Accounting Treatment For Excise Duty
The following is the text of the revised Guidance Note on Accounting Treatment For Excise Duty issued by the Institute of Chartered Accountants of India.
INTRODUCTION
1. The Institute of Chartered Accountants of India, had issued a Guidance Note on Accounting Treatment for Excise Duties m 1979. In order to bring uniformity in the accounting treatment of excise duty and inventory valuation, the Guidance Note was revised in 1988. Keeping in view further developments, viz., issuance of the revised Accounting Standard (AS) 2, "Valuation of Inventories" (which has come into effecting respect of accounting periods commencing on or after 1.4.1999 and is mandatory in nature), it has been decided to revise this Guidance Note again. This revised Guidance Notes being issued in supersession of the earlier Guidance Note issued in 1988 and is effective in respect of accounting periods beginning on or after April 1, 1999.
2. This Guidance Note recommends accounting treatment for Excise Duty in respect of excisable goods produced or manufactured by an enterprise. A separate Guidance Note on Accounting Treatment for MODVAT sets out principles for accounting for MODVAT (now renamed as ‘CENVAT’.
3. At the outset, this Guidance Note briefly deals with normally accepted accounting principles for inventory valuation as prescribed in revised Accounting Standard (AS) 2 “Valuation of Inventories” issued by the Institute of Chartered Accountants of India, and nature of excise duty For details, reference should be made to revised Accounting Standard (AS) 2 and Central Excise Act, Rules, Notifications and Circulars.
Normally Accepted Accounting Principles For Inventory Valuation
4. Normally accepted accounting principles with regard to the valuation of inventories (i.e. materials or supplies to be consumed in the production process or in the rendering of services, work‑inprocess and finished goods), as prescribed in revised Accounting Standard (AS) 2,"Valuation of Inventories", are reproduced below: 
"5. Inventories should be valued at the lower of cost and net realisable value".
"6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition."
“7. The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase."
"8. The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred m converting materials into finished goods. Fixed production overheads ate those indirect costs of production that remain relatively constant regardless of the volume of production, such as depredation and maintenance of factory buildings and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour."
"9. The allocation of fixed production overheads for the purpose of their inclusion in the costs of conversion is based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on an average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it approximates; normal capacity. The amount of fixed production overheads allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above cost. Variable production overheads are assigned to each unit of production on the basis of the actual use of the production facilities."
”11. Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include overheads other than production overheads or the costs of designing products for specific customers in the cost of inventories.”
Nature Of Excise Duty
5. Excise duty is a duty on manufacture or production of excisable goods in India. Section 3 of the Central Excise Act; 1944, deals with charge of Excise Duty This Section provides that a duty of excise on excisable goods which are produced or manufactured in India shall be levied and collected in such a manner as may be prescribed. This prescription is continued in the Central Excise Rules, 1944 which provide that excise duty shall be collected at the time of removal of goods from factory premises or from approved place of storage (Rule 49). Rate of duty and tariff valuation to be applied is the one in force on that date, ie., the date of removal (Rule 9A) and not the date of manufacture. This difference in the point of time between taxable event, viz., manufacture and that of its collection has been examined and discussed in a number of judgements. For instance, the Supreme Court m the case of Wallace Flour Mills Co. Ltd. vs. CCE 11989 (44) ELT 599 summed up the legal position as under:
“It is well settled by the scheme of the Act as clarified by several decisions that even though the taxable event is the manufacture or production of an excisable article, the duty can be levied and collected at a later stage for administrative convenience. The Scheme of the said Act read with the relevant rules framed under the Act particularly Rule 9A of the said rules, reveals that the taxable event is the fact of manufacture of production of an excisable article, the payment of duty is related to the date of removal of such article from the factory.”
Supreme Court in another case, viz., CCE vs. Vazir Sultan Tobacco Co. [1996 (83) ELT 3] held as under:
“We are of the opinion that Section 3 cannot be read as shifting the levy from the stage of manufacture or production of goods to the stage of removal. The levy is and remains upon the manufacture or production alone. Only the collection part of it is shifted to the stage of removal."
6. The levy of excise duty is not restricted only to excisable goods manufactured and intended for sale. It is also leviable on excisable goods manufactured or produced in a factory for internal consumption. Such intermediate products may be used in manufacture of final products or for repairs within the factory or for use as capital goods within the factory. Excisable goods so used for captive consumption may be eligible for exemption under specific notifications issued from time to time. Finished excisable goods cleared from the place of removal may also be eligible for whole or partial duty exemption in terms of notifications issued from time to time. Such exemption, subject to specified limits, if any, may relate to a manufacturer, e.g., a small scale industrial unit. Exemption may be goods specific, eg., handicrafts are currently wholly exempt from duty. The exemption may also be end‑use specific, e.g., goods for use by defence services. Excisable goods can be removed for export out of India either wholly without payment of duty or under bond or on payment of duty under claim for rebate of duty paid.
7. Excisable goods, after completion of their manufacturing process, are required to be kept in a storeroom or other identified place of storage in a factory till the time of their clearance. Each such storeroom or storage place is required to be declared to the Excise Authorities and approved by them. Such storeroom or storage place is generally referred to as a Bonded Storeroom. Dutiable goods are also allowed, subject to approval of Excise Authorities, to be removed without payment of duty, to a Bonded Warehouse outside factory. In such cases, excise duty is collected at the time of clearance of goods from such Bonded Warehouses.
8. Amount of excise duty forming part of the sale price of the goods is required to be indicated separately in all documents relating to assessment of duty, e.g., excise invoice used for clearance of excisable goods (Section 12A). It is, however, open to a manufacturer to recover excise duty separately or not to make a separate recovery but charge a consolidated sale price inclusive of excise duty The incidence of excise duty is deemed to be passed on to the buyer, unless contrary is proved by the payer of excise duty (Section 12B).
Excise Duty As An Element Of Cost
9. In considering the appropriate treatment of excise duty for the purpose of determination of cost for inventory valuation, it is necessary to consider whether excise duty should be considered differently from other expenses.
10. Admittedly, excise duty is an indirect tax but it cannot; for that reason alone, be treated differently from other expenses. Excise duty arises as a consequence of manufacture of excisable goods irrespective of the manner of use / disposal of goods thereafter, e.g., sale, destruction and captive consumption. It does not cease to be a levy merely because the same may be remitted by appropriate authority in case of destruction or exempted in case goods are used for further manufacture of excisable goods in the factory. Tax (other than a tax on income or sale) payable by a manufacturer is as much a cost of manufacture as any other expenditure incurred by him and it does not cease to be an expenditure merely because it is an exaction or a levy or because it is unavoidable. In fact, in a wider context any expenditure is an imposition which a manufacturer would like to minimise.
11. Excise duty contributes to the value of the product. A "duty paid" product has a higher value than a product on which duty remains to be paid and no sale or further utilisation of excisable goods can take place unless the duty is paid. It is, therefore, a necessary expense which must be incurred if the goods are to be put in the location and condition in which they can be sold or further used in the manufacturing process.
12 Excise duty cannot therefore be treated differently from other expenses for the purpose of determination of cost for inventory valuation. To do so would be contrary to the basic objective of carrying forward the cost related to inventories until these are sold or consumed.
13 As stated in para 6 above, liability to excise duty arises even on excisable goods manufactured and used in further manufacturing process. In such a case excise duty paid (if the same is not exempted) on the intermediary product becomes a manufacturing expense. Excise duty paid on such intermediary products must, therefore, be included in the valuation of work-in-process or finished goods manufactures by the subsequent processing of such products.
Provision For Unpaid Excise Duty
14. Since the point of time at which duty is collected is not necessarily the point of time at which the liability to pay the duty arises, situations will often arise when duty remains to be collected on goods which have been manufactured. The most common of these situations arises when die goods are stored under bond, i.e., in a bonded Store Room, and the duty is paid when the goods are removed from such bonded Store Room.
15. Divergent views exist as to whether provision should be made in the accounts for the liability in respect of goods which are not cleared or which are lying in bond at the balance sheet date.
16. The arguments in favour of the creation of liability are briefly summarised under:
(a) The liability for excise duty arises at the point of time at which the manufacture is completed and it is only its collection which is deferred, and
(b) failure to provide for the liability will result in the balance sheet not showing a true and fair view of the state of affairs of the enterprise.
17. The arguments against the creation of the liability briefly summarised, are as under:
(a) Though the liability for excise duty arises at the point of time at which the manufacture is completed, it gets quantified only when goods are cleared from the factory or the bonded warehouse,
(b) the actual liability for excise duty may get modified by the time the goods are cleared from the factory or bonded warehouse,
(c) where goods are damaged or destroyed before clearance, excise duty may be waived by the competent authority and therefore the duty may never be paid, and
(d) failure to provide for the liability does not affect the profits or losses.
18. Since the liability for excise duty arises when the manufacture of the goods is completed, it is necessary to create a provision for liability of unpaid excise duty on stocks lying in the factory or bonded warehouse. It is true that the recovery of the duty is deferred till the goods are removed from the factory ot the bonded warehouse and the exact quantification will, therefore, be at the time of removal and that estimate of duty made on balance sheet date may change on account of subsequent events, e.g., change in the rate of duty and exports under bond. But, this is true of many other items also, e.g., provision for gratuity and this cannot be an argument for not making a provision for existing liability on estimated basis.
19. The estimate of such liability can be made at the rates in force on the balance sheet date. For this purpose, other factors affecting liability should also be considered, e.g., exemptions being availed by the enterprise, pattern of sales – export, domestic etc. Thus, if a small scale undertaking is availing the benefit of exemption allowed in a particular financial year and declares that it wishes to avail such exemption during next financial year also, excise duty liability should be calculated after taking into consideration the availability of exemption under the relevant notification. Similarly, if an enterprise is captively consuming all its production of a specific product and has been availing of exemption from payment of duty on that product, no provision for excise duty may be required in respect of non‑duty paid stock of that product lying in factory or bonded warehouse. An auditor must, however, apply appropriate audit tests while verifying statements and declarations made by an enterprise in this regard.
Auditor's Responsibility
20.Theauditor has a responsibility to express his opinion whether the financial statements on which he reports give a true and fair view of the operating results and state of affairs of the entity. In the case of companies, under MAOCARO, 1988, the auditor has to express an opinion whether the valuation of inventories is fair and proper in accordance with normally accepted accounting principles and is on the same basis, as in the earlier years. If there is any change in the basis of valuation, the effect of such change, if material, is to be reported.
21. As explained in this Guidance Note, the liability for excise duty arises at the point of time at which the manufacture is completed. The excise duty paid or provided on finished goods should, therefore, be included in inventory valuation. Similarly, excise duty paid on purchases (other than those subsequently recoverable by the enterprise from the taxing authorities) as well as intermediary products used for manufacture should also be included in the valuation of work‑in‑progress or finished goods.
22. If the method of accounting for excise duty is not in accordance with the principles explained in this Guidance Note, the auditor should qualify his report. In the case of a company, reference to this qualification should also be made in the auditor's report under Section 227(4‑A) of the Companies Act, 1956.
23. Summary Of Recommendations
(i) Excise duty should be considered as a manufacturing expense and like other manufacturing expenses be considered as an element of cost for inventory valuation.
(ii) Where excise duty is paid on excisable goods and such goods are subsequently utilised in the manufacturing process, the duty paid on such goods, if the same is not recoverable from taxing authorities, becomes a manufacturing cost and must be included in the valuation of work‑in‑progress or finished goods arising from the subsequent processing of such goods.
(iii) Where the liability for excise duty has been incurred but its collection is deferred, provision for the unpaid liability should be made.
(iv) Excise duty cannot be treated as a period cost.
(v) If the method of accounting for excise duty is not in accordance with the principles explained in this Guidance Note, the auditor should qualify his report.
Guidance Note On Audit Of Expenses
Para 2.1 of the "Preface to the Statements on Standard Auditing Practices" issued by the Institute of Chartered Accountants of India states that the "main function of the APC is to review the existing auditing practices in India and to develop Statements on Standard Auditing Practices (SAPs) so that these may be issued by the Council of the Institute." Para 2.4 of the Preface states that the "APC will issue Guidance Notes on the issues arising from the SAPs wherever necessary."
The Auditing Practices Committee has also taken up the task of reviewing the Statements on auditing matters issued prior to the formation of the Committee. It is intended to issue, in due course of time, SAPs or Guidance Notes, as appropriate, on the matters covered by such Statements which would then stand withdrawn. Accordingly, with the issuance of this Guidance Note on Audit of Expenses, paragraphs 11.2‑11.8 of Chapter 11 of the Statement on Auditing Practices, titled 'Profit and Loss Account', shall stand withdrawn. In due course of time, the entire Statement on Auditing Practices shall be withdrawn. The following is the text of the Guidance Note on "Audit of Expenses" issued by the Auditing Practices Committee of the Council of the Institute of Chartered Accountants of India. This Guidance Note should be read in conjunction with the Statements on Standard Auditing Practices issued by the Institute.
INTRODUCTION
1. An expense is a cost relating to the operations of an accounting period or to the revenue earned during the period or the benefits of which do not extend beyond that period. The expression "cost" means the amount of expenditure incurred on or attributable to a specified article, product or activity.
2. Expenses are recognised by the following approaches:
(a) Identification with revenue transactions
Costs directly associated with the revenue recognised during the relevant period are considered as expenses and are charged to income for the period.
(b) Identification with a period of time
In many cases, although some costs may have connection with the revenue for the period, the relationship is so indirect that it is impracticable to attempt to establish it. However, there is a clear identification with a period of time.1 Such costs are regarded as ‘period costs' and are expensed in the relevant period, e.g, salaries, telephone, travelling, depreciation on office building, normal interest, etc. Similarly, the costs the benefits of which do not clearly extend beyond the accounting period are also charged as expenses.
3. The following features of expenses affect the nature, timing and extent of the related audit procedures:
(a) In the case of most items of expenses, documentary evidence originating from third parties is available.
(b) The nature and relative significance of various items of expenses usually differ from one enterprise to another, depending primarily on the nature of operations carried out by them. For example, in the case of most manufacturing enterprises, the principal items of expenses would include the cost of raw materials consumed, labour cost and other conversion costs. On the other hand in the case of a trading enterprise, the principal items of expenses would generally be the cost of goods sold. In the case of an enterprise supplying, providing, maintaining and operating any services, the principal items of expense would include personnel and professional expenses, office maintenance, etc.
(c) The amount of some expenses has a logical relationship with certain other financial statement items while the amount of some other expenses does not have such a relationship. For example, in an enterprise where the production process is standardised, the consumption of raw materials (and, therefore, the cost of raw materials consumed) has a logical relationship with the quantum of output. Similarly, the proportion of various constituents of cost of production is expected to remain more or less constant in the absence of known conditions to the contrary. Likewise, proportion of the amount of interest for a period to the amount of loans outstanding during the period is expected to vary within certain specific Emits. On the other hand, the expenditure on research and development often has little relationship with other items in the financial statements.
(d) The amount of some items of expenses (e.g., gratuity, taxes, bonus, etc.) is significantly affected by applicable laws.
4. In an audit, the auditor employs appropriate procedures to obtain reasonable assurance about various assertions (see SAP 5, Audit Evidence). In carrying out an audit of expenses, the auditor is particularly concerned with obtaining sufficient appropriate audit evidence to corroborate the management's assertions regarding the following:
Occurrence	that recorded expenses arose from transactions or events which took place during the relevant period and pertain to the entity.	
Completeness 	that there are no unrecorded expenses.	
Measurement	that expenses are recorded in the proper amounts and are allocated to the proper period.	
Presentation and Disclosure	that expenses are disclosed, classified, and described in accordance with recognised accounting policies and practices and relevant statutory require merits, if any.	
5. In view of the divergence in the nature of expenses incurred by different enterprises, it is not possible to describe the audit procedures applicable in carrying out an audit of expenses in all situations. This Guidance Note provides guidance on procedures to be employed in carrying out an audit of expenses which would be applicable in the case of most enterprises. It is recognised, however, that audit procedures different from or additional to those described in this Guidance Note may be necessary in a particular case depending upon its specific facts and circumstances.
INTERNAL CONTROL EVALUATION
6. The auditor should study and evaluate the system of internal control relating to expenses, to determine the nature, timing and extent of his other audit procedures. ~He should particularly review the following aspects of internal control relating to expenses: 2
(a) The systems and procedures relating to incurring of expenses including authorisation procedures.
(b) Accounting procedures relating to recognition of expenses.
(c) Existence of periodic reports on actual performance vis a vis budgets and internal management reports, if any.
VERIFICATION
7. Verification of expenses may be carried out by employing the procedures, viz., 
(a) examination of records; and
(b) analytical procedures. The nature, timing and extent of substantive procedures to be performed is, however, a matter of professional judgment of the auditor which is based, inter alia, on the auditor's evaluation of the effectiveness of the related internal controls. The auditor should examine whether the basis of recognition of expenses by the entity is in accordance with the recognised accounting principles.
(a) Examination of Records
8. Examination of records and documents is one of the most important techniques of auditing. An auditor has to examine a large number of documents in the course of an audit since most transactions are supported only by documentary evidence. The accounting systems of business enterprises are so designed that documentary evidence is created in respect of each transaction. The auditor should carry out an examination of the relevant records to satisfy himself about the validity, accuracy and other assertions with regard to various expenses incurred by the entity. The extent of such examination would depend on the auditor's evaluation of the efficacy of internal controls.
(b) Analytical Procedures
9. The auditor should conduct analytical procedures which involve analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or which deviate from predicted amounts.3
10. The following paragraphs describe the audit procedures applicable in respect of various items of expenses.
Goods and Raw Materials Consumed
11. The auditor's examination of the cost of goods, stores and materials consumed during the year would involve, interalia, examination of purchases of goods and materials made during the year as well as of purchase returns and of opening and closing inventories.
Purchases and Purchase Returns
12. The auditor should examine whether the entity has instituted adequate cut‑off procedures in relation to purchases and purchase returns. The objective of cut‑off procedures is to ensure that the transactions pertaining to a period are recorded in that period and not in a preceding or subsequent period. The auditor should examine the efficacy of such procedures. The auditor can examine the selected receipt documents (such as goods received notes) pertaining to a few days immediately before the year‑end and verify that the related purchase invoices have been recorded as purchases of the current year. The auditor should pay particular attention to the cut‑off procedures relating to purchases, both indigenous and imported, to determine whether these procedures ensure recognition of purchases at the time the significant risks and rewards of ownership of the related goods pass on to the entity.
13. The auditor should examine selected entries in the purchase journal with reference to the related purchase invoices, receipt records and other supporting documents such as the purchase orders. The auditor should also trace the selected entries to the suppliers' account.
14. While examining purchase invoices, the auditor should examine whether subsidies, rebates, duty drawbacks or other, similar items have been properly accounted for. As per AS‑2, costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable. to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.
15. The auditor should also examine selected receipt records with reference to related purchase invoices and the purchase journal.
16. The auditor should examine selected entries of purchase returns with reference to the goods returned notes, debit notes and entries in the suppliers' accounts. Similarly, the auditor should examine selected debit notes with reference to purchase returns, goods returned ,notes, and entries in the suppliers' accounts.
17. In case of transactions between related parties, the auditor should pay special attention to nature and description of such transactions.4
18. The auditor should obtain a representation from the management to the effect that the entity has complied with the legal and regulatory requirements, if any. When the auditor becomes aware of non‑compliance, the auditor should obtain sufficient information to evaluate the Possible effect in the financial statements. The auditor should also consider communication/reporting of non-compliance with the management including audit committee, users of financial statements and to regulatory authorities as may be appropriate.5
19. In respect of imports, the auditor should carryout the following procedures in addition to the usual audit procedures applicable in respect of domestic purchases.
(a) Besides examining the usual documents relating to purchases, the auditor should also examine such documents as bill of lading, custom documents, etc. which‑ are specific to import transactions.
(b) The auditor should pay special attention to the terms of import relating to the incidence of charges Eke insurance and freight, i.e., whether the imports are on C.I.F. basis, or F.O.B. basis, or some other basis.
(c) The auditor should examine that imports for which consideration is payable in a foreign currency are recorded at an appropriate amount in accordance with Accounting Standard (AS) 11, Accounting for the Effects of Changes in Foreign Exchange Rates.
20. In addition to the audit procedures discussed above, the following analytical procedures may often be helpful as a means of obtaining audit evidence regarding the various assertions relating to purchases.
(a) Comparison, item‑wise and location‑wise both quantity and value, of purchases for the current year/period with the corresponding figures for previous years/periods.
(b) Comparison of ratio of gross margin to sales for the current year/period with the corresponding figures for previous years/periods.
(c) Comparison of ratio of purchase returns to Purchases for the current year/period with the corresponding figures for previous years/periods.
(d) Product‑wise reconciliation of quantity sold during the year/period with opening stock, purchases/production and closing stock.
Apart from the above, the auditor may also work out quantitative ratios and reconciliations, e.g., he may relate the quantum of output to the quantum of input to judge its reasonableness. In case segment information is available, the above procedures may be carried out for each segment.
21. The auditor should also verify payments subsequent to the date of the balance sheet to identify any purchases which have not been recorded in the books of account.
Wages and Salaries
22. The auditor should examine the entries in the payroll/wage sheets with reference to relevant records, e.g., employee's records maintained by the personnel department showing details of pay such as basic pay, allowances, annual increments, leaves availed, etc. Special attention may also be paid by auditor in respect of new employees joining the entity during the year. Similarly, the payroll may also be examined with reference to the time records/attendance records and leave records maintained by the personnel department. The deductions made in respect of income‑tax, provident fund, Employees State' Insurance (ES1), welfare schemes, health schemes, etc. may be examined with reference to the returns submitted to the authorities concerned and the receipts/acknowledgments issued by such authorities.
23. The auditor should examine whether any legal, regulatory or contractual requirements having a bearing on the rate or amount of wages and salaries have been complied with. Similar considerations would also apply to payments made to a contractor for hire of labour. Such requirements would include, inter alia, the provisions of the Minimum Wages Act, 1948, agreement with the employees, award of competent authority and judicial rulings.
24. In the case of senior management officials, the auditor should pay particular attention to determining whether the salaries payable are as per the terms of contract with the employees concerned. Special requirements of terms of contract such as granting stock options (as per schemes formulated by SEB1), availing leave encashment, total amount payable annually including ex‑gratia, etc. should be specifically looked into.
25. In the case of casual labour, besides carrying out the other audit procedures, the auditor should specifically examine the sanction of the competent authority for employment of such labour and ascertain whether such employees are retained as per the time rate or piece‑rate basis. In appropriate cases, the auditor may pay a surprise visit to the sites where the casual labour is employed to assess the correctness of the attendance records maintained in respect of such labour. In cases where complete outsourcing of labour has been given to an outside agency, the term of agreement and compliance thereof would be examined.
26. The auditor should obtain a list of employees who have retired or otherwise left the services of the entity during the period under audit and examine that they have not been included in the payroll.
27. In addition to the audit procedures discussed above, the following analytical procedures may often be helpful as a means of obtaining audit evidence regarding the various assertions relating to wages and salaries:
(a) comparison of wage bill for the year/period with the wage bill of previous years/periods;
(b) comparison of the monthly wage and salaries of a month with other months during the year/period and with the corresponding month of the previous years/periods;
(c) comparison of the wage* bill for each department/unit for the current year/period with the corresponding figures for previous years/periods;
(d) comparison of the ratio of wages and salaries to sales for the current year/period with the corresponding figures for the previous years/periods;
(e) comparison of the ratio of wages and salaries to cost of production for the current year/period with the corresponding figures for previous years/periods;
(f) comparison of the ratio of contribution towards provident fund to wages and salaries for the current year/period with the corresponding figures for previous years/periods;
(g) comparison of the ratio of contribution towards provident fund to wages and salaries for the current year/period with the rate(s) of contribution specified under the law governing provident fund;
(h) comparison of the ratio of contribution towards ESI to wages and salaries for the current year/period with the corresponding figure for previous years/periods;
(i) comparison of the ratio of contribution towards ESI to wages and salaries for the current year/period with the rate(s) of contribution specified under the law governing the ESI.
Bonus
28. In the case of provision for bonus, the auditor should examine whether the liability is provided for in accordance with the Payment of Bonus Act, 1965 and/or agreement with the employees or award of competent authority. Where the bonus actually paid is in excess of the amount required to be paid as per the provisions of the applicable law/agreement/award, the auditor should specifically examine the authority for the same (e.g., resolution of the board of directors in: the case of a company).
Retirement Benefits
29. The auditor should examine whether the entity is liable to pay any retirement benefits to its employees such as provident fund, superannuation/pension, gratuity, etc., whether in pursuance of requirements of any law and/or in terms of agreement with the employees6. If so, the auditor should examine whether the amount payable has been computed in accordance with the relevant legal and/or contractual requirements. In respect of gratuity/pension, the auditor should specifically examine whether the provision for accruing gratuity/pension liability has been made by the entity. The auditor should examine the adequacy of provision with reference to the actuarial certificate obtained by the entity7, in case the entity has not obtained such an actuarial certificate, the auditor should examine that the method followed by it, say, group gratuity insurance scheme taken by the entity, for calculating the accrued liability for gratuity is rational.
Other Conversion Costs
30. The auditor should verify the other conversion costs (such as power and fuel, processing charges, etc.) with reference to the supporting documents and related agreements. In case the material is sent outside to third parties for processing, necessary charges including existence of materials, wastage, etc. need to be ascertained and accounted for. In addition, the auditor may also compare the amount of expense on a particular item with the corresponding figure for previous years. Similarly, he may work out the ratios of different items of conversion costs to total cost of production for the current year and compare the same with the corresponding figures for previous years.
Establishment and General Administrative Expenses
31. The auditor should verify establishment expenses and general administrative expenses such as insurance, rent, rates, conveyance, travelling, telephone, entertainment, printing and stationery, general expenses, etc. with reference to the sanction of the competent authority, the supporting documents, related agreements and the rules and regulations followed by the entity. The auditor may also compare the amounts of these expenses with the corresponding figures for previous years. Similarly, he may work out the ratios of different items of expenses to sales for the current year and compare the same with the corresponding figures for previous years.
Interest and Financial charges
32. The auditor should verify the amount of interest expense for the year with reference to the terms and conditions of relevant agreements. The auditor may also work out the ratio of interest expense for the year to average interest‑bearing loans and advances outstanding during the year and compare it with the corresponding figure for previous years and reconcile the same. The auditor should particularly examine that interest as well as other financing costs such as commitment fees on funds borrowed for a qualifying asset included in the gross book value of the asset to which they relate and have not been charged to the profit and loss account of the period in which they are incurred8. If the entity has paid any penal interest it should also be examined. Such interest should be disclosed as part of normal interest. The auditor should consider, having regard to the materiality, whether it requires separate disclosure.
Depreciation
33. The auditor should check the calculation of depreciation. The total depreciation arrived at should be compared with that of previous years to identify reasons for variations. The auditor should particularly examine whether the depreciation charge having regard to rate of depredation and method of depreciation followed consistently is adequate keeping in view the generally accepted bases of accounting for depreciation9. Alternatively, the auditor may consider qualifying his report. In case, assets have been revalued by entity during the year, the auditor should ensure that the depreciation has been computed properly.
Research and Development Expenses
34. The auditor should verify various items of expenses incurred on research and development with reference to supporting documents and related agreements. For example, the cost of materials consumed for research and development may be verified with reference to such documents as purchase invoices, goods received notes, records relating to issue of materials, etc. The auditor should particularly examine whether the accounting policy followed by the entity regarding treatment of research and development costs is in accordance with Accounting Standard (AS) 8, Accounting for Research and Development.
35. The auditor should examine whether the deferral meets the appropriate legal requirements, if any. If an accounting policy for deferral of research and developments is adopted, it should be applied to all such projects which meet the criteria laid down for deferral under AS 8. The auditor should examine whether the criteria laid down in AS‑8 which previously justified the deferral of certain research and development costs no longer apply, the unamortised balance has been charged as an expense of the year. Similarly, the auditor should examine that where the criteria for deferral continue to be met but the amount of unamortised balance of the deferred research and development costs and other relevant costs exceed the expected future revenues/benefits related thereto, such excess has been charged as an expense immediately.
Repairs and Maintenance
36. The auditor should scrutinise the repairs and maintenance account to ascertain that new fixed assets and substantial improvements to existing assets have not been included in repairs and maintenance. The auditor should exercise special care particularly in case large amounts charged to the profit and loss account.
Contingencies .
37. In respect of product warranties, service contracts, performance warranties, etc., the auditor should examine whether provisions have been made in accordance with Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date. The auditor should also examine the reasonableness of the basis adopted for quantifying the provision with reference to the relevant agreements and the assessment based on his past experience.
Taxes on Income
38. The auditor should examine that tax expense or tax saying has been properly computed and disclosed in the financial statements10. The tax expense for the period which comprises current tax and deferred tax is to be included in the determination of net profit or loss for the period under audit. In case of companies attracting minimum alternate tax, it has to be ensured that proper provision has been considered in the accounts. The auditor should examine that the deferred taxes have been recognised for all timing differences subject to consideration of prudence in respect of deferred tax assets as set out in Accounting Standard (AS) 22, Accounting for Taxes on Income. If there is a material departure from the provisions of AS 22, the auditor should qualify his report.
39. In respect of assessments completed, revised or rectified during the year, the auditor should examine whether suitable adjustments have been made in respect of additional demands or refunds, as the case may be. The relevant orders received up to the time of audit should be considered and, on this basis, it should be examined whether adjustment is required in the financial statements.
40. If the entity disputes its liability in regard to demands raised, the auditor should examine whether there is a positive evidence or action on the part of the entity to show that it has not accepted the demand for payment of tax or duty, e.g., where it has gone into appeal under relevant provisions of the Income‑tax Act, 1961. Where an application for rectification of mistake has been made by the entity, the amount should be regarded as disputed. Where the demand notice/intimation for the payment of tax is for a certain amount and the dispute relates to only a part and not the whole of the amount, only such amount should be treated as disputed. A disputed tax liability may require a provision or suitable disclosure (see Accounting Standard 4, Contingencies and Events Occurring After the Balance Sheet Date). In determining whether a provision is required, the auditor should, among other procedures, make appropriate inquiries of management, review minutes of the meetings of the board of directors and correspondence with the entity's lawyers, and obtain appropriate management representations.
41. The auditor should obtain from the management a statement showing the status of pending tax matters. He should examine the statements to assess the adequacy of provisions made in respect of those matters in the context of their current status.
SPECIAL CONSIDERATIONS IN THE CASE OF A COMPANY
42. In the case of audit of a company, in addition to the procedures described above, the auditor should also carry out appropriate audit procedures in respect of matters which are specifically required to be examined under the provisions of the Companies Act, 1956. Some of the illustrative procedures specifically applicable in the case of audit of a company are described below. It may be clarified that the following is not an exhaustive list of additional procedures to be carried out in the case of audit of expenses in the case of a company.
(a) The auditor should examine whether the managerial remuneration paid or payable by the company is within the limits laid own under section 198 and Schedule XIII to the Companies Act, 1956. The auditor should also examine whether the remuneration paid or payable to the directors of the company, including any managing or whole‑time director, has been determined by the Articles of Association of the company or by a resolution of the company passed in a general meeting. The auditor should also examine whether the remuneration of directors complies with the provisions of section 309 of the Companies Act, 1956. The auditor should further examine whether the computation of net profit for purposes of managerial remuneration is in accordance with sections 349 and 350 of the Companies Act, 1956.
(b) The auditor should examine whether the contributions, if any, made by the company to charitable and other funds not directly relating to the business of the company or the welfare of its employees comply with the provisions of section 293 of the Companies Act, 1956. According to this section, the board of directors of a public company cannot, except with the consent of the company in general meeting, contribute to charitable, and other funds not directly relating to the business of the company or the welfare of its employees, any amounts the aggregate of which will, in any financial year, exceed Rs.50,000 or 5 per cent of the average net profits of the company as determined in accordance with the provisions of section 349 and section 350 during the three financial years immediately preceding, whichever is greater. The auditor should examine whether the Memorandum of Association of the company empowers it to make contributions to charitable or other funds not directly relating to the business of the company or the welfare of its employees. If the objects clause in the Memorandum does not contain such authority, the company has no power to make such contributions.

