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Concept of Internal Audit - A Spoon Feeding

CS Amit Kumar 
on 26 December 2012

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When we run an enterprise we be too busy in getting the goals or losing the goals and become biased for the reason of success or failure. If we get success we think that we were strong and if we fail then think that we were not strong but in reality the things are different. Your win or defeat is totally depends on other things.

If you assess yourself or your organization well and if you know SWOT of your organization as well as if you have clear picture of your environment like resources available to you like team, machine, technology, policies, market, government rule etc. and if your decision is aligned with all above things then you will get success.

For a running enterprise it is an urgent requirement to have a watch like an Internal Audit who can do an independent evaluation and diagnosis of enterprise and give an assurance. It requires at both stages at a good stages as well as bad stages.

Internal Audit -

1. Paragraph 61 of Statement on CARO

2. Section 292A of Companies Act, 1956

3. Listing Agreement

Paragraph 61 of Statement on Companies (Auditor’s Report) Order, 2003 derive the applicability of Internal Audit but before moving to Paragraph 61, first, we have to ensure whether CARO is applicable on our company or not.

Applicability of CARO

The Central Government, in exercise of the powers conferred, under sub-section (4A) of section 227 of the Companies Act, 1956, issued the Companies (Auditor’s Report) Order, 2003, (CARO, 2003) vide Notification No. G.S.R. 480(E) dated June 12, 2003.

The Order applies to all company including a foreign company.

Exemption:

1) Banking Company

2) Insurance Company

3) Section 25 Companies

4. Private Company: but after satisfying all below conditions:

a) Paid up capital & reserves is 50 lacs or less  and

b) Outstanding loan from Banks or Financial Institutions is 25 lacs or less and

c) Turnover is 5 crores or less during the financial year.

What is paid up capital, eligible reserve, outstanding loan and how to calculate turnover, each and every thing is defined in Statement on CARO.

Now Paragraph 61 of Statement on CARO, 2003 – Internal Audit Applicability

1. In the case of listed companies and/or

2. other companies having a paid-up capital and reserves exceeding Rs.50 lakhs as at the commencement of the financial year concerned, or

3. having an average annual turnover exceeding five crores rupees for a period of three consecutive financial years immediately preceding the financial year concerned,

This paragraph requires the auditor (i.e. Statutory Auditor) to comment whether the company has an internal audit system commensurate with the size and nature of the business.

Important Terms:

Listed Company: Mandatory in any case, listed on Balance Sheet date.

Paid Up Capital

a. Paid-up capital would include equity share capital as well as the preference share capital and Bonus Shares.

b. The amount originally paid-up on forfeited shares should be added

c. Share application money received should not be considered as part of the paid-up capital.

d. Amount of calls unpaid should be deducted

Reserve:

a. The portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by management for a general or specific purpose other than provision for depreciation or diminution in the value of assets or for a known liability.

b. both capital as well as revenue reserves should be taken

c. Revaluation reserve, if any, should also be taken into consideration

d. The credit balance in the profit and loss account should also be considered

e. The debit balance of the profit and loss account, if any, should be reduced from the figure of revenue reserves only.

f. Therefore, if the company does not have revenue reserves, debit balance of profit and loss account cannot be reduced from the figures of paid-up capital, capital reserves and revaluation reserves.

For example, if the company has Rs. 40 lakhs of paid up share capital, Rs. 5 lakhs as Revaluation Reserve, Rs. 6 lakhs in Capital Reserve and Rs. 6 lakhs as debit balance in the Profit and Loss Account, the amount of Rs. 6 lakhs standing to the debit of Profit and Loss Account cannot be deducted from the figures of Rs. 11 lakhs, being the total of the Revaluation Reserve and the Capital Reserve. However, miscellaneous expenditure to the extent not written off should not be deducted from the figure of reserves for the purpose of computing the above limit.

 Turnover

“turnover”  =  the aggregate amount for which sales are effected by the company.

“sales effected” =  sale of goods + services rendered by the company.

In an agency relationship, turnover is the amount of commission earned by the agent and not the aggregate amount for which sales are effected or services are rendered.

