Verification and Valuation of Individual Current Assets
Verification and valuation of current assets states that the Balance Sheet shows true and fair view of the financial position of business enterprise. The auditor must satisfy himself that various current assets disclosed in the Balance sheet have been valued according to the Generally Accepted Principles of Accounting.
The main cash and petty cash in hand are to be physically verified at the closing hours on the last day of the financial year. The auditor has to be very careful while verifying cash-in hand. Defalcation or embezzlement of cash has become a very common technique of committing fraud. In this regard, the auditor may conduct a surprise verification of cash at any time during the course of audit. Therefore, while verifying cash, the auditor should ensure the following:
1. That the cashier is present at the time of verification.
2. That the temporary advances and payments on suspense accounts are excluded.
3. Count the cash-in-hand at one sitting and compare it with the cashbook balance. Simultaneously a statement is prepared with details of denominations and number of currency notes and coins. Both the cashier and audit staff must sign this statement. The copy of this statement is handed over to the cashier and the auditor may retain the original statement for future reference purpose. If in case of non-agreement of cash balance, the auditor should demand explanation from respective cashier or accountant for non-agreement of physical cash balance and balance as per book.
4. Also count the petty cash book, stamps in hand and IOU’s (I Owe You) slips for temporary advances made to the employees. If any discrepancy, he should get a certificate to that effect from the accountant.
5. As far as cash-in-transit is concerned, the auditor should verify this with the help of proper documentary evidences and correspondences.
6. Carryout verification of cash at the end of the year or by way of surprise check at any time during the year. The latter will enable the auditor to detect the embezzlement, if any.
7. The practice of keeping large balance of cash on hand is not a sound practice and should be discouraged from the viewpoint of internal control.
8. To prevent difficulties of physically counting the cash, auditor should ask the client to deposit the entire cash Balance on balance Sheet date with a bank.
9. As per the guidelines of Institute of Chartered Accountant of India, the auditor should see whether duties are segregated among different person to authorise cash transactions.
10. He should ensure that bank reconciliation is prepared periodically.
For the purpose of verification and valuation of cash at bank, the auditor should take following steps:
1. Compare the balances as shown in the passbook with that shown in the bank column of the cashbook.
2. Bank reconciliation statement is very helpful in detecting various types of frauds. Therefore, prepare a bank reconciliation statement as on the last day of the accounting year for ascertaining the current position of the cheques drawn by the company but not yet presented for payment, or the cheques deposited by the concern but not yet cleared.
3. The auditor shall also carefully verify the post-dated cheques issued by the organisation before the end of the year and ensure that such cheques are not taken into account for the year under audit.
4. Examine that cheques issued for more than three months are treated as unpaid and the relative entries are reversed.
5. Obtain a certificate of balance in client’s account as on the Balance Sheet date from the bankers.
6. When the organisation maintains accounts with more than one bank, the auditor should verify all the bank accounts individually.
7. Auditor should obtain separate certificates from the bank in respect of Fixed Deposit Account, Current Account, Savings Bank Account etc.
8. Scrutinise the fixed deposit receipts in respect of their date of issue, amount, rates of interest, date of maturity etc., and get interest accrued on deposits during the year duly adjusted.
9. If any charge created on the deposits or if the deposits made under any legal requirement, the auditor shall ensure that the fact is disclosed in the balance sheet.
10. Sometimes, due to legal restrictions, one or more of the bank accounts of the organisation may be blocked. In such a case, the auditor shall ensure that the fact is disclosed in the balance sheet.
Stock-in-trade or Inventories is the life-blood of a business. Therefore, value of stock-in -trade has to be properly determined for ascertaining profit or loss for the year and also to disclose a true and fair financial position of the concern. Inventories or Stock- in-trade normally includes the following:
Raw-Materials: Raw materials form a major input into the production. They are required to carry out production activities, for example, steel, copper, rubber, cotton, wool, timber, lime stone, coal etc.
Work-in-Progress: The work in progress is that stage of stocks, which are in between raw materials and finished goods. It means the total value of unfinished production at the end of each financial period. It is in the form of materials, which have absorbed varying amounts of labour and other overheads to reach the manufacturing stage at the time of counting of stock of work-in-progress. Work-in-progress should be shown in Balance Sheet separately and not as stock-in trade.