The auditor should ask the management to prepare a schedule of contributions to various funds covered by section 293 made during the year, giving the names of the institutions to which contributions have been made, the amounts paid and the dates on which the contributions were approved by the board of directors. He should also ask the management to prepare a computation showing the limits of permissible contributions which can be made under this section.
(c) The auditor should examine whether political contributions made by the company are within the limit prescribed in section 293A of the Companies Act, 1956.11 Where the limit laid down under section 293A is adhered to and the facts are properly disclosed, the auditor has no further duty. Where, however, the facts regarding such contributions are not properly disclosed, the auditor should qualify his report and state the facts therein. Where the auditor has genuine doubt regarding the applicability of the Section, he should ensure that the fact is properly disclosed in his audit report.

Where the auditor is satisfied that political contributions have been made in excess of the limit prescribed in section 293A, he should bring this to the attention of the shareholders by qualifying his audit report and making a mention of the excess amount involved, if ascertainable.

The auditor should obtain a certificate from company's board of directors to the effect that all amounts of contributions to political parties or for any political purpose to any person falling under the provisions of section 293A have been brought into the books of account of the company and that no amounts of such nature other than those so included in the books have been paid/given, directly or indirectly.
(d) The auditor should examine whether the contribution, if any, to the National Defence Fund or any other fund approved by the Central Government for the purpose of national defence complies with the provisions of section 293J3 of the Companies Act, 1956.This section empowers the board of directors to make such contributions. It may be noted that unlike the contributions to charitable or other funds n or directly relating to the business of the company or to the welfare of its employees, contributions to National Defence Fund (or other similar funds) can be made by a company even where the Memorandum of Association of the company does not specifically empower it in this regard. The auditor should examine whether the total amount or amounts contributed by the company to the National Defence Fund (or other similar funds) during the year have been suitably disclosed in the profit and loss account.
(e) In respect of payments to sole-selling agents, the auditor should examine whether the provisions of sections 294,294A and 294AA have been complied with.
(f) The auditor should examine whether the provisions of section 297 have been complied with in appropriate cases. He should also examine compliance with the terms and conditions, if any, stipulated by the Central Government in its approval under the proviso to sub‑section (1) of section 297,
(g) In case any partner or relative of a director of the company, any firm in which such director, or relative of such director, is a partner, any private company of which such director is a director or member, or any director, or manager of such a private company, holds any office or place of profit under the company or under any subsidiary of the company, the auditor should examine whether the provisions of section 314 have been complied with.
(h) The auditor should examine whether any personal expenses have been charged to revenue account.12
(i) The auditor should examine whether the transaction of purchase of goods and materials and services, made in pursuance of contracts or arrangements entered in the register(s) maintained under section 301 of the Companies Act, 1956, as aggregating during the year to Rs.50,000 (Rupees Fifty Thousand) or more in respect of each party, have been made at prices which are reasonable having regard to prevailing market prices for such goods,, materials and services or the prices at which transaction for similar goods or service have been made with other parties. 13
(j) The auditor should examine whether any undisputed amounts payable in respect of income tax, wealth tax, sales tax, customs duty and excise duty were outstanding as at the last day of financial year concerned, for a period of more than six months from the date they became payable have been reported under MAOCARO, 1988.
EXAMINATION OF PRESENTATION AND DISCLOSURE
43. The auditor should satisfy himself that the expenses have been properly classified and disclosed in the financial statements. Where the relevant statute lays down any disclosure requirements in this behalf, the auditor should examine whether the same have been complied with.
MANAGEMENT REPRESENTATION
44. The auditor should consider obtaining a management representation on expenses charged to the statement of profit or loss when other sufficient appropriate audit evidence cannot reasonably be expected to exist. 14
DOCUMENTATION
45. The auditor should maintain adequate working papers regarding audit of expenses. 15
1 Reference may be made in this regard to Guidance Note on Accrual Basis of Accounting.
2 The extent of review of internal controls would depend upon the facts and circumstances of each case. Reference may be made in this regard to the "Internal Control Questionnaire", issued by the Institute of Chartered Accountants of India in 1976 which contains, inter alia, an illustrative list of internal controls in relation to petty cash, cash and bank payments, salaries and wages And purchases.
3 Refer to SAP‑14, Analytical Procedures
4 Refer to AS‑1 8, Related Party Disclosures. 
5 Refer to SAP‑21, Consideration of Laws and Regulations in an Audit of Financial Statements.
6 Attention is invited in this regard to AS 15, Accounting for Retirement Benefits in the Financial Statements of Employers.
7 Attention is also invited in this regard to SAP 9, Using the Work of an Expert.
8 Attention is invited AS‑16, Borrowing Costs.
9 Attention is also drawn to Accounting Standard (AS) 6, Depreciation Accounting.
10 Attention is drawn to Accounting Standard (AS) 22, Accounting for Taxes on Income.
11 Reference may be made in this regard to the Guidance Note on Section 293A.of the Companies Act and the Auditor.
12 Reference may be made in this regard to the Statement on the Manufacturing and Other Companies (Auditor's Report) Order, 1988. 
13 Reference may be made in this regard to the Statement on the Manufacturing and Other Companies (Auditor's Report) Order, 1988. 
14 Reference may be made in this regard to SAP 11, Representation by Management. 
15 Reference may be made in this regard to SAP‑3, Documentation.
Guidance Note on Audit of Cash and Bank Balances
The following is the text of the Guidance Note on Audit of Cash and Bank Balances issued by the Auditing Practices Committee of the Council of the Institute of Chartered Accountants of India. This Guidance Note should be read in conjunction with the Statements on Standard Auditing Practices issued by the Institute.1
1 . Para 2.1 of the Preface to the Statements on Standard Auditing Practices issued by the Institute of Chartered Accountants of India states that the "main function of the APC is to review the existing auditing practices in India and to develop Statements on Standard Auditing Practices (SAPs) so that these may be issued by the Council of the Institute." Para 2.4 of the Preface states that the "APC will issue Guidance Notes on the issues arising from the SAPs wherever necessary."
2. The Auditing Practices Committee has also taken up the task of reviewing the Statements on auditing matters issued prior to the formation of the Committee. It is intended to issue, in due course of time, SAPs or Guidance Notes, as appropriate, on the matters covered by such Statements which would then stand withdrawn. With the issuance of this Guidance Note on Audit of Cash and Bank Balances, Chapter 6 of the Statement on Auditing Practices, titled 'Cash and Bank Balances', shall stand withdrawn. 2 In due course of time, the entire Statement on Auditing Practices shall be withdrawn.
INTRODUCTION
3. Cash and bank balances may constitute a significant proportion of the total assets of an entity. An important feature of cash and bank balances which has a significant impact on the related audit procedures is that these assets are highly prone to misappropriation, misapplication and other forms of fraud.
4. In any auditing situation, the auditor employs appropriate procedures to obtain reasonable assurance about various assertions (see Statement of Standard Auditing Practices 'Audit Evidence). In carrying out an audit of cash and bank balances, the auditor is particularly concerned with obtaining sufficient appropriate audit evidence to corroborate the management’s assertions regarding the following:
Existence – that recorded cash and bank balances exist as at the year-end.
Rights and obligations – that recorded cash and bank balances represent the assets of the entity.
Completeness – that there are no unrecorded cash and bank balances.
Besides the above, in certain situations, the auditors may also be particularly concerned with the valuation of cash and bank balances, e.g., in the case of (g) safe custody of cash, foreign currency held by the entity or in the case of bank accounts designated in foreign currencies.
INTERNAL CONTROL EVALUATION
5. The auditor should study and evaluate the system of internal control relating to cash and bank balances to determine the nature, timing and extent of his other audit procedures. He should particularly review the following aspects of internal control relating cash and bank balances. 3
(a) Segregation of duties relating to authorisation of transactions, handling of cash/ issuance of cheques and writing of books of account, and rotation of the duties periodically;
(b) proper authorisation of cash and banking transactions;
(c) daily recording of cash transactions;
(d) safeguards such as restrictive crossing of cheques, use of pre-printed, pre-numbered forms;
(e) periodic reconciliation of bank balances;
(f) reconciliation of cash-on-hand with book balance on a daily basis or at other appropriate intervals, including surprise checks by higher authorities;
(g) safe custody of cash, cheque books, receipt books etc.; and
(h) cash/fidelity insurance.
VERIFICATION
6. Verification of cash and bank balances may be carried out by employing the procedures described in paragraphs 7-27. It may, however, be emphasised that the nature, timing and extent of substantive procedures to be performed is a matter of professional judgment of the auditor which is based, inter alia, on the auditor's evaluation of the effectiveness of the related internal controls.
Verification of Cash Balances
7. The auditor should carry out physical verification of cash at the date of the balance sheet. However, if this is not feasible, physical verification may be carried out, on a surprise basis, at any time shortly before or after the date of the balance sheet. In the latter case, the auditor should examine whether the cash balance shown in the financial statements reconciles with the results of the physical verification after taking into account the cash receipts and cash payments between the date of the physical verification and the date of the balance sheet. Besides physical verification at or around the date of the balance sheet, the auditor should also carry out surprise verification of cash during the year. 
8. All cash balances in the same location should be verified simultaneously. Where petty cash is maintained by one or more officials, the auditor should advise the entity to require the officials concerned to deposit the entire petty cash on hand on the last day with the cashier. The auditor should enquire whether the cashier also handles cash of sister concerns, staff societies, etc. in such a case, cash pertaining to them should also be verified at the same time so as to avoid chances of cash balances of one entity being presented as those of another.
9. If IOUs (‘I owe you') or other similar documents are found during physical verification, the auditor should obtain explanations from a senior official of the entity as to the reasons for such IOUs/ other similar documents remaining pending. It should also be ensured that such IOUs/other similar documents are not shown as cash-on-hand.
10. The quantum of torn or mutilated currency notes should be examined in the context of the size and nature of business of the entity. The auditor should also examine whether such currency notes are exchanged within a reasonable time.
11. If, during the course of the audit, it comes to the attention of the auditor that the entity is consistently maintaining an unduly large balance of cash-on-hand, he should carry out surprise verification of cash more frequently to ascertain whether the actual cash on hand agrees with the balance as shown by the books. If the cash on hand is not in agreement with the balance as shown in the books, he should seek explanations from a senior official of the entity. In case any material difference is not satisfactorily explained, the auditor should state this fact appropriately in his audit report. In any case, he should satisfy himself regarding the necessity for such large balances having regard to the normal working requirements of the entity. The entity may also be advised to deposit the whole or the major part of the cash balance in the bank at reasonable intervals.
12. Where post dated cheques are on hand on the balance sheet date, the auditor should verify that they have not been accounted for as collections during the period under audit.
Verification of Bank Balances
13. The auditor should advise the entity to send a letter to all its bankers to directly confirm the balances to the auditor. The Appendix to this Guidance Note gives an illustrative proforma letter of request for confirmation to be used for this purpose. The request for confirmation should also cover dormant accounts as well as accounts closed during the year.
14. The auditor should examine the bank reconciliation statement prepared as on he last day of the year. He may also examine the reconciliation statements as at other dates during the year. It should be examined whether (i) cheques issued by the entity but not presented for payment, and (ii) cheques deposited for collection by the entity but not credited in the bank account, have been duly debited/credited in the subsequent period. For this purpose, the bank statements of the relevant period should be examined. If the cheques issued before the end of the year have not been presented within a reasonable time, it is possible that the entity might have prepared the cheques before the end of the year but not delivered them to the parties concerned. 1 n such a case, the auditor should examine that the entity has reversed the relevant entries.
15. Where the auditor finds that post dated cheques are issued by the entity, he should verify that any cheques pertaining to the subsequent period have not been accounted for as payments during the period under audit.
16. The auditor should pay special attention to those items in the reconciliation statements which are outstanding for an unduly long period. The auditor should ascertain the reasons for such outstanding items from the management. He should also examine whether any such items require an adjustment/write off.
17. 1he auditor should be alert to the possibility that even though the balance in an apparently inoperative account may have remained stagnant, transactions may have taken place in that account during the year.
18. Where a large number of cheques has been issued/ deposited in the last few days of the year, and a sizeable proportion of such cheques has subsequently remained unpaid/uncleared, this may indicate an intention of understating creditors/debtors or understating/overstating bank balances. In such a case, it may be appropriate for the auditor to obtain confirmations from the parties concerned, especially in respect of cheques involving large amounts. The auditor should also examine whether a reversal of the relevant entries would be appropriate underthe circumstances.
19. The procedures discussed in paragraph 18 should also be considered by the auditor in cases where a large number of cheques is on hand at the date of the balance sheet and a sizable proportion of such cheques has subsequently remained undeposited/uncleared.
20. In relation to balances/deposits with specific charge on them, or those held under the requirements of any law, the auditor should examine that suitable disclosures are made in the financial statements. 
21. In respect of fixed deposits or any other type of deposits with banks, the relevant receipts/certificates, duly supported by bank advices, should be examined.
22. Remittances shown as being in transit should be examined with reference to their credit in the bank in the subsequent period. Where the auditor finds that such remittances have not been credited in the subsequent period, he should ascertain the reasons for the same. He should also examine whether the entity has reversed the relevant entries in appropriate cases.
23. The auditor should examine that suitable adjustments are made in respect of cheques which have become stale as at the close of the year.
24. Where material amounts are held in bank accounts which are blocked, e.g, in foreign banks with exchange control restrictions or any banks which are under moratorium or liquidation, the auditor should examine whether the relevant facts have been suitably disclosed in the financial statements. He should also examine whether suitable adjustments on this account have been made in the financial statements in appropriate cases.
25. Where the auditor finds that the number of bank accounts maintained by the entity is disproportionately large in relation to its size, the auditor should exercise greater care in satisfying himself about the genuineness of banking transactions and balances.
Examination of Valuation and Disclosure
26. The auditor should satisfy himself that cash and bank balances have been valued and disclosed in the financial statements in accordance with recognised accounting policies and practices and relevant statutory requirements, if any. 4 In this regard, the auditor should examine that following items are not included in cash and bank balances.
(a) Temporary advances.
(b) Stale or dishonoured cheques.
Postage and revenue stamps, if material in amount, may be shown separately instead of being included under cash and bank balances.
27. The auditor should also examine that suitable disclosures as mentioned in paragraphs 20 and 24 above are made in relevant cases.
APPENDIX
ILLUSTRATIVE LETTER OF CONFIRMATION BANK BALANCES
(Ref. Paragraph 13)
[Letterhead of Entity]
[Date]
[Name and Address of Bank]
Dear Sirs,
Please send directly to our auditors ........... (name and address of the auditors) details of balances as at the close of business on [date] …………… of all our accounts with you as well as details of charges held against such balances, with a copy to us. For your convenience, we enclose in duplicate a form in which details of our balances with you can be filled in. If you find the spaces on the form insufficient to contain ail the relevant information, please attach a separate statement.
Please note that this request covers all our accounts with you as at the above mentioned date, including any dormant accounts. We would also request you to give particulars of any of our accounts closed during the year. We would request you to state "Nil”, wherever applicable.
Yours faithfully,
(Signature of person authorised to operate accounts)