The term “turnover” is a commercial term and it should be construed in accordance with the method of accounting regularly employed by the company. For ascertaining the limit of rupees five crores:

a. sales tax collected or excise duty collected should not be taken into account if they are credited separately to sales tax account or excise duty account;

b. trade discounts should be deducted from the figure of turnover;

c. commission allowed to third parties should not be deducted from the figure of turnover;

d. sales returns should be deducted from the figure of turnover even if the returns are from the sales made in the earlier years. As a corollary, any sales returns etc., in respect of the sales made during the year under report, if received after the end of that year, would not be deductible from the figure of turnover of such year; and

e. The income received by way of rent or dividend/interest would not form part of “turnover”. However, Part II of Schedule VI to the Companies Act, 1956 clarifies that in case of companies rendering or supplying services, gross income derived from services rendered or supplied, would be shown as turnover. Therefore, in cases where the principal business of the company is letting out of property of the company or it is an investment company, the rent or dividend/interest, respectively, would constitute “turnover”.

f. financial year may comprise of a period more or less than 12 months.

Outstanding loan from Banks or Financial Institutions:

a. i.e. Outstanding Balance of term loans, demand loans, export credits, working capital limits, cash credits, overdraft facilities, bills purchased or discounted.

b. Non-fund based credit facilities, to the extent such facilities have devolved

c. would also include the amount of bank guarantees issued.

d. interest accrued and due is considered as a loan whereas interest accrued but not due is not considered as a loan.

e. cash credit facility, whose balance is fluctuating in nature, the Order would apply to the company in case on

f. any day during the financial year concerned, the amount outstanding in the cash credit facility exceeds Rs. 25 lakhs.

g. Whether long-term loan or a short-term loan or secured or unsecured.

h. outstanding dues in respect of credit cards would also be considered.

Internal Auditor or Department of Internal Audit:

a. A company may either have its own internal audit department or entrust the work of internal audit to an outside agency.

b. In the case of a group of concerns, it is also quite common to have a central internal audit department.

c. It is important to note that the Act does not require a company to necessarily have an internal audit system. However, where such a system does not exist, the Order requires the statutory auditor to mention the fact in his report.

d. The Statutory auditor has to examine whether the internal audit system is commensurate with the size of the company and the nature of its business.

e. Internal audit department should normally be headed by a chartered accountant.

Section 292A of Companies Act, 1956 and Clause 49 Listing Agreement - Audit Committee

The Board Meetings are usually held once in three months and only for the policy matters, but Board does not have the benefit of in depth study of the affairs of the company, especially the financial matters. This lacuna has been rectified by inserting section 292A and now finance professionals can also attend the meeting and discuss the matter.

Some important points of section 292A are here below:

a. Every public company having paid-up capital of not less than five crores of rupees shall constitute a committee of the Board known as "Audit Committee"

b. The auditors, the internal auditor, if any, and the director-in-charge of finance shall attend and participate at meetings of the Audit Committee but shall not have the right to vote.

c. The Audit Committee should have discussions with the auditors periodically about internal control systems, the scope of audit including the observations of the auditors and review the half-yearly and annual financial statements before submission to the Board and also ensure compliance of internal control systems and so on …..

Clause 49 of Listing Agreement: All listed Companies shall constitute a Committee of Directors to be known as “Audit Committee of Directors” to look into accounting, financial and audit aspects of a Company.

Review of information by Audit Committee

The Audit Committee shall mandatory review the following information:--

a. Management discussion and analysis of financial condition and results of operations.

b. Statement of significant related party transactions (as defined by the Audit Committee), submitted by management.

c. Management letters/letters of internal control weaknesses issued by the statutory auditors.

d. Internal audit reports relating to internal control weaknesses, and

e. The appointment, removal and terms of remuneration of the Chief Internal Auditor shall be subject to review by the Audit Committee.

Disclaimer: This is only an article not an opinion, readers are requested to check respected Act/Orders as per their requirement.

Readers are also requested to post your suggestions and comments for improve knowledge and future references and further if you like article Click on Thank User for appreciation, every comment/appreciation count for success.

Regards

ACS Amit Kumar

Email: amitarora999@gmail.com

Source: CARO, 2003 and various books




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