Semi-Finished Goods: Goods in a semi-finished condition on the date of Balance Sheet should be valued at cost of raw materials plus a reasonable proportion of factory overhead or production overheads. The auditor should get a certificate from production manager about the portion of overheads related to semi-finished goods. He should also examine the method of absorption of overheads as a percentage of raw materials, labour and volume of production for fair allocation.
Finished Goods: These are the goods, which are ready for the consumers. The stock of finished goods provides a buffer between the production and the market. If there is purchase of finished goods for resale, their valuation should be at purchase price and a reasonable proportion of direct expenses incurred on them, such as freight, duty, taxes etc., finished goods, Valuation of should be at lower of cost of manufacture and market price. Whatever the method of valuation is adopted, the auditor must confirm that valuation of finished goods should never be at a rate higher than market price of identical goods in the market.
Consumable Stores and Spare Parts: 'Spare', as the name suggests, refers to additional or extra to what is required for ordinary use. That purely means an item kept as standby, in case another item of the same type is lost, broken, or worn out. These are purchased for reducing the idle time of machineries and other auxiliary processes in case of sudden breakdowns or any other contingencies. The auditor should confirm the adequacy of spare parts according to plant capacity to reduce idle time by repairing the breakdown of machineries immediately, thereby increasing the production efficiency of concern. It is very helpful to reduce the idle time wages and increase the profitability position of the company.
Loose-Tools: These are part of current assets, and will be typically found on any Balance Sheets that may be produced for the business. There is another definition of what qualifies as current assets, and this is expected to be used within the next 12 months. In the context of verification of loose tools, the auditor should obtain a list of loose tools duly authorised by some responsible officer and examine the same. Revaluation of loose tools is the most appropriate method of valuation. The difference between the cost price and the current price should be treated as depreciation or loss to be charged to the profit and loss account.
Auditor's Duty in Verification
1. Evaluation of Accounting and Internal Control System: The auditor should study and evaluate the accounting system and internal controls relating to inventories. This would facilitate him in determining the nature, timing and extent of substantive procedures to be carried out by him. The auditor should review the following aspects of internal controls over stock–in-trade.
Custody: There must be provision of adequate controls to guard the stock from loss through pilferage, exposure to weather and other hazards. The storage of various items of inventories should be sound enough to protect them against damage, deterioration, etc.
Records: There should be adequate records of all stock movements, periodically reconciled with accounts and costing records.
Authorization: All stock movements should be properly authorized. Authorities for giving purchase orders and receipts of goods should be clearly laid down. Issues from stores should be made only against proper requisitions notes approved by authorized managers.
Insurance: Different items of inventory should be adequately insured against fire, theft, etc. Insurance Premium should be paid in time and insurance policies should be kept in proper custody.
Slow-Moving Stock: There should be a regular review to identify and take action to get rid of slow-moving, obsolete or defective stock.
2. Examine Existence of Stock: Auditor should verify the existence of stock by exercising physical stock verification as on the date of Balance Sheet. While undertaking physical stock taking or verification the following points should be borne in mind:
· Ensuring that staffs involved are both knowledgeable about the stock and independent of the day-to-day handling or recording of the stock.
· Issue of written stock taking instructions regarding counting procedures and clearly defining the responsibilities of all staff involved.
· Computing and checking calculations and additions on stock sheets.
· Continuous or periodic agreement of physical checks with records, and all material differences investigated.
3. Verify Stock Records: He should ensure that stock records are properly maintained and must verify receipts and issues of materials. He must also verify that Inspection Reports and Stock Sheets are authorised by a responsible person.
Auditor's Duty in Valuation
Stock-in-trade is a Current Asset and the auditor should ensure that stock-in -trade is valued at cost price or market price whichever is lower. The Institute of Chartered Accountants of India Accounting Standards - 2 (AS 2) “Valuation of Inventories” states that, stock of material is valued at cost or market price (Net Realizable Value) whichever is lower on the date of Balance Sheet.
Methods of Valuation of Stock
Valuation of stock-in-trade is ordinarily at cost or market price whichever is less. Auditor generally adopts either of the two methods in valuing stock such as: (1) Pick and Choose Method, (2) Global Method.