Reply from (Bank) 
Date ..................
Re: (Name of Client) 
At the request of our client we submit below particulars of their accounts, investments, bills, etc., as at the close of business on ….………. as shown by our records 
1 . Current Accounts in Credit:
Designation of Account	Amount		
2. Overdrawn Current Accounts, Overdraft Accounts, Cash Credit Accounts
Designation of Account	Amount	Security Held (Give brief description. In the case of securities please list fully)	
3. Loan Accounts:
Designation of Account	Amount	Security Held (Give brief description. In the case of securities please list fully)	
4. Fixed, Call and Short Deposit Accounts:
Amount. Interest Accrued to the Closing Date	Due Date	Particulars of any charges or liens	
5. Investments and Other Documents of Title Held in Safe Custody:
Designation		Face Value or number of shares held	
6. Margin against letters of credit, Guarantees issued, etc:
Designation of Account	Amount		
7. Bills for Collection:
Designation of Account	Amount	Due Date	
8. Bills Discounted or Purchased:
Name of Drawee	Amount	Due Date	
9. Letters of Credit Open and Outstanding:
In favour of	Amount not utilised	Valid up to	
10. Guarantees given on behalf of clients:
In favour of	Amount	Date of expiry	

We certify that the above particulars are full and correct and do not exclude any other obligations of the entity to us. 
Yours faithfully,
Name of Bank
Designation of Signatory

1. With the formation of the Auditing Practices Committee in 1982, the Council of the Institute has been issuing a series of Statements on Standard Auditing Practices (SAPs). Statements on Standard Auditing Practices lay down the principles governing an audit. These principles apply whenever an independent audit is carried out. Statements on Standard Auditing Practices become mandatory on the dates specified in the respective SAPs. Their mandatory status implies that, while discharging their attest function, it will be. the duty of the members of the Institute to ensure that the SAPs are followed in the audit of financial information covered by their audit reports. If, for any reason, a member has not been able to perform an audit in accordance with the SAPs, his report should draw attention to the material departures therefrom.
The Auditing Practices Committee has also been issuing, from time to time, guidance notes on issues arising from SAPs. The Guidance Notes provide guidance on procedures to be employed by an auditor in order to comply with the principles laid down in SAPs. It is recognised that in determining the nature, timing and extent of audit procedures to be employed in a specific situation, an auditor will have to exercise his professional judgment. The Guidance Notes, therefore, are recommendatory. A member should ordinarily follow the recommendations in a guidance note relating to an auditing matter except where he is satisfied that, in the circumstances of the case, it may not be necessary to do so.
2. The special aspects of audit of cash and bank balances in the case of banks are dealt with in the Guidance Note on Audit of Banks issued by the Auditing Practices Committee.
3. The extent of review of controls would depend upon the facts and circumstances of each case. Reference may be made in this regard to the Internal Control Questionnaire, issued by the Institute of Chartered Accountants of India in 1976 which contains, inter alia, an illustrative list of internal controls in relation to cash and bank balances.
4. For valuation of foreign currency held as cash on hand and bank balances designated in foreign currencies, reference may be made to Accounting Standard 11, Accounting for the Effects of Changes in Foreign Exchange Rates, issued by the Institute of Chartered Accountants of India

Guidance Note on Accounting for Fringe Benefits Tax	
(The following is the text of the Guidance Note on Accounting for Fringe Benefits Tax, issued by the Council of the Institute of Chartered Accountants of India 1.)	
1. The Finance Act, 2005, has introduced Chapter XII-H on ‘Income-tax on Fringe Benefits’ [hereinafter referred to as ‘Fringe Benefits Tax’]. The relevant extracts from Chapter XII-H of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’), governing the Fringe Benefits Tax, have been reproduced in the Annexure to this Guidance Note. This Guidance Note is being issued to provide guidance on accounting for Fringe Benefits Tax, particularly with regard to the recognition and presentation of Fringe Benefits Tax in the financial statements. The Guidance Note does not deal with accounting for ‘fringe benefits’ as such.
	
2. The salient features of Fringe Benefits Tax are as below: 
Fringe Benefits Tax is tax payable by an employer in respect of fringe benefits provided or deemed to have been provided by the employer to his employees during the previous year.

Fringe Benefits Tax is in addition to the income-tax charged under the Act.

Fringe Benefits Tax is payable at the specified rate on the value of fringe benefits. The value of fringe benefits is calculated in accordance with the provisions of section 115WC of the Income-tax Act, 1961, reproduced in the Annexure to this Guidance Note.

An employer is required to pay Fringe Benefits Tax even if no income-tax on the total income is payable.

The term ‘employer’ means:

a company;

a firm;

an association of persons or a body of individuals, whether incorporated or not, but excluding any fund or trust or institution eligible for exemption under clause (23C) of section 10 or registered under section 12AA of the Act;

a local authority; and

every artificial juridical person, not falling within any of the preceding sub-clauses.

The term ‘fringe benefits’ means any consideration for employment provided by way of –

any privilege, service, facility or amenity, directly or indirectly, provided by an employer, whether by way of reimbursement or otherwise, to his employees (including former employee or employees);

any free or concessional ticket provided by the employer for private journeys of his employees or their family members; and

any contribution by the employer to an approved superannuation fund for employees.

The fringe benefits shall be deemed to have been provided by the employer to his employees, if the employer has, in the course of his business or profession (including any activity whether or not such activity is carried on with the object of deriving income, profits or gains), incurred any expense on or made any payment for the purposes stated in section 115WB(2) of the Act. Examples of the purposes stated under the said section are entertainment, festival celebrations, gifts, maintenance of guest house, employees’ welfare, hotel, boarding and lodging, conveyance, tour and travel (including foreign travel), etc.

Every employer who during a previous year has paid or made provision for payment of fringe benefits to his employees, is required to furnish a return of fringe benefits to the Assessing Officer in the prescribed form, on or before the due date, in respect of the previous year.

Fringe Benefits Tax, like any other direct tax, is not an allowable expenditure for the purpose of computation of taxable income. 	
NATURE OF FRINGE BENEFITS TAX	
3. With a view to recommend a proper and uniform accounting treatment for the Fringe Benefits Tax, it is necessary to understand the nature of Fringe Benefits Tax which is discussed in paragraphs 4.
	
4. The Fringe Benefits Tax has been introduced under the Income-tax Act, 1961, as ‘additional income-tax’, vide section 115WA(1) which provides as below: 
“In addition to the income-tax charged under this Act, there shall be charged for every assessment year commencing on or after the 1st day of April, 2006, additional income-tax (in this Act referred to as fringe benefit tax) in respect of the fringe benefits provided or deemed to have been provided by an employer to his employees during the previous year at the rate of thirty per cent on the value of such fringe benefits.”
Thus, the above stated tax is an additional income-tax payable by the employer on the value of fringe benefits provided or deemed to have been provided to its employees.	
RECOGNITION AND MEASUREMENT OF FRINGE BENEFITS TAX	
5. An employer becomes liable to pay Fringe Benefits Tax as soon as it incurs an expense which is considered to be a fringe benefit as per the requirements of Chapter XII-H of the Income-tax Act, 1961, even though the actual payment of the tax and/or assessment of the tax takes place on a later date. Accordingly, the employer should recognise, in the financial statements for the period, expense for the Fringe Benefits Tax paid/payable in respect of all expenses giving rise to such tax incurred during that period.
	
6. As discussed in paragraph 2(c) above, the Fringe Benefits Tax is payable at the specified rate on the value of fringe benefits. The value of fringe benefits is calculated in accordance with the provisions of section 115WC of the Act. The employer should, therefore, measure the amount of the Fringe Benefits Tax keeping in view the aforesaid provisions of the Act.
	
PRESENTATION OF FRINGE BENEFITS TAX IN FINANCIAL STATEMENTS	
7. Paragraph 5 of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India, provides as below: 
“5. All items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period unless an Accounting Standard requires or permits otherwise.”
Since the Fringe Benefits Tax is an additional tax for the employer, it should be included in the determination of net profit or loss for the period, i.e., the Fringe Benefits Tax, should be charged to the profit and loss account.
	
8. In the context of presentation of the Fringe Benefits Tax in the profit and loss account of companies, it has been considered whether the tax is covered by the requirement of clause 3(vi) of Part II of Schedule VI to the Companies Act, 1956, which provides as below: 
"The amount of charge for Indian income-tax and other Indian taxation on profits, including, where practicable, with Indian income-tax any taxation imposed elsewhere to the extent of the relief, if any, from Indian income-tax and distinguishing, where practicable, between income-tax and other taxation."
As discussed in paragraph 4 above, the Fringe Benefits Tax is an additional income tax. Accordingly, the Fringe Benefits Tax is covered by the above clause and should be shown separately, if material.
	
9. Keeping in view the above, the Fringe Benefits Tax should be disclosed as a separate item after determining profit before tax on the face of the profit and loss account for the period in which the related fringe benefits are recognised. An illustration of the disclosure of Fringe Benefits Tax may be as below:	

Profit before tax				xxx	
Less: Income-tax expense:					
	Current tax	xxx			
	Deferred tax	xxx	xxx		
	Fringe Benefits Tax	xxx	xxx		
Profit after tax			xxx		

10. The amount of the Fringe Benefits Tax (net of the advance tax thereon), outstanding if any, at the year-end, should be disclosed as a provision in the balance sheet.
	
Annexure	
The Relevant Extracts from Chapter XII-H of the Income-tax Act, 1961, Governing the Fringe Benefits Tax

(For assessment year 2006-07)	
A.—Meaning of certain expressions	
Definitions	
115W. In this Chapter, unless the context otherwise requires,—

“employer” means,—

a company;

a firm;

an association of persons or a body of individuals, whether incorporated or not, but excluding any fund or trust or institution eligible for exemption under clause (23C) of section 10 or registered under section 12AA;

a local authority; and

every artificial juridical person, not falling within any of the preceding sub-clauses;

“fringe benefit tax” or “tax” means the tax chargeable under section 115WA.
	
B.—Basis of charge	
Charge of fringe benefit tax	
115WA. (1) In addition to the income-tax charged under this Act, there shall be charged for every assessment year commencing on or after the 1st day of April, 2006, additional income-tax (in this Act referred to as fringe benefit tax) in respect of the fringe benefits provided or deemed to have been provided by an employer to his employees during the previous year at the rate of thirty per cent on the value of such fringe benefits.
	
(2) Notwithstanding that no income-tax is payable by an employer on his total income computed in accordance with the provisions of this Act, the tax on fringe benefits shall be payable by such employer.
	
Fringe benefits	
115WB. (1) For the purposes of this Chapter, “fringe benefits” means any consideration for employment provided by way of— 
any privilege, service, facility or amenity, directly or indirectly, provided by an employer, whether by way of reimbursement or otherwise, to his employees (including former employee or employees);

any free or concessional ticket provided by the employer for private journeys of his employees or their family members; and

any contribution by the employer to an approved superannuation fund for employees.

The privilege, service, facility or amenity does not include perquisites in respect of which tax is paid or payable by the employee.
	
(2) The fringe benefits shall be deemed to have been provided by the employer to his employees, if the employer has, in the course of his business or profession (including any activity whether or not such activity is carried on with the object of deriving income, profits or gains) incurred any expense on, or made any payment for, the following purposes, namely:— 
entertainment;

provision of hospitality of every kind by the employer to any person, whether by way of provision of food or beverages or in any other manner whatsoever and whether or not such provision is made by reason of any express or implied contract or custom or usage of trade but does not include—

any expenditure on, or payment for, food or beverages provided by the employer to his employees in office or factory;

any expenditure on or payment through paid vouchers which are not transferable and usable only at eating joints or outlets;

conference (other than fee for participation by the employees in any conference).

Explanation.—For the purposes of this clause, any expenditure on conveyance, tour and travel (including foreign travel), on hotel, or boarding and lodging in connection with any conference shall be deemed to be expenditure incurred for the purposes of conference;

sales promotion including publicity:

Provided that any expenditure on advertisement,—

being the expenditure (including rental) on advertisement of any form in any print (including journals, catalogues or price lists) or electronic media or transport system;

being the expenditure on the holding of, or the participation in, any press conference or business convention, fair or exhibition;

being the expenditure on sponsorship of any sports event or any other event organised by any Government agency or trade association or body;

being the expenditure on the publication in any print or electronic media of any notice required to be published by or under any law or by an order of a court or tribunal;

being the expenditure on advertisement by way of signs, art work, painting, banners, awnings, direct mail, electric spectaculars, kiosks, hoardings, bill boards or by way of such other medium of advertisement; and

being the expenditure by way of payment to any advertising agency for the purposes of clauses (i) to (v) above,

shall not be considered as expenditure on sales promotion including publicity;

employees’ welfare.

Explanation.—For the purposes of this clause, any expenditure incurred or payment made to fulfil any statutory obligation or mitigate occupational hazards or provide first aid facilities in the hospital or dispensary run by the employer shall not be considered as expenditure for employees’ welfare;

conveyance, tour and travel (including foreign travel);

use of hotel, boarding and lodging facilities;

repair, running (including fuel), maintenance of motor cars and the amount of depreciation thereon;

repair, running (including fuel) and maintenance of aircrafts and the amount of depreciation thereon;

use of telephone (including mobile phone) other than expenditure on leased telephone lines;

maintenance of any accommodation in the nature of guest house other than accommodation used for training purposes;

festival celebrations;

use of health club and similar facilities;

use of any other club facilities;

gifts; and

scholarships. 	
(3) For the purposes of sub-section (1), the privilege, service, facility or amenity does not include perquisites in respect of which tax is paid or payable by the employee.
	
Value of fringe benefits	
115WC. (1) For the purpose of this Chapter, the value of fringe benefits shall be the aggregate of the following, namely:— 
cost at which the benefits referred to in clause (b) of sub-section (1) of section 1I5WB, is provided by the employer to the general public as reduced by the amount, if any, paid by, or recovered from, his employee or employees:

Provided that in a case where the expenses of the nature referred to in clause (b) of sub-section (1) of section 115WB are included in any other clause of sub-section (2) of the said section, the total expenses included under such other clause shall be reduced by the amount of expenditure referred to in the said clause (b) for computing the value of fringe benefits;

actual amount of contribution referred to in clause (c) of sub-section (1) of section 115WB;

twenty per cent of the expenses referred to in clauses (A) to (K) of subsection (2) of section 115WB;

fifty per cent of the expenses referred to in clauses (L) to (P) of subsection (2) of section 115WB.
	
