchers (cheque or cash) for at least the first two months of the next year in order to distinguish as to (i) which expenses relate to the period under audit and (ii) which do not relate to the period under audit.
(2) To obtain a list from the management showing the liabilities for expenses that are provided for and also to verify them with reference to relevant vouchers.
Q.7. State the audit examination procedure for stock-in-trade.
Ans. The audit examination should be adopted on the following: 1. Where Stock Records are Maintained 2. Where Stock Records are not Maintained:
1. Where Stock Records are Maintained:
(a) applying test checks to ensure proper maintenance ;
(b) comparing quantities as per stock sheets with those of the balances in the stock records;
(c) checking consistency in their valuation ;
(d) comparing ‘gross profit on turnover’ (%) with that of previous years, including the explanations for material variations, if any ; and
(e) ensuring separate disclosure of the value of the various components of stock-in-trade in the balance sheet.
2. Where Stock Records are not Maintained:
(a) Inquiring into the system of stock-taking and stock sheets, preparation by reference to counts, pricing, extensions and totals;
(b) Inquiring into the system of internal accounting and administrative controls and evaluating its adequacy;
(c) Verifying the stock movements (i.e., receipts, issues, etc.) during the count, the listing of items in the stock sheets ;
(d) Determining the obsolete, slow-moving, non-moving, and damaged items and ascertaining their treatment in accounts ;
(e) Ensuring that the stock sheets include the goods sent on consignment but not yet sold, and do not include any goods:
(i) held on consignment,
(ii) sold but not dispatched, and
(iii) received but not purchased ;
(f) Examining that the quantities and corresponding values have neither been over-stated nor under-stated, and that the valuation has been done as per the company’s policy in accordance with the generally accepted accounting principles;
(g) Testing the appropriateness of allocation of costs of materials and labour, and of the proportion of overhead charges (if any) relating to the goods-in-process ;
(h) Comparing ‘gross profit on turnover’ (%) with that of previous years and ascertaining the reasons for material variations ;
(i) Obtaining a certificate from the management to the effect that the stock sheets are accurate, and confirming that the stock sheets have been signed by a partner or director or a responsible officer, and
(j) Finally ensuring that the various components of stock have been separately disclosed in the balance sheet with their mode of valuation.
Q.8. State the verification steps for assets.
Ans. The verification steps for various assets of a company include:
1. Loans Against Security of Landed Property:
(1) Examining the documents like: Memorandum and Articles which empower the company to lend money, security papers, mortgage deeds, title deeds of properties, insurance policies, etc.
(2) Vouching the date and amount of loan, the rate of interest, and the date on which due.
(3) Examining the value’s certificate for sufficiency or otherwise of the securities held.
(4) In case of land and property having been mortgaged, seeing that:
(i) The mortgage has been properly executed.
(ii) The mortgager is empowered to do so.
(iii) The mortgage is registered with the Registrar of Companies in the case of a company.
(iv) The first mortgagee is aware of the second mortgagee (if any) and the title deeds are with the first mortgagee.
(5) Scanning the loan accounts in the ledger and obtaining confirmation from the borrowers as to the loan amounts on the date of balance sheet.
2. Loans Against Security of Stocks and Shares:
(1) Obtaining the list of stocks and shares held as securities and ascertaining that these are transferred in the client’s name.
(2) Examining the status of shares as fully or partly paid as because the transferee will have to pay the uncalled amount whenever the company makes a call.
(3) Checking the valuation of securities held to ascertain its sufficiency or otherwise against the amount of loan.
(4) Examining the terms of agreements, viz., rate and amount of interest payable by the borrower, etc.
(5) Verifying whether such securities have been lodged with the bank for safe custody and obtaining a certificate from the bank.
(6) Confirming from the borrowers as to the loan amounts on the date of the balance sheet.
3. Loans Against Security of Goods:
(1) Examining the documents like:
(i) Go-down-keeper’s receipt/Warehouse receipt/Dock warrant against which a loan has been advanced.
(ii) Railway receipt/Bill of Lading/Letters of Hypothecation/Insurance policy/Invoice on the basis of which a loan has been advanced for the goods-in-transit.
(iii) Inspection Reports to ascertain the quantity of goods which have been held as securities.
(2) Ensuring that the above documents have been duly endorsed in favour of the client.
(3) Ascertaining the value of the goods from the invoices, market quotations, etc., in order to determine the value of securities.
(4) Confirming/inspecting the turnover of the stock, where the goods are of perishable mature.
4. Loans Against Personal Security of the Borrower:
(1) Making an inquiry as to the financial solvency of the surety, if any.
(2) Examining the validity periods of the Securities e.g., promissory notes.
(3) Ensuring that the terms, on which a loan has been advanced, have not been changed during the repayment period of the loan.
(4) Vouching of repayments and enquiry as to steps for recovery.
5. Loans Against Insurance Policy:
(1) Examining whether the insurance policies:
(i) Are running policies;
(ii) Have been assigned in favour of the client , and
(iii) So assigned have been notified to the insurance company.
(2) Seeing that the amount of loan advanced is within the surrender value of such policies.
(3) Checking the premiums paid by the borrower by reference to the last receipts.
(4) Ascertaining whether the client has paid any premiums to prevent the policies lapsing and whether amounts so paid have been debited to the concerned loan Account of the borrower.