1. ‘Individual or Pick and Choose’ Method: According to this method, the lower of cost or market price is the basis in respect of each individual item and the total of the same is the value of the inventory.
2. Global Method: Under this method, first the cost of all items is determined and aggregated. Then, the market price of all the items is ascertained and aggregated. The lower of these two valuations is the value of the stock.
Illustration of Valuing Stock in-Trade at Individual and Global Method
However, the following methods are used in determining cost price and market price of stock.
Methods of Calculating Cost Price: In the context of valuation of inventories, any one of the following methods is adopted to determine the cost price of stock.
1. Unit Cost Method or Actual Cost Method: In this method, each item or batch of goods is valued at the actual price at which it was purchased. This method can only be applied where goods have been purchased in different lots. The cost price of unsold stock will be the cost price at which such a lot is acquired.
2. First in First Out Method (FIFO): In this method, issues are priced in the order of the purchase lots. The price of the first lot is taken first, and when that lot is exhausted, the price of the next lot is taken and so on. Hence, items issued are valued at the earliest price or cost. As materials purchased at earlier rates are charged first, the value of closing stock is more or less nearer to the current market price.
3. Last in First Out Method (LIFO): In this method, issues are priced in the reverse order of purchase. The price of the last lot is taken first, and when that lot is exhausted, the price of the previous lot is taken and so on. Hence, items issued are valued at the latest price or cost. The inventory in hand remaining unsold is assumed to be out of the earliest lot and valued at the earliest price paid or cost incurred for the same.
4. Base Stock Price Method: Under this method, a minimum quantity of stock known as base stock or safety stock is always held at fixed price. The fixed price is kept below the original cost of the ‘base stock’.
5. Highest in First Out Method (HIFO): This method is based on the assumption that issues are priced at the highest value of available consignments in the store. The closing stock of materials should always remain at the minimum value. The method is not popular as it always undervalues the stock, which amounts to creating secret reserves.
6. Average Cost Method: When large volumes of materials are available in stores with largely varied prices, pricing based on actual cost may be difficult. In such cases average price methods can be followed. Following are the different average price methods which is used to value material issues.
(a) Simple Average Price Method: According to this method, items issued are priced at average of the prices of the different lots in stores, on the day of issue regardless of the quantity of each lot. It is assumed that materials received first are issued first, at the simple average price. Stock is valued at average of the prices of different lots in stores.
(b) Weighted Average Price Method: In this method, the items issued are valued at weighted average price, which is calculated by taking into consideration both the quantities of items and the cost of the items. The costs of all items are added and the total cost is divided by the total quantity of items available. It is the most commonly used method for valuation of Inventories.
7. Standard Cost Method: In this method stock is valued at some predetermined cost per unit called the Standard Cost.
8. Adjusted Selling Price: In this method, the unsold stock is valued at the prevailing price out of which the normal profit plus the estimated cost of disposal, i.e., selling expenses and overhead expenses are deducted.
Methods of Calculating Market Price: Market price of stock is determined by following any of the two methods:
1. Net Realisable Value: It refers to the estimated price at which stock of goods can be sold in the market after deducting cost of marketing, selling and distribution expenses etc.
2. Replacement Cost: It represents the cost of replacing the stock of identical items at the date of balance sheet.
Sundry debtors fall in the category of current assets. The task of verifying this asset would be reduced largely in case there is an efficient internal check system for recording sales and writing off the sales ledger. According to the Companies Act, 2013 the book debts of a company should be shown as under:
1. Debts considered good in respect of which the company is fully secured.
2. Debts considered good for which the company holds no security other than the debtor’s personal security.
3. Debts considered doubtful or bad.
The object of verification in case of Book Debts is to ascertain-
(A) Correctness or Accuracy of the amount of book debt.Validity or
(B) Confirmation of claims against recorded debtors.
(C) Collectability and determination of realisable value.
(D) Appropriate disclosure in accordance with legal provisions and professional pronouncements.