(2) Notwithstanding anything contained in sub-section (1),— 
in the case of an employer engaged in the business of hotel, the value of fringe benefits for the purposes referred to in clause (B) of sub-section (2) of section 115WB shall be “five per cent” instead of “twenty per cent” referred to in clause (c) of sub-section (1);

in the case of an employer engaged in the business of construction, the value of fringe benefits for the purposes referred to in clause (F) of subsection (2) of section 115WB shall be “five per cent” instead of “twenty per cent” referred to in clause (c) of sub-section (1);

in the case of an employer engaged in the business of manufacture or production of pharmaceuticals, the value of fringe benefits for the purposes referred to in clauses (F) and (G) of sub-section (2) of section 115WB shall be “five per cent” instead of “twenty per cent” referred to in clause (c) of sub-section (1);

in the case of an employer engaged in the business of manufacture or production of computer software, the value of fringe benefits for the purposes referred to in clauses (F) and (G) of sub-section (2) of section 115WB shall be “five per cent” instead of “twenty-per cent” referred to in clause (c) of sub-section (1);

in the case of an employer engaged in the business of carriage of passengers or goods by motor car, the value of fringe benefits for the purposes referred to in clause (H) of sub-section (2) of section 115WB shall be “five per cent” instead of “twenty per cent” referred to in clause (c) of sub-section (1);

in the case of an employer engaged in the business of carriage of passengers or goods by aircraft, the value of fringe benefits for the purposes referred to in clause (I) of sub-section (2) of section 115WB shall be taken as Nil.
	
C.— Procedure for filing of return in respect of fringe benefits, assessment and payment of tax in respect thereof	
Return of fringe benefits	
115WD. (1) Without prejudice to the provisions contained in section 139, every employer who during a previous year has paid or made provision for payment of fringe benefits to his employees, shall, on or before the due date, furnish or cause to be furnished a return of fringe benefits to the Assessing Officer in the prescribed form and verified in the prescribed manner and setting forth such other particulars as may be prescribed, in respect of the previous year.
	
Explanation.—In this sub-section, “due date” means,— 
where the employer is—

a company; or

a person (other than a company) whose accounts are required to be audited under this Act or under any other law for the time being in force,

the 31st day of October of the assessment year;

in the case of any other employer, the 31st day of July of the assessment year.
	
Payment of fringe benefit tax	
115WI. Notwithstanding that the regular assessment in respect of any fringe benefits is to be made in a later assessment year, the tax on such fringe benefits shall be payable in advance during any financial year, in accordance with the provisions of section 115WJ, in respect of the fringe benefits which would be chargeable to tax for the assessment year immediately following that financial year, such fringe benefits being hereafter in this Chapter referred to as the “current fringe benefits”.
	
Advance tax in respect of fringe benefits	
115WJ. (1) Every assessee who is liable to pay advance tax under section 115WI, shall on his own accord, pay advance tax on his current fringe benefits calculated in the manner laid down in sub-section (2).
	
(2) The amount of advance tax payable by an assessee in the financial year shall be thirty per cent of the value of the fringe benefits referred to in section 115WC, paid or payable in each quarter and shall be payable on or before the 15th day of the month following such quarter:
	
Provided that the advance tax payable for the quarter ending on the 31st day of March of the financial year shall be payable on or before the 15th day of March of the said financial year.
	
(3) Where an assessee, has failed to pay the advance tax for any quarter or where the advance tax paid by him is less than thirty per cent of the value of fringe benefits paid or payable in that quarter, he shall be liable to pay simple interest at the rate of one per cent on the amount by which the advance tax paid falls short of, thirty per cent of the value of fringe benefits for any quarter, for every month or part of the month for which the shortfall continues.	
1. Recommendations contained in this Guidance Note are intended to apply only to items which are material.	

Guidance Note on Special Considerations in the Audit of Small Entities
INTRODUCTION
Auditing and Assurance Standards (AASs) {earlier known as Statements on Standard Auditing Practices (SAPs)} contain basic principles and essential procedures together with related guidance that apply to the audit of the financial statements of any entity, irrespective of its size, its legal form, ownership or management structure, or the nature of its activities. The Council of the institute recognises that audit of small entities gives rise to a number of special considerations. This guidance is a supplement to, and not a substitute for, the guidance contained in the relevant AAS and takes account of the special considerations relevant to the audit of small entities. For the specific requirements of AASs, the auditor should refer to the AAS concerned. This Guidance Note does not establish any new requirements for the audit of small entities nor does it establish any exemptions from the requirements of AASs. All audits of small entities are to be conducted in accordance with AASs.

The objective of this Guidance Note is to describe the characteristics that are commonly found in small entities and indicate how they might affect the application of AASs. This Guidance Note, thus, includes:
(a) discussion of the characteristics of small entities; and
(b) guidance on the application of AASs to the audit of small entities;
In determining the nature and extent of the guidance provided in this Guidance Note, the Auditing and Assurance Standards Board (AASB) has aimed to provide a level of guidance that will be of general applicability to all audits of small entities and that will assist the auditor in exercising professional judgement with respect to the application of AASs. However, detailed guidance of a procedural nature has not been provided as the issue of such guidance may undermine the proper exercise of professional judgement in auditing.
Normally, in the case of small entities, the auditors provide advisory services on accounting matters. It may be noted that with a view to ensure the independence of auditor, the Council of the Institute of Chartered Accountants of India has clarified that the members are not permitted to write the books of accounts of their auditee clients. Therefore, although the auditor may provide advisory services on accounting matters, he should refrain from writing the books of accounts of the auditee. Also, while providing the advisory services, the auditor must ensure that:
(a) he does not land in a situation where there could be conflict of interests and duty;
(b) the client accepts the responsibility for the financial statements; and
(c) provision of advisory services does not result into breach of any provisions of the Chartered Accountants Act, 1949 and Rules and Regulations framed thereunder. 
The Characteristics of Small Entities
The auditor of any entity adapts the audit approach to the circumstances of the entity and the terms of engagement. The audit of a small entity differs from the audit of a large entity as documentation maybe simple, and audits of small entities are ordinarily less complex and may be performed using fewer assistants.
The meaning of "small entity" in this context gives consideration not only to the size of an entity but also to its typical qualitative characteristics. Quantitative indicators of the size of an entity may include balance sheet totals, revenue and the number of employees, but such indicators are not definitive. Therefore, it is not possible to give an adequate definition of a small entity solely in quantitative terms.

For the purposes of this Guidance Note, a small entity is any entity in which:
(a) there is concentration of ownership and management in a small number of individuals (often a single individual1); and
(b) one or more of the following are also found:
• few sources ofincome and uncomplicated activities;
• simple and personalized record‑keeping;
• limited internal controls together with the potential for management override of controls.
The qualitative characteristics described above are not exhaustive, they are not exclusive to small entities and small entities do not necessarily display all of those characteristics. For the purposes of this Guidance Note, small entities will ordinarily display characteristic 7(a) and one or more of the characteristics included mentioned at 7(b). These characteristics need to be examined in every audit period and if an entity doesn't display these characteristics in the period, the entity would not be categorized as small entity in such period. 
Concentration of Ownership and Management
Small entities usually have few owners, often there is a sole proprietor. Many owner‑managers adopt a 'hands on' approach to internal control issues by personally exercising supervisory controls. The owner may employ a manager to run the business but in most cases is directly involved in running the business on a day‑to‑day basis. As the proprietor, the owner manager has a personal interest in safeguarding the assets of the business, measuring its performance and controlling its activities, but may be unable to divert limited management time to such matters as formal internal control procedures. However, the lack of formality does not of itself indicate circumstances giving rise to a high risk of fraud or error, the auditors of a small entity make their assessment of risk in the light of its particular circumstances.
This Guidance Note uses the term "owner‑manager" to indicate the proprietors of entities who are involved in the running of the entity on a day to day basis. Where proprietors are not involved on a day to day basis, the term "owner‑manager" is used to refer to both the proprietors, and to any managers hired to run the entity. 
Few Sources of Income and Uncomplicated Activities
Small entities typically have a limited range of activities and often specialize in a single product or se and operate from a single location.

Uncomplicated activities can make it easier for the auditors to acquire, record and maintain knowledge of the business. In addition, in many small entities, accounting populations are often small and easily analysed; the application of a wide range of audit procedures can often be straightforward in such circumstances. For example, effective predictive models for use in analytical procedures can sometimes be constructed. 
Simple Record‑Keeping
Most small entities employ few, if any, personnel who are solely engaged in record keeping. Consequently, the book keeping functions and accounting records are often simple. Record keeping may be simple, customised or personalised, which results in a greater risk that the financial statements may be inaccurate or incomplete. Many small entities outsource some of or all their record keeping. Small entities often find it convenient to use branded accounting software packages designed for use on personal computer. Small entities need to keep sufficient accounting records to comply with any relevant statutory or regulatory requirements and to meet the needs of the entity, including the preparation an audit of financial statements. Therefore, the accounting system needs to be designed in such a manner so as to provide reasonable assurance that:
(a) all the transactions and other accounting information that should have been recorded have in fact been recorded;
(b) assets and liabilities recorded in the accounting system exist and are recorded at the correct amounts; and
(c) Fraud or error in processing accounting information can be detected.

Limited Internal Controls
Size and economic considerations in small entities mean that sophisticated internal controls are often neither necessary nor desirable, the fact that there are few employees limits the extent to which segregation of duties is practicable. However, for key areas, en in the very small entity, it can be practicable to implement some degree of segregation of duties or other form of unsophisticated but effective controls. Supervisory controls exercised on a day‑to‑day basis by the owner‑manager may also have a significant beneficial effect as the owner‑manager has a personal interest in safeguarding the assets of the entity, measuring its performance and controlling its activities. 
The owner‑manager occupies a dominant position in a small entity. The owner‑manager's direct control over all decisions, and the ability to intervene personally at any time to ensure an appropriate response to changing circumstances, are often important features of the management of small entities. The exercise of this control can also compensate for otherwise weak internal control procedures. For example, in cases where there is limited segregation of duties in the area of purchasing and cash disbursements, internal control is improved when the owner‑manager personally signs all cheques. When the owner‑manager is not involved, there is a greater risk that employee fraud or error may occur and not be detected. 
While a lack of sophistication in internal controls does not, of itself, indicate a high risk of fraud or error, an owner‑manager's dominant position can be abused: management override of controls may have a significant adverse effect on the control environment in any entity, leading to an increased risk of management fraud or material misstatement in the financial statements. For example, the owner‑manager may direct personnel to make disbursements that they would otherwise not make in the absence of supporting documentation. 
The impact of the owner‑manager and the potential for management override of internal controls on the audit depend to a great extent on the integrity, attitude, and motives of the owner‑manager. As in any other audit, the auditor of a small entity exercises professional skepticism. The auditor neither assumes that the owner manager is dishonest nor assumes unquestioned honesty. This is an important factor to be considered by the auditor when assessing audit risk, planning the nature and extent of audit work, evaluating audit evidence, and assessing the reliability of management representations. 
COMMENTARY ON THEAPPLICATION OFAUDITING AND ASSURANCE STANDARDS
The commentary that follows provides guidance on the application of AASs to the audit of a small entity. It is reiterated that this guidance is a supplement to, and not a substitute for, the guidance contained in the relevant AAS and takes account of the special considerations relevant to the audit of small entities. For the specific requirements of AASs, the auditor should refer to the AAS concerned. Where a AAS is, in principle, applicable to audit of financial statements of small entities and there are no special considerations applicable to the audit of a small entity, no guidance is given in respect of that AAS. 
AAS 3, Documentation
Paragraph 5 of AAS 3 states:
"The form and. content of working papers are affected by matters such as:
• The nature of the engagement.
• The form of the auditor's report.
• The nature and complexity of the client's business.
• The nature and condition of the client's records and degree of reliance on internal controls.
• The need in particular circumstances for direction, supervision and review of work performed by assistants." 
The auditor may have an in‑depth understanding of the entity and its business, because of the close relationship between the auditor and the owner‑manager, or because of the size of the entity being audited, or the size of the audit team and the audit firm. However, that understanding does not eliminate the need for the auditor to maintain adequate working papers. Working papers assist in the planning, performance, supervision and review of the audit, and they record the evidence obtained to support the audit opinion. 
The discipline imposed by the requirement to record the reasoning and conclusions on significant matters requiring the exercise of judgment can often, in practice, add to the clarity of the auditor's understanding of the issues in question and enhance the quality of the conclusions. This is so for all audits, even in the case of a sole practitioner with no assistants. 
Different techniques may be used to document the entity's accounting and internal control systems, depending on their complexity. However in small entities, the use of flowcharts or narrative descriptions of the system are often the most efficient techniques. These can be kept as permanent information and are reviewed and updated as necessary in subsequent years. 
Paragraphs 11 & 12 of AAS 3 provides examples of the contents of working papers. These examples are not intended to be used as a checklist of matters to be included in all cases. The auditor of a small entity uses judgement in determining the contents of working papers in any particular case.

Nevertheless, the auditor of a large or a small entity, records in the working papers:
(a) the audit planning;
(b) an audit programme setting out the nature, timing, and extent of the audit procedures performed;
(c) the results of those procedures; and
(d) the conclusions drawn from the audit evidence obtained together with the reasoning and conclusions on all significant matters requiring the exercise of judgement.

In the audit of a small entity, the nature and extent of the auditor's procedures and, consequently, of the documentation needed, are likely to be influenced by the following characteristics of small entities:
(a) Simple ownership and management structures;
(b) Uncomplicated activities with few products and services (and few locations);
(c) Few, if any. Employees;
(d) Simplified accounting records;
(e) Packaged accounting software; and
(f) Few, if any, internal controls. 
AAS 4, The Auditor's Responsibility to Consider Fraud and Error in an Audit of financial Statements
Paragraph 10 of AAS 2, "Objective and Scope of the Audit of Financial Statements” states as follows:
”In forming his opinion on the financial statements, the auditor follows procedures designed to satisfy himself that the financial statements reflect a true and fair view of the financial position and operating results of the enterprise. The auditor recognises that because of the test nature and other inherent limitations of an audit, together with the inherent limitations of any system of internal control, there is an unavoidable risk that some material misstatement may remain undiscovered. While in many situations the discovery of a material misstatement by management may often arise during the conduct of the audit, such discovery is not the main objective of audit nor is the auditor's programme of work specifically designed for such discovery. The audit cannot, therefore, be relied upon to ensure the discovery of all frauds or errors but where the auditor has any indication that some fraud or error may have occurred which could result in material misstatement, the auditor should extend his procedures to confirm or dispel his suspicions."

Paragraph 2 of AAS 4 (Revised) states:
"Where planning and performing audit procedures and evaluating and reporting the results thereof, the should consider the risk of material misstatement in the financial statements resulting from fraud and error.”

The presence of a dominant owner‑manager is an important factor in the overall control environment as the need for management authorization can compensate for otherwise weak control procedures and reduce the risk of employee fraud and error. However, this can be a potential weakness since is the opportunity for management override of controls. The owner‑manager's attitude to control issues in general and to the personal exercise of supervisory controls can have a significant influence on the auditor's approach. The auditor's assessment of the effect on such matters is conditioned by knowledge of that particular entity and the integrity of its owner-manager. Matters that auditors may take into account this assessment include the following:
• Whether the owner‑manager has a specific identifiable motive (for example, dependence of the owner‑manager on the success of the entity) to distort the financial statements, combined the opportunity to do so.
• Whether the owner‑manager makes no distinction between personal and business transactions.
• Whether the owner‑manager's life‑style is materially inconsistent with the level of his or her remuneration (this includes other sources of income which the auditor may be aware by completing the owner‑manager's tax return, for example).
• Whether there are frequent changes of professional advisors.
• Whether the start date for the audit has been repeatedly delayed or there are unexplained demands to complete the audit in an unreasonably short period of time.
• Whether there are unusual transactions around the year‑ end that have a material effect on profit.
• Whether there are unusual related party transactions.
• Whether the payments of fees or commissions to agents and consultants appear excessive.
• Whether there are disputes with tax authorities
• Whether parts of the detailed accounting records are unavailable or have been lost implausible reasons;
• Whether there is a significant level of cash transactions without adequate documentation;
• Whether there are many transactions without adequate documentation.
* Whether numerous unexplained aspects of audit evidence (such as differences between the accounting records and third‑party confirmations, or unexpected results of analytical procedures);
• Whether there is inappropriate use of accounting estimates;
• Whether the owner‑manager or key personnel have not taken annual leave for a long period of time.
• Whether there is lack of sufficient working capital.
• Whetherweaknesses reported earlier are continued.
• Whether there is non‑maintenance of year ending inventory and stock registers. 
AAS5, Audit Evidence
Paragraphs 1 to 5 of AAS 5 state:
”1. Statement on Standard Auditing Practices (AAS) 1, "Basic Principles Governing an Audit”, states (paragraphs 15‑17):
"The auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial information.
Compliance procedures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in effect.
Substantive procedures are tests designed to obtain evidence as to the completeness, accuracy and validity of the data produced by the accounting system.
They are of two types: 
(a) Tests of details of transactions and balances;
(b) Analysis of significant ratios and trends including the resulting enquiry of unusual fluctuations and items.
Sufficient Appropriate Audit Evidence
2. Sufficiency and appropriateness are interrelated and apply to evidence obtained from both compliance and substantive procedures. Sufficiency refers to the quantum of audit evidence obtained; appropriateness relates to its relevance and reliability. Normally, the auditor finds it necessary to rely on evidence that is persuasive rather than conclusive. He may often seek evidence from different sources or of different nature to support the same assertion.

3. The auditor should evaluate whether he has obtained sufficient appropriate audit evidence before he draws his conclusions therefrom. The audit evidence should, in total, enable the auditor to form an opinion on the financial information. In forming such an opinion, the auditor may obtain audit evidence on a selective basis by way of judgmental or statistical sampling procedures. For example, the auditor may select only certain account receivables for confirmation purposes, or make a selection of personnel records for the purpose of testing that changes in payroll rates have been properly authorised.
4. The auditor's judgement as to what is sufficient appropriate audit evidence is influenced by such factors as:
(a) The degree of risk of misstatement, which may be affected by factors such as:
(i) The nature of the item;
(ii) The adequacy of internal control;
(iii) The nature or size of the business carried on by the entity;
(iv) Situations which may exert an unusual influence on management;
(v) The financial position of the entity.

(b) The materiality of the item.
(c) The experience gained during the previous audits.
(d) The results of the auditing procedures, including fraud and error which may have been found.
(e) The type of information available.
(f) The trend indicated by accounting ratios and analysis.
5. Obtaining audit evidence from compliance procedures is intended to reasonably assure the auditor in respect of the following assertions:
Existence that the internal control exists.
Effectiveness that the internal control is operating effectively.
Continuity that the internal control has so operated throughout the
period of reliance."
In the audit of small entities, there are particular problems in obtaining audit evidence to support the assertion of completeness. There are two principal reasons for this:
(a) the owner‑manager occupies a dominant position and may be able to ensure that some transactions are not recorded; and
(b) the entity may not have internal control procedures that‑provide documentary evidence that all transactions are recorded. 
The auditor plans and conducts the audit with an attitude of professional skepticism. In the absence of evidence to the contrary, the auditor is entitled to accept representations as truthful and records as genuine. 
The auditor of a small entity need not assume that there will be limited internal controls over the completeness of important populations such as revenue. Many small entities have some form of numerically based system to control the dispatch of goods or the provision of services. Where there is such a system to ensure completeness, the auditor may obtain audit evidence of its operation, by means of tests of control, to assist in determining whether control risk can be assessed at less than high in order to justify a reduction in the extent of substantive testing. 
Where there are no internal controls relevant to the assertion, the auditor may be able to obtain sufficient evidence from substantive procedures alone. Such procedures may include the following:
• Comparing recorded amounts with amounts calculated on the basis of separately recorded data, for example, goods issues recorded in physical stock records may be expected to give rise to sales income, and job sheets or time records may be expected to give rise to charges to clients.
• Reconciling total quantities of goods bought and sold.
• Analytical procedures.
• External confirmation.
• A review of transactions after the balance sheet date. 
AAS 6, Risk Assessments and Internal Control
Paragraph 2 of A‑AS 6 requires that the auditor should obtain an understanding of the accounting and internal control systems sufficient to plan the audit and develop an. effective audit approach. The auditor should use professional judgement to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level. 
Inherent Risk
Paragraph 12 of AAS 6 requires that in developing the overall audit plan, the auditor should assess inherent risk at the level of financial statements. In developing the audit programme, the auditor should relate such assessment to material account balances and classes of transactions at the level of assertions made financial statements, or assume that inherent risk is high for the assertion, taking into account factors relevant both to the financial statements as a whole and to the specific assertions. When the auditor makes an assessment that the inherent risk is not high, he should document the reasons for such assessment.

In the audit of a small entity, control risk is often assumed or assessed as high, at least for certain financial statement assertions. The assessment of inherent risk for those assertions takes on a particular significance, as it has a direct impact on the extent of substantive procedures. There are difficulties in the assessment of the inherent risk of a small entity, for example there may be increased risk as a result of the concentration of ownership and control. However, the auditor's assessment of inherent risk in a small entity depends on its particular characteristics; careful assessment of inherent risk for material financial statement assertions, rather than an assumption that it is high, may enable the auditor to conduct a more efficient and effective audit. 
Control Risk
Paragraph 22 of AAS 6 requires that after obtaining an understanding of the accounting system and internal control system, the auditor should make a preliminary assessment of control risk, at the assertion level, each material account balance or class of transactions.

An understanding of the control environment is essential to the understanding of control risk. The auditor considers the overall influence of the owner‑manager and other key personnel. For example, the auditor considers whether the owner‑manager displays a positive control consciousness and considers the extent to which the owner‑manager and other key personnel are actively involved in day‑to‑day operations. 
After obtaining an understanding of the accounting and internal control systems, the auditor makes a preliminary assessment of control risk, at the assertion level, for each material account balance or class of transactions. Substantive procedures may be reduced if reliance on these controls is warranted after investigation and testing. However, many internal controls relevant to large entities are not practical in the small entity, and as a result it may not be possible to rely on internal control to detect fraud or error. For example, segregation of duties may be severely limited in small entities because accounting procedures may be performed by few persons who may have both operating and custodial responsibilities. Similarly, when there are few employees, it may not be possible to set up a system of independent checking of their work. 
Inadequate segregation of duties and the risk of error may, in some cases, be offset by other control procedures such as the exercise of strong supervisory controls by the owner‑manager by means of direct personal knowledge of the entity and involvement in transactions. However this, in itself, may introduce other risks such as the potential for management override and fraud. Particular difficulties include the possible understatement of income by the non-recording or misrecording of sales. In circumstances where segregation of duties is limited and evidence of supervisory controls is lacking, the audit evidence necessary to support the auditor's opinion on the financial statements may have to be obtained entirely through the performance of substantive procedures. 
The auditor of a small entity may decide, based on the auditor's understanding of the accounting system and control environment, to assume that control risk is high without planning or performing any detailed procedures (such as tests of controls) to support that assessment. Even where there appear to be effective controls it may be more efficient for the auditor to confine audit procedures to those of a substantive nature. 
The auditor makes management aware of material weaknesses in the design or operation of the accounting and internal control systems that have come to the auditor's attention. Recommendations for improvement may also be made in this communication. Such recommendations are particularly valuable for the development of the small entity's accounting and internal control systems. 
Detection Risk
Paragraph 43 of AAS 6 (Revised) states:
"The auditor should consider the assessed levels of inherent and control risks in determining the nature, timings and extent of substantive procedures required to reduce the audit risk to an acceptably low level. In this regard the auditor would consider:
(a) The nature of substantive procedures, for example, using tests directed toward independent parties outside the entity rather than tests directed toward parties or documentation within the entity, or using tests of details for a particular audit objective in addition to analytical procedures;
(b) The timing of substantive procedures, for example, performing them at period end rather than at an earlier date; and
(c) The extent of substantive procedures, for example, using a larger sample size." 
The auditor uses the assessments of inherent and controls risk to determine the substantive procedures that will provide the audit evidence to reduce detection risk, and therefore audit risk, to an acceptable level. In some small entities, such as those where most transaction are for cash and there is no regular pattern of costs and margins, the available evidence may be inadequate to support an unqualified opinion on the financial statements.

Accounting and Internal Control Systems
Paragraph 14 of AAS 6 states:
"Internal controls relating to the accounting system are concerned with achieving the following objectives:
• Transactions are executed in accordance with management's general or specific authorisation.
• All transactions and other events are promptly recorded in the correct amount, in the appropriate accounts and in the proper accounting period so as to permit preparation of financial statements in accordance with the applicable accounting standards, other recognized accounting policies and practices and relevant statutory requirements, if any, and to maintain accountability for assets.
• Assets and records are safeguarded from unauthorized access, use or disposition.
• Recorded assets are compared with the existing assets at reasonable intervals and appropriate action is taken with regard to any differences. 
Audit Risk in the Small Business
Paragraph 49 of AAS 6 states –
“The auditor needs to obtain the same level of assurance in order to express an unqualified opinion on the financial statements of both small and large entities. However, many internal controls, which would be relevant to large entities are not practical in the small business.
For example, in small businesses, accounting procedures may be performed by a few persons who may have both operating and custodial responsibilities, and therefore, segregation of duties may be missing or severely limited. Inadequate segregation of duties may, in some cases, be offset by a strong management control system in which owner/manager supervisory controls exist because of direct personal knowledge of the entity and involvement in transactions.
In circumstances where segregation of dudes is limited and audit evidence of supervisory controls is lacking, the audit evidence necessary to support the auditor's opinion on the financial statements may have to be obtained entirely through the performance of substantive procedures." 
AAS 8, Planning
Paragraph 1 of AAS 8 states:
"Statement on Standard Auditing Practices 1, Masic Principles Governing an Audit", states (paragraphs 12‑14):
"The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. Plans should be based on knowledge of the client's business.
Plans should be made to cover, among other things:
(a) Acquiring knowledge of the client's accounting systems, policies and internal procedures;
(b) Establishing the expected degree of reliance to be placed on internal control;
(c) Determining and programming the nature, timing and extent of the audit procedures to be performed; and
(d) Coordinating the work to be performed.
Plans should be further developed and revised as necessary during the course of the audit." 
Paragraph 16 of AAS 8 states, "the audit planning ideally commences at the conclusion of the previous year's audit, and alongwith the related programme, it should be reconsidered for modification as the audit progresses. Such consideration is based on the auditor's review of the internal control, his preliminary evaluation thereof, and the results of his compliance and substantive procedures. 
Many audits of small entities are conducted by the audit engagement partner (or sole practitioner) working with one audit assistant (or without audit assistants). These circumstances will affect the auditor's approach to planning: planning can be performed on a less formal scale. With a smaller team, co‑ordination and communication between team members is less complicated. 
Planning the audit of a small entity need not be a complex or time‑consuming exercise. Planning varies according to the size of the entity and the complexity of the audit. For example, on some small audits, planning may be carried out at a meeting with the owner‑manager of the entity or when the entity’s records become available to the auditor for audit. 
Planning the audit can, however, start at the completion of the previous year's audit as the auditor will be well placed to plan ahead for the next year. A file note prepared at this time, based on a review of the working papers and highlighting issues identified in the audit just completed that will have some bearing on the next year, can be particularly helpful. This file note, amended for changes arising during the subsequent year, could be the initial basis for planning the next audit. 
Discussion with the owner‑manager is a very important part of planning, especially in a first‑year audit. Such discussions do not need a special meeting; they can often take place as a part of other meetings, conversations or correspondence. 
In principle, planning comprises developing a general strategy (reflected in an overall audit plan) and a detailed approach for implementing the strategy in terms of the nature, timing and extent of the audit work (reflected in an audit program). However, a practical approach to the audit of a small entity need not involve excessive documentation. In the case of a small entity where, because of the size or nature of the entity, the details of the overall plan can be adequately documented in the audit program, or vice versa, separate documentation of each may not be necessary. When standard audit programs are used, these should be tailored to the particular circumstances of the client. 
AAS 11, Representations by Management
Paragraphs 2, 3, 5 & 6 of AAS 11 state ‑
"2.The auditor should obtain representation from management, where considered appropriate.
3. The Auditor should obtain evidence that management acknowledges its responsibility for the appropriate preparation and presentation of financial information and that management has approved financial information."
" 5. During the course of an audit, management makes many representations to the auditor, either unsolicited or in response to specific enquiries. When such representations relate to matters which are material to the financial information, the auditor should:
(a) seek corroborative audit evidence from sources inside or outside the entity;
(b) evaluate whether the representations made by management appear reasonable and consistent with other audit evidence obtained, including other representations; and
(c) consider whether the individuals making the representation can be expected to be well-informed on the matter.
6. Representation by management cannot be a substitute for other audit evidence that the auditor could reasonably expect to be available. For example, a representation by management as to the quantity, existence and costs of inventories is no substitute for adopting normal audit procedures regarding verification and valuation of inventories. If the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be available regarding a matter which has or may have a material effect on the financial information, this will constitute a limitation on the scope of his examination even if he has obtained a representation from management on the matter."

In view of the particular characteristics of small entities, the auditor may judge it appropriate to obtain written representations from the owner‑manager as to the completeness and accuracy of the accounting records and of the financial statements (for example, that all income has been recorded). Such representations, on their own, do not provide sufficient audit evidence. The auditor assesses the representation in conjunction with the results of other relevant audit procedures, the auditor's knowledge of the business and of its ownermanager, and considers whether, in the particular circumstances, it would be reasonable to expect other audit evidence to be available. In view of specific characteristics of small entities described in paragraph 6, while assessing the evidentiary value of management representation it may be viewed with circumspection. The possibility of misunderstandings between the auditor and the owner‑manager is reduced when oral representations are confirmed by the owner‑manager in writing. 
AAS 13, Audit Materiality
Paragraph 3 of AAS 13 states:
"Information is material if its misstatement (i. e., omission of erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of the item, judged in the particular circumstances of its misstatement. Thus, materiality provides a threshold or cut‑off point rather than being a primary qualitative characteristic which the information must have if it is to be useful."

For audit planning purposes, it is generally necessary to assess materiality from a qualitative and quantitative perspective. One purpose of this preliminary judgment about materiality is to focus the auditor's attention on the more significant financial statement items while determining the audit strategy. As there are no authoritative pronouncements on how materiality is assessed in quantitative terms, the auditor in each case applies professional judgment in the light of the circumstances. One approach to the assessment of quantitative materiality is to use a percentage of a key figure in the financial statements such as one of the following.
• Profit or loss before tax (adjusted, if appropriate, for the effect of any abnormal levels of items of expenditure such as the owner‑manager's remuneration).
• Revenue.
• Balance sheet total. 
Often in the case of small entities, draft financial statements are not available to the auditor at the commencement of the audit. When this is the case, the auditor uses the best information available at the time. The current year's trial balance may be used, if available. Often an estimate of revenue for the current period can be more readily obtained than of profit (or loss) or of a balance sheet total‑ A common approach in the preliminary judgment of materiality is to calculate materiality on the previous year's audited financial statements as amended for known circumstances in relation to the year subject to audit.

Assessing materiality as a percentage of pre‑tax results may be inappropriate when the entity is at or near the break‑even point as it may give an inappropriately low level of materiality, leading to unnecessarily extensive audit procedures. In such cases, the auditor may apply the percentage method to, for example, revenue or balance sheet totals. Alternatively, materiality may be assessed having regard to assessed levels of materiality in prior years and the normal level of results. In addition to considering materiality at the overall financial statement level, the auditor considers materiality in relation to individual account balances, classes of transactions, and disclosures. 
Whatever basis may be used to assess materiality for audit planning purposes, when the auditors assess 'the aggregate of uncorrected misstatements', their conclusion as to whether the financial statements give a true and fair view is based on a re‑assessment of materiality. This reassessment takes account of the final version of the draft financial statements, incorporating all agreed adjustments and information obtained during the course of the audit. 
Although materiality at the reporting stage is considered in quantitative terms, there is no clear threshold value but rather a range of values within which the auditor exercises judgment. Amounts above the upper limit of the range may be presumed material and amounts below the lower limit may be presumed not material, although either presumption may be rebutted by applying qualitative considerations. 
In addition, although planning may have been based on a quantitative assessment of materiality, the auditor's opinion will take into account not only the amount but also the qualitative nature of unadjusted misstatements within the financial statements. 
AAS 14, Analytical Procedures
Paragraphs 2 and 3 of AAS 14 state ‑
"2. The auditor should apply analytical procedures at the planning and overall review stages of the audit. Analytical procedure may also be applied at other stages.
3. "Analytical procedures" means the analysis of significant ratios and trend including the resulting investigation of fluctuations and relationships that are in consistent with other relevant ‑information or which deviate from predicted amounts." 
Analytical Procedures in Planning the Audit
The auditor applies analytical procedures at the planning stage of the audit. The nature and extent of analytical procedures at the planning stage of the audit of a small entity may be limited by the timeliness of processing of transactions by the small entity and the lack of reliable financial information at that point in time. Small entities may not have interim or monthly financial information that can be used in analytical procedures at the planning stage. The auditor may, as an alternative conduct a brief review of the general ledger or such other accounting records as may be readily available. In many cases, there may be no documented information that can be used for this purpose, and the auditor may obtain the required information through discussion with the owner‑manager. 
Analytical Procedures as Substantive Procedures
Analytical procedures can often be a cost‑effective means of obtaining evidence required by the auditor. The auditor assesses the controls over the preparation of information used in applying analytical procedures. When such controls are effective, the auditor will have greater confidence in the reliability of the information and, therefore, in the results of analytical procedures.

An unsophisticated predictive model can sometimes be effective. For example, where a small entity has employed a known number of staff at fixed rates of pay throughout the period, it will ordinarily be possible for the auditor to use this data to estimate the total payroll costs for the period with a high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements and reducing the need to perform tests of details on the payroll. The use of widely recognized trade ratio (such as profit margins for different types of retail entities) can often be used effectively in analytical procedures to provide evidence to support the reasonableness of recorded items. The extent of analytical procedures in the audit of a small entity may be limited because of the non‑availability of information on which the analytical procedures are based.

Predictive analytical procedures can often be an effective means of testing for completeness, provided the results can be predicted with a reasonable degree of precision and confidence. Variations from expected results may indicate possible omissions that have not been detected by other substantive tests.

However, different types of analytical procedure provide different levels of assurance. Analytical procedures can be a very persuasive source of evidence and may eliminate the need for further verification by means of tests of details. In contrast, calculation and comparison of gross margin percentages as a means of confirming a revenue figure may be a less persuasive source of evidence, but may provide useful corroboration if used in combination with other audit procedures. 
Analytical Procedures as Part of the Overall Review
The analytical procedures ordinarily performed at this stage of the audit are very similar to those that would be used at the planning stage of the audit.
These include the following:
• Comparing the financial statements for the current year to those of previous years.
• Comparing the financial statements with any budgets, forecasts, or management expectations,
• Reviewing trends in any important financial statement ratios.
• Considering whether the financial statements adequately reflect any changes in the entity of which the auditor is aware.
• Inquiring into unexplained or unexpected features of the financial statements. 
AAS 15, Audit Sampling
Paragraphs 2‑4 of AAS 15 state:‑
"2.When using either statistical or non‑statistical sampling methods, the auditor should design and select an audit sample, perform audit procedures thereon, and evaluate sample results so as to provide sufficient appropriate audit evidence.
"3. Audit sampling" means the application of audit procedures to less than 100% of the items within an account balance or class of transactions to enable the auditor to obtain and evaluate audit evidence about some characteristic of the items selected in order to form or assist in forming a conclusion concerning the population.
4. It is important to recognize that certain testing procedures do not come within the definition of sampling. Tests performed on 100% of the items within a population do not involve sampling.
Likewise, applying audit procedures to all items within a population which have a particular characteristic (for example, all items over a certain amount) does not qualify as audit sampling with respect to the portion of the population examined, nor with regard to the population as a whole, since the items were not selected from the total population on a basis that was expected to be representative. Such items might imply some characteristic of the remaining portion of the population."

There are a variety of methods of selecting items for testing, the auditor's choice of an appropriate method will be guided by considerations of effectiveness and efficiency. The means available to the auditor are:
(a) selecting all items (100% examination);
(b) selecting specific items; or
(c) audit sampling.

The small population ordinarily encountered in small entities may make it feasible to test:
(a) 100% of the population; or
(b) 100% of some part of the population, for example, all items above a given amount, applying analytical procedures to the balance of the population, if it is material.

When the above methods of obtaining audit evidence are not adopted, the auditor considers the use of procedures involving audit sampling. When the auditor decides to use audit sampling, the same underlying principles apply in both large and small entities. The auditor selects sample items in such a way that the sample can be expected to be representative of the population. One choice to be made by the auditor is whether to use statistical or non‑statistical sampling methods. Both methods involve the exercise of a high degree of judgement by the auditor. However, in the audit of small entities the required level of assurance can often be obtained in a cost-effective manner by the use of non‑statistical methods of determining the sample size and selecting the sample items.

With non‑statistical methods, auditors apply the auditing standards set out in the AAS when using their judgement to design the size and structure of the audit sample and to select the sample items. For example, they consider:
• the audit objective, to ensure the procedure is likely to achieve the objective;
• the population, to ensure it is appropriate and complete (a sample cannot provide evidence about the completeness of the population from which it is drawn).
The auditors select the sample items in such away that they can reasonably be expected to be representative of the population in respect of the relevant characteristics. Three methods commonly used are random, systematic and haphazard selection: these are described in para 19 of the AAS. So‑called 'block' testing methods (for example, examining all items of a particular type in one month) are not designed to be representative of the total population and are therefore not an application of audit sampling. (Block testing may, however, form part of other audit techniques, such as analytical procedures). 

AAS 16, Going Concern
AAS 16 paragraphs 1 to 6 state as follows: 
“1 . The purpose of this Statement on Standard Auditing Practices (AAS) is to establish standards on the auditor's responsibilities in the audit of financial statements regarding the appropriateness of the going concern assumption as a basis for the preparation of the financial statements.
2. When planning and performing audit procedures and in evaluating the results thereof, the auditor should consider the appropriateness of the going concern assumption underlying the preparation of the financial statements.
3. The auditor's report helps establish the credibility of the financial statements. However, the auditor's report is not a guarantee as to the future viability of the entity.
4. An entity's continuance as a going concern for the foreseeable future, generally a period not to exceed one year after the balance sheet date, is assumed in the preparation of financial statements in absence of information to the contrary. Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of business. If this assumption is unjustified, the entity may not be able to realize its assets at the recorded amounts and there m ay be changes in the amount and maturity dates of liabilities. As a consequence, the amounts and classification of assets and liabilities in the financial statements may need to be adjusted.
5. The auditor should consider the risk that the going concern assumption may no longer be appropriate
6. Indications of risk that continuance as a going concern may be questionable could come from the financial statements or from other sources.
Examples of such indications that would be considered by the auditor are listed below. This listing is not all‑inclusive nor does the existence of one or more always signify that the going concern assumption needs to be questioned."
Financial Indications
•	Negative net worth or negative working capital. 
•	Fixed term borrowing approaching maturity without realistic prospects of renewal or repayment, or excessive reliance on short‑term borrowings to finance long‑term assets. 
•	Adverse key financial ratios. 
•	Substantial operating losses. 
•	Substantial negative cash flows from operations. 
•	Arrears or discontinuance of dividends. 
•	Inability to pay creditors on due dates. 
•	Difficulty in complying with the terms of loan agreements. 
•	Change from credit to cash‑on‑delivery transactions with suppliers. 
•	Inability to obtain financing for essential new product development or other essential investments. 
•	Entering into a scheme of arrangement with creditors for reduction of liability. 
Operating Indications
•	Loss of key management without replacement. 
•	Loss of a major market, franchise, licence, or principal supplier. 
•	Labour difficulties or shortages of important supplies. 
Other Indications
•	Non-compliance with capital or other statutory requirements. 
•	Pending Legal Proceedings against the entity that may, if successful, result in judgements that could not be met. 
•	Changes in legislation or government policy. 
•	Sickness of the entity under any statutory definition.” 
The assessment of going concern may be dependent on a particular assumption. For example;
(a) if the entity's operations are largely financed by a loan from the owner‑manager, it may be important that these funds are not withdrawn from the business. For example, the continuance of the small entity may be dependent on the owner-manager subordinating his loan account to the entity in favour of other creditors, bank, other financial institutions;
(b) if the entity has, in effect, a single customer, it will be important that the trading relationship continues; or
(c) If aggregate contingent liabilities are more than net worth.
In such circumstances, the auditor considers the evidence available to support the assumption in question. For example, the auditor inspects appropriate evidence of the subordination. Where the entity is dependent on additional support from the owner-manager, the auditor needs to consider the owner-manager's ability to meet the obligation under the support arrangement, in addition, the auditor may ask for a written representation confirming the owner‑manager's intention or understanding.