For verification and valuation of debtors or book debts, an auditor should carefully examine the following points:
(A) Accuracy of the amount of Book Debts or Debtors: Accuracy of the book debts amount or debtors amount shall be:
1. Auditor should obtain a list (Schedule) of debtors, duly certified by some responsible officer of the company.
2. Check whether the debit balance of the sales ledger is in agreement with the control account or not.
(B) Validity: Confirmation requires direct communication with the debtors. The auditor should carefully determine the method, the time of requesting such confirmation and the number of debtors to be requested after taking into consideration the following:
· Undertake test checking of individual accounts, the balances of ledger accounts and some of the entries of control accounts for common items.
· Probability of response from the debtors.
· Examine thoroughly the system of internal check in operation in relation to book debts.
· Materiality of accounts.
The Institute of Chartered Accountants of India through its Standard of Audit recommends that the direct confirmation of balance should be done along the following points.
a. Scrutinize the accuracy of the debtor’s list and verify the existence of debts by receiving directly the confirmation letters or statement of accounts from the debtors (or) arrangements should be made with the client for sending out these letters to the debtors. This may be done on selective basis. However, the confirmation of the balance by the debtor is not a guarantee as regards its realization.
b. Confirmation procedures should be carried out within a reasonable period from the end of the year.
Where the number of debtors is small, letters may be sent to all of them, but when there are numerous debtors these could be done on a test basis.
d. List of debtors selected for confirmation should be prepared in duplicate. A copy of this list should be handed over to the client for preparing request for confirmation, which should be fully addressed. In this regard, the client should enclose stamped envelope bearing the auditor’s name and address for confirmation.
e. Replies received should be carefully gone through and in cases, where balances do not agree, client should be asked to investigate.
f. The auditor must pay special attention to those balances for which confirmations are not available. They might have been either fictitious or made to conceal a fraud.
(C) Collectability and Collection of Book Debts or Debtors: Confirmation of a debt is not an evidence of its collectability.
1. In regarding with collectability, the auditor should make ageing analysis of the debts and classify them as those under 30 days, between 30 and 60 days, between 60 and 90 days, and 120 days and above. This will enable him to ascertain the collectability of individual debts.
Determination of non-collectability of any debt will depend on credit-period allowed to the debtor; how regularly he is paying; how many times he has defaulted in payments; etc. Certain indications of doubtful or uncollectable debts may be as follows.
a. Continuous violation of the terms of credit.
b. Old debts remaining unpaid while new ones are fully paid on time.
c. Stopping of payments after withdrawal of credit facility.
d. Insolvency, disease, or death of a debtor.
e. Closure of debtor’s business or his disappearance.
f. Time- barred debts.
g. Handing over of old debts to company lawyer to file legal suit for recovery.
h. Finally, in case of writing down any bad debt or allowing excessive discount to any debtor, the auditor should carefully go through relevant correspondence and see that there is proper authorization for the same.
2. In regard with collection of debtors, the auditor must consider the following points:
· Make sure that all payments collected from debtors, particularly towards the closing of the year, are promptly credited to their accounts. Auditor should also see that duly authorized vouchers issued by the company acknowledging payments in respect of debts substantiate all such receipts.
· Examine carefully amount paid by debtors, but not credited in their accounts, if any.
· Make sure that customer’s account is duly debited for goods sold or credit.
· Vigilantly enquire into disputed balances owing to some claims or complaints.
· Check the adequacy of the provision for bad and doubtful debts made by the management by undertaking an analysis of the provision for doubtful debts. The auditor should allow a debt to be written off as bad debt when he is fully satisfied that it is irrecoverable. Inadequacy of provision for bad and doubtful debts, if any, must be brought to the knowledge of the owner of the business and highlighting the same in audit report.
(D) Disclosure in Balance Sheet
Book-debts must appear in Balance Sheet at their estimated realisable value. That means there should be deduction of the provision kept for Doubtful Accounts from the total book debts. According to Para III Schedule to Companies Act 2013, there should be disclosure of Sundry Debts in Balance Sheet as follows:
· There should be separate statement of aggregate amount of trade receivable (book debts) not paid for more than six months from the date they became due.
· Classification of Trade receivables must be as follows: (a) Secured, considered good, (b) Unsecured, considered good and (c) Doubtful.
· There should be separate disclosure of allowance for bad and doubtful debts.
· Debts owned by Directors or other officer of the company, or any of them either individually or jointly with any other person, or debts owned by firms or private companies respectively in which any director is a partner, a director, or member, should be separately stated.