AAS 17, Quality Control for Audit Work
The primary objective of quality control is to provide assurance that audits are conducted in accordance with generally accepted auditing standards. The auditor of a small entity keeps this objective in mind when determining the nature, timing, and extent of the policies and procedures appropriate to the circumstances.

Paragraph 1 of AAS 17 states: 'The purpose of this Statement on Standard Auditing Practices (AAS) is to establish standards on the quality control:
(a) policies and procedures of an audit firm regarding audit work generally; and
(b) procedures regarding the work delegated to assistants on an individual audit."

Paragraph 6 of AAS 17 states that the objectives of quality control policies to be adopted by an audit firm will ordinarily incorporate the following:
(a) professional requirements;
(b) skills and competence;
(c) assignment;
(d) delegation;
(e) consultation;
(f) acceptance and retention of clients; and
(g) monitoring

With the possible exception of "assignment" and “delegation" (which may not be relevant to sole practitioners with no assistants), each of these will ordinarily be reflected in the arrangements established by firms auditing small entities.

The requirements of AAS 17 relating to quality control on individual audits are mostly relevant to engagements where some of the work is delegated to one or more assistants. Many small entity audits are carried out entirely by the audit engagement partner (who may be a sole practitioner). In such situations, questions of direction and supervision of assistants and review of their work do not arise as the audit engagement partner, having personally conducted all significant aspects of the work, is aware of A material issues.

The audit engagement partner (or sole practitioner) nevertheless needs to he satisfied that the audit has been conducted in accordance with AASs. Developing or obtaining a suitably designed form of audit completion checklist may provide a useful tool for testing the completeness and adequacy of the process followed in an audit. Forming an objective view on the appropriateness of the judgements made in the course of the audit can present practical problems when the same individual also performed the entire audit. It can often therefore be helpful for that individual to allow a short interval after performing the entire audit work before reviewing the working papers relating to any material issues with, so far as possible, a 'fresh eye'. When particularly complex or unusual issues are involved, and the audit is performed by a sole practitioner, it may be desirable to consult with other suitably‑experienced auditors or the auditor's professional body, on a confidential basis. 
AAS 18, Audit of Accounting Estimates
Paragraphs 2 & 3 of AAS 18 state –
“2. The auditor should obtain sufficient appropriate audit evidence regarding accounting estimates.
3. "Accounting estimate," means an approximation of the amount of an item in the absence of a precise means of measurement. Examples are:
• Allowances to reduce inventory and accounts receivable to their estimated realisable value.
• Provisions to allocate the cost of fixed assets over their estimated useful lives.
• Accrued revenue.
• Provision for taxation.
• Provision for a loss from a lawsuit.
• Insurer's liability for outstanding claims.
• Losses on construction contracts in progress.
• Amortization of certain items like goodwill and deferred revenue expenditure.
• Provision to meet warranty claims
• Provision for retirement benefits in the financial statements of employers."

The steps ordinarily involved in reviewing and testing of the process used by management are:
(a) Evaluation of the data and consideration of assumptions on which the estimate is based;
(b) Testing of the calculations involved in the estimate,
(c) Comparison, when possible, of estimates made for prior periods with actual results of those periods; and
(d) Consideration of management's approval procedures.

Although the owner‑manager is responsible for determining the amount of the estimate to be included in the financial report, the auditor of a small entity may often be asked to assist with or advise on the preparation of any accounting estimates. By assisting with the process of preparing the accounting estimate, the auditor at the same time gains evidence relevant to meeting the requirement of AAS 18. However, assisting with this process does not relieve the auditor from obtaining sufficient and appropriate audit evidence regarding accuracy and the underlying assumptions used in arriving at the estimates. 
AAS 19, Subsequent Events
AAS 19, paragraphs 2 and 4 state as follows:
"2. The auditor should consider the effect of subsequent events on the financial statements and on the auditor's report.
4. The auditor should perform procedures designed to obtain sufficient appropriate audit evidence that all events up to the date of the auditor’s report that may require adjustment of, or disclosure in, the financial statements have been identified." 
Subsequent Events Between the Period and the Date of the Auditor's Report
It is not common for small entities to he required to report shortly after their period end. It is often the case that more time elapses between the period end and the approval or signature of the financial statements by the owner‑manager in the case of small entities than in the case of large entities. The period to be covered by the auditors' subsequent events procedures is therefore often longer in the audit of a small entity, allowing more opportunities for the occurrence of subsequent events that can affect the financial statement.

The subsequent event procedures that the auditor of small entities performs will depend on the information that is available and, in particular, the extent to which the accounting records have been written up since the period end. When the accounting records are not upto date and minutes of the meetings of the directors have not been prepared, relevant procedures can take the form of enquiry of the ownermanager, recording the owner‑manager's responses and inspection of bank statements.

The auditor, may, depending on the circumstances, consider that the letter of representation should cover subsequent events. The letter of representation is ordinarily dated on the same day as the audit report, thus covering the entire period since the period end. 
Subsequent Events Between the Date of Auditor's Report and the Financial Statements Being Issued
Where, as in many small entities, the meeting at which (he financial statements are approved or signed is immediately followed by the annual general meeting, the interval between the two does not to require any separate consideration by the auditor as it is so short.

If the auditor becomes aware of a fact that materially affects the financial statements, the auditor considers whether the financial statements require amendments, discusses the matter with management, and takes action appropriate in the circumstances. 
AAS20, Knowledge of the Business
Paragraph 2 of AAS 20 requires that in performing an audit of financial statements, the auditor should have or obtain knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in the auditor's judgement, may have a significant effect on the financial statements or on the examination or audit report. Such knowledge is used by the auditor in assessing inherent and control risks and in determining the nature, timing and extent of audit procedures.

The appendix to AAS 20 gives a list of matters that the auditor may consider in relation to knowledge of the business. This list is illustrative only, it is not exhaustive, nor are all the matters listed relevant to every audit. In particular, the auditor of a small entity will often find that many of the points in this list are simply not relevant. It would therefore be inappropriate to regard this Appendix as a form of checklist to be applied routinely in all audits. It may however be sufficient for the auditor to use a checklist that has been appropriately tailored to the particular small entity, such a checklist can be reviewed and updated in subsequent years.

The auditor of a small entity is often in a position to have a wide and up‑to‑date knowledge of the business by virtue of the fact that there maybe regular close contact with the owner‑manager. This relationship often provides information on matters such as the following:
• The activities of the small entity, its main products and services, and the industry in which it operates.
• The management style, aims, and attitudes of the owner‑manager.
• Any plans for changes to the nature, managemerit or ownership of the entity.
• Trends in profitability or liquidity and the adequacy of working capital.
• Legal or regulatory issues facing the entity, including its relationship with the taxation authorities.
• The accounting records.
• The control environment.

Documenting the auditor's knowledge of the business is equally important in all audits, irrespective of the size of the entity. However, the extent of the documentation depends on the complexity of the entity and the number of persons which are being engaged in the audit. Small entities are ordinarily not complex and their audit rarely involves large teams of assistants. In many cases, the partner and perhaps, a single assistant may perform the audit. Therefore, whilst the auditor of a small entity will prepare documentation to a level sufficient to:
(a) facilitate proper planning of the audit; and
(b) Provide for any change of responsibility within the audit firm, such as changes of audit engagement partner or the departure, illness or incapacity of assistants.
Such documentation will ordinarily be unsophisticated in format and as brief as circumstances allow. 
AAS 21, Consideration of Laws and Regulations in an Audit of Financial Statements
Paragraph 2 of AAS 21, 'Consideration of Laws and Regulations in an Audit of Financial Statements' requires that when planning and performing audit procedures and in evaluating and reporting the results thereof, the auditor should recognize that non-compliance by the entity with laws and regulations may materially affect the financial statements. However, an audit cannot be expected to detect non-compliance with A laws and regulations. Detection of non-compliance, regardless of materiality, requires consideration of the implications for the integrity of management or employees and the possible effect on other aspects of the audit.

Apart from those laws and regulations that relate directly to the preparation of the financial statements, there may also be laws and regulations that provide a legal framework for the conduct of the entity and that are central to the entity's ability to conduct its business. As most small entities have uncomplicated activities, the legal and regulatory environment to which they are subject is less complicated than the environment in which large or more diversified entities operate.

Once the auditor of a small entity has identified any relevant industry‑specific laws and regulations, this information is recorded as permanent information as part of the knowledge of the entity and is reviewed and updated as necessary in subsequent years. 
AAS 22, Initial Engagements‑Opening Balances
Paragraph 3 of AAS22 states:
"For initial audit engagements, the auditor should obtain sufficient appropriate audit evidence that:
(a) the closing balances of the preceding period have been correctly brought forward to the current period;
(b) the opening balances do not contain misstatements that materially affect the financial statements for the current period; and
(c) appropriate accounting policies are consistently applied."

AAS 22 gives guidance on circumstances in which the opening balances are derived from financial statements of the preceding period which were not audited.

The fact that the preceding period financial statements were not audited does not reduce the auditors' need to obtain sufficient audit evidences regarding the opening balances and comparatives. Information about some of the opening balances may be readily available (for example, cash, debtors and creditors) and evidence may also be obtained through some of the audit procedures in the current period (for example, debtor write offs, stock obsolescence and fixed assets). Where the auditors cannot obtain such evidence by other means, they consider the implications for their report. 
AAS 23, Related Parties
Paragraph 2 of AAS 23 states:
"2. The auditor should perform audit procedures designed to obtain sufficient appropriate audit evidence regarding the identification and disclosure by management of related parties and the related party transactions that are material to the financial statements. However, an audit cannot be expected to detect all related party transactions." 
Significant transactions are often entered into between the small entity and the owner‑manager, or between the small entity and entities related to the owner‑manager. Small entities seldom have sophisticated policies and codes of conduct on related party transactions. Indeed, related party transactions are a regular feature of many entities that are owned and managed by an individual or by a family. Further, the owner‑manager may not fully understand the definition of a related party, especially where relevant accounting standards deem certain relationships to be related and others not. The provision of management representations in respect of the completeness of disclosure may entail some explanation by the auditor of the technical definition of a related party.

The auditor of a small entity ordinarily performs substantive procedures on the identification of related parties and related party transactions. However, if the auditor assesses the risk of undisclosed related party transactions, as low, such substantive procedures need not be extensive. The auditor often acts as the auditor of other entities related to the small entity, which may assist in identifying related parties. Where detailed substantive tests are required, the fact that the accounting populations in small entities are generally small may enable the auditor to examine all items.

The auditor's in‑depth knowledge of the small entity may be of assistance in the identification of related parties, which in many instances, will be with entities controlled by the owner‑manager. This knowledge can also help the auditor assess whether related party transactions might have taken place without recognition in the entity's accounting records. In this context, when performing audit procedures which may identify related parties and related party transactions, the auditor should consider the substance of the relationship and/ or transaction being tested and not merely the legal form. 
AAS 27, Comparatives
Paragraphs 2 and 3 of AAS 25 state:
”2.The auditor should determine whether the comparatives, comply, in all material respects, with the financial reporting framework relevant to the financial statements being audited.
3. The existence of differences in financial reporting frameworks results in comparative financial information being presented differently in each framework. Comparatives in financial statements, for example, may present amounts (such as financial position, results of operations, cash flows) and appropriate disclosures of an entity for more than one period, depending on the framework. The frameworks and methods of presentation that are referred to in this AAS are as follows:
(a) corresponding figures where amounts and other disclosures for the preceding period are included as part of the current period financial statements, and are intended to be read in relation to the amounts and other disclosures relating to the current period (referred to as "current period figures" for the purpose of this AAS). These corresponding figures are not presented as complete financial statements capable of standing alone, but are an integral part of the current period financial statements intended to be read only in relationship to the current period figures; and
(b) comparative financial statements where the amounts and other disclosures for the preceding period. are included for comparison with the financial statements of the current period, but do not form part of the current period financial statements," 
AAS 26, Terms of Audit Engagement
AAS 26, paragraphs 2 and 5 state:
"2.The auditor and the client should agree on the terms of the engagement. The agreed terms would need to be recorded in an audit engagement letter or other suitable form of contract."
"5. In the interest of both client and auditor, the auditor should send an engagement letter, preferably before the commencement of the engagement, to help avoiding any misunderstandings with respect to the engagement. The engagement letter documents and confirms the auditor’s acceptance of the appointment, the objective and scope of the audit and the extent of the auditor's responsibilities to the client. 
In many cases, owner‑managers of small entities are not fully aware of their own responsibilities or those of the auditors. In particular, owner-managers may not appreciate that the financial statements are their responsibility, particularly where the owner‑manager has outsourced the preparation of the financial statements. One of the purposes of an engagement letter is to communicate clearly the respective responsibilities of the owner‑manager and the auditor. The Appendix to AAS 26 provides an example of an audit engagement letter. 
AAS 28, The Auditor's Report on Financial Statements
AAS 28, paragraphs 2 and 4, state:
"2. The auditor should review and assess the conclusions drawn from the audit evidence obtained as the basis for the expression of an opinion on the financial statements."
"4. The auditor's report should contain a clear written expression of opinion on the financial statements taken as a whole."

The objective of any audit is for the auditor to obtain sufficient appropriate audit evidence to be able to express an opinion on the financial statements. In many cases the auditor will be able to express an unqualified opinion on the financial statements small entities. However there may be circumstances that necessitate a modification of the auditor's report.

When the auditor is unable to design or carry out procedures to obtain sufficient appropriate audit evidence as to the completeness of accounting records, this may constitute a limitation in the scope of auditor's work. The limitation would lead to a qualification of the opinion or, in circumstances where the possible effects of the limitation are so significant that the auditor is unable to express an opinion on the financial statements, a disclaimer of opinion. 
AAS 29, Auditing in a Computer Information Systems Environment
AAS 29, paragraphs 3 and 4, state:
"3.The auditor should consider the effect of a CIS environment on the audit. The auditor should evaluate, inter alia, the following factors to determine the effect of CIS environment on the audit:
(a) the extent to which the CIS environment is used to record, compile and analyse accounting information.
(b) the system of internal control in existence in the entity with regard to:
(i) flow of correct and complete data to the processing centre;
(ii) processing, analysis and reporting tasks undertaken in the installation; and
(c) the impact of computer‑based accounting system on the audit trail that could otherwise be expected to exist in an entirely manual system.
4. The auditor should have sufficient knowledge of the Computer Information Systems to plan, direct, supervise, control and review the work performed. The sufficiency of knowledge would depend on the nature and extent of CIS environment. 
When the CIS are significant the auditor should also obtain an understanding of the CIS environment and whether it may influence the assessment of inherent and control risk. The nature of the risks and the internal control characteristics in CIS environments include the following:
* Lack of transaction trails
* Uniform processing of transactions
* Lack of segregation of functions
* Potential for errors and irregularities
* Initiation or execution of transaction.
* Dependence of other controls over computer processing
• Potential for increased management supervision
• Potential for use of computer‑assisted audit techniques
Both the risks and the controls introduced as a result of these characteristics of CIS have a potential impact on the auditor's assessment of risk, and the nature, timing and extent of audit procedures. 
The increasing availability of computer‑based accounting systems that are capable of meeting both functional and economic circumstances of even the smallest entity impacts on the audits of those entities. Small entities accounting systems often make use of personal computers,

Small entities are likely to use less sophisticated hardware and software packages than large entities (often "packaged" rather than developed "in house"). Nevertheless, the auditor should have sufficient knowledge of the computer information system to plan, direct, supervise, and review the work performed. The auditor should consider whether specialized skills are needed in an audit.

Because of the limited segregation of duties, the use of computer facilities by a small entity may have the effect of increasing control risk. For example, it is common for users to be able to perform two or more of the following functions in the accounting system:
• Initiating and authorizing source documents.
• Entering data into the system.
• Operating the computer.
• Changing programs and data files.
• Using or distributing output.
• Modifying the operating systems. 
OVERALL REVIEW OF FINANCIAL STATEMENTS
For the purpose of overall review of financial statements analytical procedures are to be carried out on the basis of considerations enumerated in Paragraph 4 and of AAS 14.

The overall review of the financial statements is not primarily a matter of completion of checklists on compliance matters. In addition it requires the auditors to 'stand back' from the detail of accumulated audit evidence relating to individual components of the financial statements, so as to be able to express an objective opinion on the financial statements as a whole. The auditors' consideration of whether the financial statement assertions are:
(a) consistent with their knowledge of the business and the results of other audit procedures; and
(b) fairly disclosed,
is a matter of the auditors' judgement, requiring appropriate levels of experience and skill.

The auditors' analytical procedures applied when completing the audit are designed to assist in arriving at an overall conclusion as to whether the financial statements as a whole are consistent with their knowledge of the business; the results of such procedures are therefore an important factor to be considered for this purpose. 

1 The word "individual" denotes ownership by a natural person, rather than by other entity. An entity owned by other enterprises may, however, be regarded as a "small entity" for the purpose of this Guidance Note, if the owner exhibits the relevant characteristics.

Guidance Note on Audit of Consolidated Financial Statements*
INTRODUCTION 
The Council of the Institute of Chartered Accountants of India has issued Accounting Standard (AS) 21 'Consolidated Financial Statements' which lays down principles and procedures for preparation and presentation of consolidated financial statements. Consolidated financial statements are presented for a group of entities under the control of a parent. A 'parent' is an entity that has one or more subsidiaries. A group comprises a parent and its subsidiaries. Thus, consolidated financial statements are the financial statements of a group presented as those of a single entity. AS 21 is applicable to a parent that presents consolidated financial statements. In other words, whenever a parent decides to prepare and present consolidated financial statements, it should do so in accordance with the requirements of Accounting Standard (AS) 21, Consolidated Financial Statements.
Consolidated financial statements normally include consolidated balance sheet, consolidated statement of profit and loss, and notes, explanatory material that form an integral part thereof, and also consolidated cash flow statement (in case a parent presents its own cash flow statement). Consolidated financial statements are presented, to the extent possible, in the same format as adopted by the parent for its separate financial statements.
An entity which prepares the consolidated financial statements, either under any law or regulation governing the entity or suo motu, might be required to or otherwise engage a member for conducting the audit of consolidated financial statements1. The auditor of the consolidated financial statements may not necessarily be the auditor of the separate financial statements of the parent or one or more of the components2 included in the consolidated financial statements. However, a law or regulation governing the entity may require the consolidated financial statements to be audited by the statutory auditor of the entity. This Guidance Note provides guidance on the specific issues and audit procedures to be applied in an audit of consolidated financial statements. 
DEFINITIONS
Various terms used in this Guidance Note, have the same meaning as in Accounting Standard (AS) 21, 'Consolidated Financial Statements', Accounting Standard (AS) 23, 'Accounting for Investments in Associates in Consolidated Financial Statements' and Accounting Standard (AS) 27, 'Financial Reporting of Interests in Joint Ventures' respectively. 
RESPONSIBILITY OF PARENT
The responsibility for the preparation and presentation of consolidated financial statements, among other things, is that of the management of the parent. This includes: 
(a) identifying components, and including the financial information of the components to be included in the, consolidated financial statements;
(b) where appropriate, identifying reportable segments for segmental reporting;
(c) identifying related parties and related party transactions for reporting;
(d) obtaining accurate and complete financial information from components; and
(e) making appropriate consolidation adjustments.
Apart from the above, the parent ordinarily issues instructions to the management of the component specifying the parent's requirements relating to financial information of the components to be included in the consolidated financial statements. The instructions ordinarily cover the accounting policies to be applied, statutory and other disclosure requirements applicable to the parent, including the identification of and reporting on reportable segments, and related parties and related party transactions, and a reporting timetable. 
RESPONSIBILITY OF THE AUDITOR OF THE CONSOLIDATED FINANCIAL STATEMENTS
The auditor of the consolidated financial statements is responsible for expressing an opinion on whether the consolidated financial statements are prepared, in all material respects, in accordance with the financial reporting framework under which the parent prepares the consolidated financial statements.
Therefore, the auditor's objectives in an audit of consolidated financial statements are: 
(a) to satisfy himself that the consolidated financial statements have been prepared in accordance with the requirements of Accounting Standard (AS) 21, Consolidated Financial Statements. Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of Interests in joint Ventures; and
(b) to enable himself to express an opinion on the true and fair view presented by the consolidated financial statements.
Auditing and Assurance Standards, Statements and Guidance Notes on auditing matters issued by the Institute of Chartered Accountants of India apply in the same manner to audit of consolidated financial statements as they apply to audit of separate financial statements. It means that the auditors, while conducting the audit of consolidated financial statements are, inter alia, expected to: 
(a) plan their work to enable them to conduct an effective audit in an efficient and timely manner;
(b) obtain an understanding of the accounting and internal control systems sufficient to plan the audit and determine the nature, timing and extent of his audit procedures. Such an understanding would help the auditors to develop an effective audit approach;
(c) use professional judgement to assess audit risk and to design audit procedures to ensure that the risk is reduced to an acceptable level; etc.
AUDIT CONSIDERATIONS 
The following features of consolidated financial statements have an impact on the related audit procedures: 
(a) The consolidated financial statements are prepared oil the basis of separate financial statements of the parent and its subsidiaries and associates and/or joint ventures, using the consolidation procedures prescribed by Accounting Standard (AS) 21, Consolidated Financial Statements, Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of Interests, in joint Ventures; and
(b) The auditor of the consolidated financial statements has to use the work of other auditors unless the auditor of consolidated financial statements is not the auditor of the other components of the group. This may, however, not be true in all cases.
The consolidated financial statements are prepared using the separate financial statements of the parent, subsidiaries, associates and joint ventures and also other financial information, which might not he covered by the separate financial statements of these entities. The 'other financial information' would include disclosures to be made in the consolidated financial statements about the subsidiaries associates and joint ventures, proportion of items included in the consolidated financial statements to which different accounting policies have been applied, adjustments made for the effects of significant transactions or other events that occur between the financial statements of subsidiaries, associates or joint ventures and the parent, as the case may be, etc. Thus, this other financial information would be required to be additionally generated. 
When an auditor accepts the audit of consolidated financial statements, the auditor should assess whether based on his work alone he would be able to express an opinion on the true and fair view presented by the consolidated financial statements. If the auditor is of the view that his own participation may not be enough or sufficient, he should consider using the work of 'other auditors'. 
Such 'other auditors' might be the auditors of the separate financial statements of one or more of the components of the consolidated financial statements or the auditors appointed specifically for assisting the auditor of the consolidated financial statements (the principal auditor). 
Where the statutory auditors of one or more of the components of the consolidated financial statements are also requested to assist the principal auditor, the work to be performed by such statutory auditors for use by the principal auditor would constitute an assignment separate from the assignment to conduct the statutory audit of the respective component. 
The Auditing and Assurance Standard (AAS) 1 'Basic Principles Governing an Audit', states (paragraph 9):

"When the auditor delegates work to assistants or uses work performed by other auditors and experts, he will continue to be responsible for forming and expressing his opinion on the financial information. However, he will be entitled to rely on work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. In the case of any independent statutory appointment to perform the work on which the auditor has to rely in forming his opinion, such as in the case of the work of branch auditors appointed under the Companies Act, 1956 the auditor's report should expressly state the fact of such reliance". 
Auditing and Assurance Standard (AAS) 10,'Using the Work of Another Auditor' establishes standards when an auditor, reporting on the financial statements of an entity (the group‑in the case of consolidated financial statements), uses the work of another auditor on the financial information of one or more components included in the financial statements of the entity. The principal auditor, if he decides to use the work of another auditor in relation to the audit of consolidated financial statements, should comply with the requirements of AAS 10. 
While complying with the requirements of AAS 10, 'Using the Work of Another Auditor', the principal auditor should keep the following under consideration: 
(a) When planning to use the work of another auditor, the principal auditor is not required to consider the professional competence of the other auditor if the other auditor is a member of the Institute of Chartered Accountants of India
(b) The principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor's purposes, in the context of the audit of consolidated financial statements. When using the work of another auditor, the principal auditor should ordinarily perform the following procedures: 
(i) The principal auditor should determine the information/assurance required by the other auditor; this emanates/precludes the principal auditor's determination of how the work of the other auditor would affect the audit of consolidated financial statements, for example, the information required from the auditor of a subsidiary would be different from that required from the auditor of a joint venture.
(ii) Advise the other auditor of the use that is to be made of the other auditor's work and report and make sufficient arrangements for co-ordination of their efforts at the planning stage of the audit. The principal auditor would inform the other auditor of matters such as areas requiring special consideration, procedures for the identification of inter‑component transactions that may require disclosure and the timetable for completion of audit. It may, however, be noted that the principal auditor, if using the work of the auditors of one or more of the components unless such other auditors are specifically appointed for the purpose, should not enlarge the scope of the audit of the separate financial statements of the subsidiary or component to be included in the consolidated financial statements. Thus, the instructions that are to be issued should be confined to the other information required for consolidation.
(iii) Advise the other auditor of the significant accounting, auditing and reporting requirements and obtain representation as to compliance with them.
AUDITING THE CONSOLIDATION 
Before commencing an audit of consolidated financial statements, the auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. The auditor should make plans, among other things, for the following: 
(a) understanding of accounting policies of the parent, subsidiaries, associates and joint ventures;
(b) determining the extent of use of other auditor's work in the audit;
(c) determining and programming the nature, tim ing, and extent of the audit procedures to be performed., and
(d) coordinating the work to be performed.
A parent which presents consolidated financial statements is required to consolidate all subsidiaries include all associates and jointly controlled entities in the consolidated financial statements other than those for which exceptions have been provided in the relevant Accounting Standards.
The auditor should obtain a listing of subsidiaries, associates and joint ventures included in the consolidated financial statements. The auditor should review the information provided by the management of the parent identifying the subsidiaries, associates and joint ventures. The auditor should verify that all the subsidiaries, associates and joint ventures have been included in the consolidated financial statements unless a subsidiary, associate or joint venture meets a criterion for exclusion. In respect of completeness of this information, the auditor should perform the following procedures: 
(a) review his working papers for the prior years for the known subsidiaries, associates and joint ventures;
(b) review the parent's procedures for identification of subsidiaries, associates and joint ventures;
(c) review the investments to determine the share holding in other entities;
(d) review the joint venture and other relevant agreements entered into by the parent;
(e) review the statutory records maintained by the parent, for example registers under section 302, 372A of the Companies Act, 1956. 
The auditor should also identify the changes in the shareholding that might have taken place since the last audit.
It is also important to note that ownership of voting power is not necessary for an entity to own more than one‑half of the voting power of another to control the other enterprise. Control of the composition of the Board of Directors (in the case of a company) or corresponding governing body (in the case of any other enterprise), with a view to obtain economic benefits from its activities, ownership of voting power is not important. For example, an entity holds only 10 percent of the share capital of another entity but it has control over the composition of the Board of Directors/governing body of the second entity. In such a case, the first entity would be considered as a parent of the second entity and, therefore, it would consolidate the second entity in the consolidated financial statements as subsidiary. The auditor, therefore, apart from carrying out above procedures, should verify whether the parent controls the composition of the Board of Directors or corresponding governing body of any entity. There would be various means by which such kind of control can be obtained. In this regard, the auditor may verify the Board's minutes, shareholder agreements entered into by the parent, agreements with the entities to which the parent might have provided any technology or know how, enforcement of statute, as the case may be, etc. The auditor would have to use his professional judgement to determine whether the parent controls the composition of the Board of Directors of any other entity. If yes, whether that entity has been consolidated as a subsidiary in the consolidated financial statements.

Where a subsidiary or an associate or a jointly controlled entity is excluded from the consolidated financial statements, the auditor should examine the reasons for exclusion. There could be two reasons for exclusion of a subsidiary, associate or jointly controlled entity ‑ one, that the relationship of parent with the subsidiary, associate or jointly controlled entity is intended to be temporary or the subsidiary, associate or joint venture operates under several long‑term restrictions which significantly impair its ability to transfer funds to the parent. The auditor should satisfy himself that the exclusion made by the management falls within these two categories. The auditor should verify such long‑term restrictions from the relevant laws and regulations, agreements entered by the parent with such entities which prohibit transfer of funds. In the case of an entity which is excluded from consolidation on the ground that the relationship of parent with the other entity as subsidiary, associate or joint venture is temporary, the auditor should verify that the intention of the parent, to dispose the subsidiary, investment in associate or interest in jointly controlled entity, in the near future, existed at the time of acquisition of the subsidiary, making investment in associate or jointly controlled entity. The auditor should also verify that the reasons for exclusion are given in the consolidated financial statements. If an entity is excluded from the consolidated financial statements for reasons other than those allowed by the relevant accounting standards, the auditor should consider its effect on the report to be issued. The auditor should consider the need to issue a modified report on the consolidated financial statements. The auditor should also verify that in consolidated financial statements, investments in such subsidiaries, associates or jointly controlled entities should be accounted for in accordance with Accounting Standard (AS) 13, Accounting for Investments.

The auditor should also examine whether any subsidiary, associate or jointly controlled entity has ceased to be a subsidiary, associate or jointly controlled entity during the period under audit. It is also possible that a subsidiary might have become an associate or an associate might have become a subsidiary of the parent. The auditor, in such cases, should examine whether these changes have been appropriately accounted for in the consolidated financial statements as required by the respective accounting standards.

In preparing consolidated financial statements, the financial statements of the parent and its subsidiaries are combined on a line by line basis by adding together like items of assets, liabilities, income and expenses and then certain calculations like determination of goodwill or capital reserve, minorities interest and adjustments like elimination of intra group transactions, balances and unrealised profits etc. are made in accordance with the requirements of Accounting Standard (AS) 21, Consolidated Financial Statements. Investments in associates are accounted for using the Equity Method as prescribed in Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements. A parent that has an interest in a jointly controlled entity, reports its interest in the consolidated financial statements using proportionate consolidation method in accordance with Accounting Standard (AS) 27, Financial Reporting of Interests in joint Ventures. Many of the procedures appropriate for the application of equity method and the proportionate consolidation are similar to the consolidation procedures set out in Accounting Standard (AS) 21, Consolidated Financial Statements.

The auditor should verify that the adjustments warranted by the relevant accounting standards have been made wherever required and have been properly authorised by the management of the parent The preparation of consolidated financial statements gives rise to permanent consolidation adjustments and current period consolidation adjustments. 
SPECIAL CONSIDERATIONS
Permanent Consolidation Adjustments3
Permanent consolidation adjustments are those adjustments that are made only on the first occasion of the preparation and presentation of consolidated financial statements. Permanent consolidation adjustments are: 
(a) determination of excess or deficit of the cost to the parent of its investment in a subsidiary over the parent's portion of equity of the subsidiary, at the date on which investment in the subsidiary is made (determination of goodwill or capital reserve);

(b) determination of the amount of equity attribut able to minorities at the date on which investment in subsidiary is made; and

(c) determination ofgoodwill or capital reserve arising on application of equity method to account for investments in associates in consolidated financial statements.
The auditor should verify that the above calculations have been made appropriately. The auditor should pay particular attention to the determination of pre-acquisition reserves of the subsidiary and associates. Date(s) of investment in subsidiary and associates assumes importance in this regard. The auditor should also examine whether the pre‑acquisition reserves have been allocated appropriately between the parent and the minorities of the subsidiary. The auditor should also verify the changes that might have taken place in these permanent adjustments on account of subsequent acquisition of shares in the subsidiary/associates, disposal of the subsidiary/ associate in the subsequent years. The auditor should also examine the joint venture agreements, to establish whether any change has taken place in the interest of the parent in the joint venture.

It may happen that in the case of one subsidiary, goodwill arises and in the case of another subsidiary a capital reserve arises. The parent may choose to net off these amounts to disclose a single amount in the consolidated balance sheet. In such cases, the auditor should verify that the gross amounts of goodwill and capital reserves arising on acquisition of various subsidiaries have been disclosed in the notes to the consolidated financial statements to reflect the excess/shortage over the parents' portion of the subsidiary's equity. 
Current Period Consolidation Adjustments4 
Current period adjustments are those adjustments that are made in the accounting period for which the consolidation of financial statements is done. Current period consolidation adjustments primarily relate to elimination of intra‑group transactions and account balances including. 
(a) intra‑group interest paid and received, or management fees, etc;
(b) unrealised intra‑group profits on assets acquired 1 from other subsidiaries;
(c) intra‑group indebtedness;
(d) adjustments related to harmonising the different accounting policies being followed by the parent enterprise and its subsidiaries;
(e) adjustments made for the effects of significant transactions or other events that occur between the date of the financial statements of the parent and one or more of the components, if the financial statements to be used for consolidation are not drawn upto the same reporting date; and
(f) determination of movement in equity attributable to the minorities since the date of acquisition of the subsidiary.
The adjustments required for preparation of consolidated financial statements are made in memorandum records kept for the purpose by the parent. The auditor should review the memorandum records to verify the adjustment entries made in the preparation of consolidated financial statements. This would also help the auditor in ascertaining whether there is any difference in the elimination. Apart from reviewing the memorandum records, the auditor should: 
(a) verify that the inter‑group transactions and account balances have been eliminated;
(b) verify that the consolidated financial statements have been prepared using uniform accounting policies for like transactions and other events in similar circumstances;
(c) verify that adequate disclosures have been made in the consolidated financial statements of application of different accounting policies in case, it was impracticable to do so;
(d) verify the adjustments made to harmonise the different accounting policies; and
(e) verify that the calculation of minorities interest 'has been correctly done.
The auditor should gain an understanding of the procedures adopted by the management of the enterprise to make the above mentioned adjustments. This helps the auditor in reducing the audit risk to an acceptably low level.

One of the important adjustment that may be required in the current period is determination of impairment loss that might exist for goodwill arising on consolidation. Goodwill arising on consolidation is carried at the value determined at the date of acquisition of the subsidiary, and the same is to be tested for impairment at every balance sheet date. The auditor should examine whether any impairment loss has been determined by the parent. If yes, the auditor should examine the procedure followed for determination of impairment. The auditor should satisfy himself that the amount of impairment loss determined is fair.

The auditor should also verify that the disclosures required by Accounting Standard (AS) 21, Consolidated Financial Statements, Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of Interests in joint Ventures have been made in the consolidated financial statements.

Apart from verifying that the calculation and disclosures regarding minorities interest have been made appropriately, the auditor also determines, in cases where the minority interests' share of the losses exceed the minority interests' share of the equity, the excess, and any further losses applicable to the minority interest, have been accounted for in accordance with the relevant accounting standards. Where the minority interest has a binding obligation to make good losses, the auditor of the consolidated financial statements determines whether it is able to do so.

If the financial statements of one or more of the components are drawn upto different financial reporting dates, the auditor of the consolidated financial statements should review the component's results between its financial reporting date and that of the parent for significant transactions or other events that have taken place during the period and therefore, need to be reflected in the consolidated financial statements. For example, where a subsidiary has a different accounting period and after the end of its accounting period, the subsidiary has discontinued its one of the major operations, adjustments would be required to be made to reflect this in the consolidated financial statements.

The fundamental accounting assumption of "consistency" requires the auditor of the consolidated financial statements to consider whether the length of the reporting periods and any difference in financial year‑ends are the same from period to period.

Notes to accounts and other explanatory material are an integral part of any financial statements since they pro vide information which isperse not reflected in the balance sheet and profit and loss account. Consolidated financial statements are not an exception to the need of notes to accounts and other explanatory material. In this regard paragraph 6 of Accounting Standard (AS) 21, Consolidated Financial Statement states as below:

”6. Consolidated financial statements normally include consolidated balance sheet, consolidated statement of profit and loss, and notes, other statements and explanatory material that form an integral part thereof. Consolidated cash flow statement is presented in case a parent presents its own cash flow statement. The consolidated financial statements are presented, to the extent possible, in the same format as that adopted by the parent for its separate financial statements".

The Accounting Standards Board of the Institute has issued General Clarification (GC)‑5/2002 on Notes to the Consolidated Financial Statements. The Clarification lays down certain principles that should be observed in respect of notes and other explanatory material that form integral part of the consolidated financial statements. The auditor should verify that the principles enunciated by the Clarification have been followed in preparation of notes to accounts. The auditor to verify, the compliance, should: 
(a) examine that the notes which are necessary for presenting a true and fair view of the consolidated financial statements have been included in the consolidated financial statements as an integral part thereof; and
(b) examine that additional statutory information disclosed in separate financial statements of the subsidiary and/or a parent having bearing on the true and fair view of the consolidated financial statements have been disclosed in the consolidated financial statements.
If as a result of the above examinations, the auditor is of the view that the consolidated financial statements do not disclose all the information which is necessary for presenting a true and fair view, the auditor should give a modified report. 
MANAGEMENT REPRESENTATIONS 
Auditing and Assurance Standard (AAS) 11, "Representations by Management" requires the auditor to obtain appropriate representations from management The auditor of the consolidated financial statements should obtain evidence that the management of the parent acknowledges its responsibility for a true and fair presentation of the consolidated financial statements in accordance with the financial reporting framework applicable to the parent and that parent management has approved the consolidated financial statements. In addition, the auditor of the consolidated financial statements obtains written representations from parent management on matters material to the consolidated financial statements. Examples of such representations include: 
(a) Completeness of components included in the consolidated financial statements;
(b) Identification of reportable segments for segmental reporting;
(c) Identification of related parties and related party transactions for reporting;
(d) Appropriateness and completeness of consolidation adjustments, including the elimination of intra‑group transactions.
REPORTING* 
There could be two situations in an audit of consolidated financial statements‑when the parent's auditor is also the auditor of all the components to be included in the consolidated financial statements and when the parent's auditor is not the auditor of one or more subsidiaries and therefore, uses the work of other auditors in the audit. The auditor should, while preparing the report, should consider the requirements of Auditing and Assurance Standard (AAS) 28, The Auditor's Report on Financial Statements. Where, the auditor uses the work of other auditors in the audit of consolidated financial statements, the requirements of Auditing and Assurance Standard (AAS) 10, Using the Work of Another Auditor should also be considered 
WHEN THE PARENT'S AUDITOR IS ALSO THE AUDITOR OF ITS SUBSIDIARIES 
While drafting the audit report, the auditor should report whether principles and procedures for preparation and presentation of consolidated financial statements as laid down in the relevant accounting standards have been followed. In case of any deviation, the auditor should make adequate disclosure in the audit report so that users of the consolidated financial statements are aware of such deviation.

Auditor should issue an audit report expressing opinion whether the consolidated financial statements give a true and fair view of the state of affairs of the Group as on balance sheet date and as to whether consolidated profit and loss statement gives true and fair view of the results of consolidated profit or losses of the Group for the period under audit. Where the consolidated financial statements also include a cash flow statement, the auditor should also give his opinion on the true and fair view of the cash flows presented by the consolidated cash flow statements. Suggested format of the audit report to be issued in such circumstance is given as Annexure I to this Guidance Note. 
WHEN THE PARENT'S AUDITOR IS NOT THE AUDITOR OF ITS SUBSIDIARY(IES) 
In a case where the parent's auditor is not the auditor of the components included in the consolidated financial statements, the auditor of the consolidated financial statements should also consider the requirement of AAS 10.

When the parent's auditor decides that he will make reference to the audit of the other auditors, the auditor's report on consolidated financial statements should disclose clearly the magnitude of the portion of the financial statements audited by the other auditor(s). This may be done by stating the rupee amounts or Percentages of total assets and total revenue of subsidiary(s) included in consolidated financial statements not audited by the parent's auditor. However, reference in the report of the auditor of consolidated financial statements to the fact that part of the audit of the group was made by other auditor(s) is not to be construed as a qualification of the opinion but rather as an indication of the divided responsibility between the auditors of the parent and its subsidiaries. Suggested format of the audit report to be issued by the auditor of consolidated financial statements in this circumstance is given in Annexure II to this Guidance Note. 
Annexure I
Illustrative Auditor's Report on the Consolidated Financial Statements When the Parent's Auditor is also the Auditor of all the Components
Auditor's Report
The Board of Directors
___________ (Name of the Parent)5
We have audited the attached consolidated balance sheet of XYZ Group, as at 31st March 2XXX, and also the consolidated profit and loss account and the {consolidated cash flow statement}6 for the year ended on that date annexed thereto. These financial statements are the responsibility of the XYZ's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the auditing standards generally accepted in India. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
We report that the consolidated financial statements have been prepared by the XYZ's management in accordance with the requirements of Accounting Standards (AS) 21, Consolidated financial statements, (Accounting Standards (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of interests in joint Ventures}7 issued by the Institute of Chartered Accountants of India.
In our opinion and to the best of our information and according to the explanations given to us, the consolidated financial statements give a true and fair view in conformity with the accounting principles generally accepted in India:
(a) in the case of the consolidated balance sheet, of the state of affairs of the XYZ Group as at 31st March 2XXX;
(b) in the case of the consolidated profit and loss account, of the profit / loss 8 for the year ended on that date; and
(c) in the case of the consolidated cash flow statement, of the cash flows for the year ended on that date.
For ABC and Co.
Chartered Accountants
Signature
(Name of the Member Signing the Audit Report)
(Designaiion9)
Membership Number
Place of Signature
Date
Annexure II
Illustrative Auditor's Report on the Consolidated Financial Statements When the Parent's Auditor is Not the Auditor of All the Components
Auditor's Report
The Board of Directors
__________ (Name of the Parent)10
We have audited the attached consolidated balance sheet of XYZ Group, as at 31st March 2XXX, and also the consolidated profit and loss account and the {consolidated cash flow statement}11 for the year ended on that date annexed thereto. These financial statements are the responsibility of the XYZ's management and have been prepared by the management on the basis of separate financial statements and other financial information regarding components. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the auditing standards generally accepted in India. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
We did not audit the financial statements of certain subsidiaries, whose financial statements reflect total assets of Rs. as at 31 st March 2XXX, the total revenue of Rs. ____ and cash flows amounting to Rs.____ for the year then ended. These financial statements and other financial information have been audited by other auditors whose report(s) has (have) been furnished to us, and our opinion is based solely on the report of other auditors.
We report that the consolidated financial statements have been prepared by the XYZs management in accordance with the requirements of Accounting Standards (AS) 21, Consolidated financial statements, {Accounting Standards (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of interests in joint Ventures}12 issued by the Institute of Chartered Accountants of India.
Based on our audit and on consideration of reports of other auditors on separate financial statements and on the other financial information of the components, and to the best of our information and according to the explanations given to us, we are of the opinion that the attached consolidated financial statements give a true and fair view in conformity with the accounting principles generally accepted in India:
(a) in the case of the consolidated balance sheet, of the state of affairs of the XYZ Group as at 31st March 2XXX;
(b) in the case of the consolidated profit and loss account, of the profit/ loss13 for the year ended on that date; and
(c) in the case of the consolidated cash flow statement, of the cash flows for the year ended on that date.
For ABC and Co.
Chartered Accountants
Place of Signature:
Date:
Signature
(Name of the Member Signing the Audit Report)
(Designation14)
Membership Number
Appendix I
Consolidated Balance Sheet of a Group
The appendix is illustrative only and does not form part of the Guidance Note. The purpose of this appendix is to illustrate the application of Accounting Standard (AS) 21, Consolidated Financial Statements.
1. The example shows only current period amounts.
2. The amounts given in the brackets indicate deductions.
3. The working notes given towards the end of this appendix are intended to assist in understanding the manner in which the various figures appearing in the consolidated balance sheet have been derived. These working notes do not form part of the consolidated balance sheet and, accordingly, need not be published.
4. The following are the balance sheets as at 31st March, 2003 of X Limited (the holding company), Y limited and Z Limited (both subsidiaries of X Limited)
				(Rs.'000)	
Sources of Funds		X Limited	Y Limited	Z Limited	
Share Capital		4,500.00	1,000.00	2,000.00	
Reserves and Surplus		150.00	195.00	390.00	
6% Debentures		--	250.00	---	
Current Liabilities		420.00	210.00	300.00	
	Total	5,070.00	1,655.00	2,690.00	
					
Application of Funds		X Limited	Y Limited	Z Limited	
Fixed Assets		1,600.00	490.00	1,400.00	
Investments in Subsidiaries		2,560.00	--	--	
Inventories		520.00	650.00	850.00	
Cash		200.00	230.00	160.00	
Other Current Assets		190.00	285.00	280.00	
	Total	5,070.00	1,655.00	2,690.00	
5. The following additional information is also relevant for the preparation of the consolidated balance sheet: 
(i) The break-up of investments of X Limited is as follows:
	Carrying Cost	
(a) 80,000 equity shares of Rs.10 each of Y limited	880.00	
(b) 1,35,000 equity shares of Rs.10 each of Z limited	1,200.00	
(c) 4,000 preference shares of Rs.100 each of Z Limited	400.00	
(d) 800 6% Debentures of Rs.100 each of Y Limited	80.00	
Total	2,560.00	
6. All the above investments were made on 30th September, 1998. The summarised balance sheets of Y Limited and Z Limited as on that date were as follows: 
			(Rs.'000)	
Sources of Funds		Y Limited	Z Limited	
Share Capital		1,000.00	2,000.00	
Reserves and Surplus		152.50	350.00	
6% Debentures		250.00	---	
Current Liabilities		300.00	400.00	
	Total	1,702.50	2,705.00	
				
Application of Funds		Y Limited	Z Limited	
Fixed Assets		500.00	1450.00	
Current Assets		1,202.50	1,255.00	
	Total	1,702.50	2,705.00	
7. The Share Capital of Subsidiary consisted of
Sources of Funds		Y Limited	Z Limited	
Equity Shares of Rs.10/- each		1,000.00	1,500.00	
Pref. Shares of Rs.100/- each		Nil	500.00	
	Total	1,000.00	2,000.00	
8. Current assets of Y Limited includes bills receivables for Rs.8,000 accepted by X Limited.
9. Current liabilities of Z Limited. Include Rs.2,000 due to X Limited.
10. Stock of X Limited include goods of Rs.10,000 purchased from Y Limited on which the latter company made a profit of Rs.2,000.
Consolidated Balance Sheet of X Limited and its Subsidiaries Y Limited and Z Limited as at 31st March, 2003
					(Rs.'000)	
Sources of Funds	X Limited	Y Limited	Z Limited	Elimination Entries	Consolidation Amounts	
Share Capital	4,500.00	1,000.00	2,000.00	(3,000.00)1	4,500.00	
Reserves and Surplus	150.00	195.00	390.00	(476.50)2	258.50	
Capital Reserve	--	--	--	466.503	466.50	
6% Debentures	--	250.00	--	(80.00)4	170.00	
Current Liabilities	420.00	210.00	300.00	(28.00)5	902.00	
Minorities Interest	--	--	--	528.006	528.00	
Total	5,070.00	1,655.00	2,690.00	(2590.00)	6,825.00	
						
Application of Funds	X Limited	Y Limited	Z Limited			
Fixed Assets	1,600.00	490.00	1,400.00	--	3,490.00	
Investments	2,560.00	--	--	(2,560.00)	NIL	
Cash	200.00	230.00	160.00	--	590.00	
Inventories	520.00	650.00	850.00	(2.00)7	2,018.00	
Other Current Assets	190.00	285.00	280.00	(28.00)5	727.00	
	5,070.00	1,655.00	2,690.00	(2590.00)	6,825.00	
WORKING NOTES
1. Elimination of share capital of subsidiaries 15
	Y Limited	Z Limited	Total	
Equity Share Capital				
(i) Used in elimination of carrying cost of investment in each subsidiary	800.00	1,350.00	2,150.00	
(ii) Included in the Minorities Interest	200.00	150.00	350.00	
Preference Share Capital				
(i) Held within the Group (held by holding company)	Nil	400.00	400.00	
(ii) Included in the Minorities Interest	Nil	100.00	100.00	
Total share capital eliminated	1,000.00	2,000.00	3,000.00	
2. Break‑up of reserves and surplus eliminated: 
	Y Limited	Z Limited	Total	
(i) Reserves up to the date of investment;16				
(a) Attributable to the holding company (utilised in eliminating carrying cost of investment) 17	122.00	274050	396.50	
(b) Attributable to Minorities (included in minorities interest)	30.50	30.50	61.00	
				
(ii) Movement in reserves and surplus after the date if investment:				
(a) Attributable to Minorities (included in minorities interest	8.50	8.50	17.00	
(b) Profit earned by the subsidiary Y Limited on account of sale of goods to X Limited	2.00	--	2.00	
Total reserves and surplus eliminated	163.00	313.50	476.50	
3. Elimination of carrying cost of investments in equity shares of each subsidiary: 
	Y Limited	Z Limited	
Carrying Cost	880.00	1,200.00	
Less: Equity attributable to the holding company at the date at which investment was made (see working note 8 below)	(922.00)	(1,624.50)	
Negative Goodwill (capital reserve)	(42.00)	(424.50)	
4. The elimination of investment in Y Limited's 6% Debentures needs explanation. The holding company acquired debentures at face value of Rs.80,000. The consolidated amounts should represent debentures of the subsidiary Y Limited outside the group.
5. Bills payable of Rs.8,000 and debtors of Rs.20,000 are inter company owings and therefore eliminated.
6. Computation of Minorities Interest
	Y Limited	Z Limited	Total	
(a) Amount of equity attributable to minorities at the date at which investment in each subsidiary is made (as computed in working note 8 below)	230.50	180.50	411.00	
(b) Minorities' share in movement in equity since the date of investment in each subsidiary (as computed in working note 9 below)	8.50	8.50	17.00	
(c) Amount of Preference Share Capital held outside the Group	Nil	100.00	100.00	
Total 	239.00	289.00	528.00	
7. The profit earned by Y Limited is reduced from the consolidated amount of inventories so that it can be valued at cost to the group as a whole.
8. Equity of the subsidiary companies Y Limited and Z Limited at the date at which investment is made:
	Y Limited	Z Limited	
Fixed Assets	500.00	1,450.00	
Current Assets	1,202.50	1,255.00	
Debentures	(250.00)	--	
Current Liabilites	(300.00)	(400.00)	
Preference Share Capital	--	(500.00)	
Equity on the date of investment	1,152.50	1,802.00	
Equity attributable to the holding company {see para 13(a)}	922.22	1,624.50	
Equity attributable to the minorities {see para 13(c)}	230.50	180.50	
Total	1,152.50	1,805.00	
9. Movement in equity of subsidiaries since the date of investment in each subsidiary: 
	Y Limited	Z Limited	
Equity as on 31st March, 1999	1,195.00	1,890.00	
Less: Equity on the date of Investmen as compared in working note (8) above	(1,152.50)	(1,805.00)	
Movement in equity	42.50	85.00	
Movement in Equity attributable to the holding company {see paragraph 13(a)}	34.00	76.50	
Movement in Equity attributable to the minorities {see paragraph 13(c)}	8.50	8.50	
	42.50	85.00	
Appendix II
Consolidated Profit and Loss Statement
The appendix is illustrative only and does not form part of the Guidance Note. The purpose of this appendix is to illustrate the application of the Accounting Standard (AS) 21, Consolidated Financial Statements.
1. The example shows only current period amounts.
2. The following additional information is also relevant for the preparation of the consolidated profit and loss statement (figures are in Rs.'000):
(a) The holding company A Limited purchased 2,70,000 equity shares of Rs.10 each (75% of the total equity share capital) and 9,000 9%preference shares of Rs.100 each (50% of the total preference share capital) of the subsidiary company B Limited on 1st November, 1998.
(b) A Limited proposes to pay a final dividend on equity shares @ 25%. A Limited paid an interim dividend Rs. 1,350 during the financial year 2002‑2003.
(c) B Limited proposes to pay a final dividend on equity shares @ 20%. B Limited paid an interim dividend of Rs.720 on 1st October, 2002. An interim dividend of Rs.81 was paid on preference shares also. The holding company did not participate in the interim dividend.
(d) B Limited sold to A limited in March, 1999 material for Rs.750 at cost plus 25% of which A Limited unsold stock of Rs. 500 as on 31st March, 2003.
Consolidated Profit and Loss Statement of A Limited and its Subsidiary B Limited for the year ended 31st March, 2003
Income	A Limited	B Limited	Elimination Entries	Consolidated Amounts	
Sales	16,200.00	15,300.00	(750.00)1	30,750.00	
Proposed Dividend from B Limited	540.00	--	(540.00)2	NIL	
Dividend on preference Shares of B Ltd.	40.50	--	(40.50)2	NIL	
Total Income (A)	16,780.50	15,300.00	(1,330.50)	30,750.00	
					
Expenditure	A Limited	B Limited	Elimination Entries	Consolidated Amounts	
Consumption of raw materials	8,280.00	8,820.00	(750.00)1	16,350.00	
Overhead Expenses	2,070.00	945.00	--	3,015.00	
Selling Expenses	810.00	1,215.00	--	2,025.00	
Provision for Tax	2,700.00	1,944.00	--	4,644.00	
Total Expenditure (B)	13,860.00	12,924.00	(750.00)	26,034.00	
Net Profit for the year (A-B)	2,920.50	2,376.00	(580.50)	4,716.00	
Consolidated Profit and Loss Appropriation Account of A Limited and its Subsidiary B Limited for the year ended 31st March, 2003
		A Limited		B Limited	Elimination Entries	Consolidated Amounts	
Opening Balance		481.50		576.00	--	1,057.50	
Add: Net Profit for the year		2,920.50		2,376.00	(580.50)	4,716.00	
Less: Preference Dividend for the year				(162.00)	40.502	(121.50)	
Less: Equity dividend for the year		(2,700.00)		(1,440.00)	540.002	(3,600.00)	
Balance to be adjusted for consolidation		702.00		1,350.00	000.00	2,052.00	
							
Amount credited to Investment Account	321.753		--		--	321.75	
Amount utilised in elimination of the Cost of Investment in Subsidiary	--		--		545.624	545.62	
Balance attributable to minorities	--		--		337.505	337.50	
Unrealised Profit on Stock (stock reserve)	--		--		100.006	100.00	
Amounts transferred to consolidated Balance Sheet	380.25		1,350.00		(983.12)	747.13	
Total	702.00		1,350.00		000.00	2,052.00	
							
Working Notes 
For the purpose of the working notes, it is assumed that profits accrued evenly throughout the financial year 2003-04. Accordingly, the profits are apportioned as 'Profits upto the date of Investment' and 'Profits after the date of Investment’ on the basis of months. An alternative treatment calls for preparation of Profit and Loss Statement and Balance Sheet of the subsidiary company on the date at which investment is made by the Holding Company.
1. Since sales made by the subsidiary company B limited to A Limited in March, 2003 is an inter‑company transaction, it is therefore, eliminated.
2. The holding company did not participate in the interim dividend declared by the subsidiary. The holding company is entitled to receive the final dividend as follows:
(a) Final dividend on equity shares [72 x 0.75]	Rs.540.00	
(b) Final dividend on preference share [81 x 0. 51	Rs.40.50	
3. Amount credited to Investment Account: The holding company A Limited credited to its Profit and Loss Statement the dividends received from the subsidiary B Limited. The dividends pertaining to pre‑acquisition period represent recovery of cost and do not form part of income. Therefore, the same is required to be credited to the Investment Account.
Pre-acquisition period is for 7 months i.e., April 1998 to 1st November 1999
(a) Pre‑acquisition equity dividend [Rs.540 x 7/12]	Rs.31.50	
(b) Pre‑acquisition preference dividend [Rs.40.50 x 1/61	Rs.6.75	
4. Holding company's share in the profit upto the date of investment in subsidiary forms part of equity on the date at which investment in subsidiary is made. Therefore, such profits are utilised in eliminating the cost of investments in subsidiary. Profits are computed as under: 
(a) Opening Balance of the Profit and Loss Account	Rs.576.00	
(b) Net Profit earned during the period 1.4.98 to 1. 11.98 i.e.,, 2376 x 7/12	Rs.1,386.00	
(c) Interim dividend on equity shares	Rs.(720.00)	
(d) Final dividend on equity shares for the period 2002‑2003 (apportioned in the ratio of months 7:5) [720 x 7/12]	Rs.(420.00)	
(e) Interim dividend on preference shares	Rs.(81.00)	
(f) Final dividend on preference shares (it relates to the last six months of the financial year, therefore, apportioned in the ratio of E5) [Rs.81.00 x 1/6]	Rs.(13.50)	
Total profits of the subsidiary upto the date of Investment	Rs.727.50	
Holding Company's share in the profits computed (0.75 x 727.5)	Rs.545.62	

5. Minorities have a share of 25% in the total profit of the subsidiary company. [Rs.1,350 x 0.25]	Rs.337.50	
6. Computation of Unrealised Profit on Stock
(i) Value of unsold stock	Rs.500.00	
(ii) Profit included is 20% on cost Unrealised profit [Rs.500.00 x 0.20]	Rs.100.00	

* Issued in September, 2003. With the issuance of this Guidance Note, the Format of Auditor's Report to the Board of Directors on Consolidated Financial Statements which was published in March, 2002 issue of 'The Chartered Accountant' stands withdrawn.
1 The Securities and Exchange Board of India, vide its circular SMI3RP/Policy/Cir.44/01 dated August 31, 2001 has amended clause 32 of the listing agreement which now requires the listed companies to publish consolidated financial statements in addidon to the separate financial statements in its annual report. The amended clause further requires that the statutory auditors of the company should audit the consolidated financial statements. The filing of consolidated financial statements with stock exchanges has also been made mandatory.
Similarly, the Reserve Bank of India, vide its circular no. DBOD No. BR13C. 72/21.04,018/2001‑02 dated February 25,2003 have required the banks to prepare consolidated financial statements to facilitate consolidated financial supervision.
2 Paragraph 8 of Auditing and Assurance Standard (AAS) 10, Using the Work of Another Auditor defines "components" as a division, branch, subsidiary, joint venture, associated enterprises or other entity whose financial information is included in the financial information audited by the principal auditor
3 Reference may be made to Appendix I Consolidated Balance Sheet of Group for an understanding of permanent consolidation adjustments.
4 Reference may be made to Appendices I and II for current period consolidation adjustments.
* With the issuance of the Guidance Note, the format of report on Consolidated Financial Statements issued in March, 2001 shall stand withdrawn,
5 As per paragraph 8 of AAS 28, "The Auditor's Report on Financial Statements”, "The auditor's report should be appropriately addressed as required by the circumstances of the engagement and applicable laws and regulations. Ordinarily, the auditor's report is addressed to the authority appointing the auditor".
6 Where applicable.
7 ibid.
8 ibid.
9 Partner or proprietor, as the case may be
10 See Footnote 5.
11 Where applicable.
12 ibid
13 ibid.
14 Partner or proprietor, as the case may be.
15 Permanent consolidation adjustments.
16 ibid.
17 Current period consolidation adjustments
Guidance Note on Audit of Miscellaneous Expenditure [2003]*
INTRODUCTION
The following is the text of the Guidance Note on Audit of Miscellaneous Expenditure. This Guidance Note provides guidance on audit procedures to be applied while auditing miscellaneous expenditure. This Guidance Note also provides guidance for audit of items that generally constitute miscellaneous expenditure when Accounting Standard (AS) 26, Intangible Assets comes into effect or is voluntarily applied by an enterprise in accounting for intangible assets. This Guidance Note, however, does not provide any guidance on audit of intangible assets that are recognised in accordance with AS 26. The guidance provided herein is restricted to only those items which were hitherto (before application of AS 26‑whether mandatory or otherwise) being classified as items of miscellaneous expenditure, but because of application of AS 26, accounting treatment of such items would change.

'Miscellaneous expenditure' shown in the balance sheet of companies (or shown under this or some other appropriate heading in the balance sheet of other enterprises) embraces within its fold a variety of items of expenditure which are not entirely charged to income in the year in which they are incurred, but are carried forward in the balance sheet to be written‑off in subsequent periods. Unless some benefit from the expenditure can reasonably be expected to be received in future and unless the amount of such benefit is reasonably determinable, there is no justification for carrying forward the expenditure for being written‑off in subsequent periods. Also, the amount of expenditure to be carried forward should not exceed the expected future revenue/other benefits related to the expenditure.

The Guidance Note deals with the audit considerations related to the following items that normally constitute 'miscellaneous expenditure’: 
(a) preliminary expenses;
(b) expenses including commission or brokerage on underwriting or subscription of shares or debentures including discount allowed on the issue of shares or debentures;
(c) research and development expenditure, etc.
The Council of the Institute of Chartered Accountants of India has issued Accounting Standard (AS) 26, ‘Intangible Assets’. The objective of this AS 26 is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another Accounting Standard. AS 26 requires an enterprise to recognise an intangible asset if, and only if, certain criteria are met. The accounting stand also specifies how to measure the carrying amount intangible assets and requires certain disclosures about intangible assets. Consequently, the accounting treatment of some of the items that generally constitute 'miscellaneous expenditure' would change and when an enterprise adopts Accounting Standard 26 ‘Intangible Assets' to account for intangible assets.

Accounting Standard (AS) 26, 'Intangible Assets’ comes into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1‑4‑2003 and is mandatory nature from that date for the following: 
(i) Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange in India as evidenced by the board of directors' resolution in this regard.
(ii) All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crores.
In respect of all other enterprises, the Accounting Standard comes into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1‑4‑2004 and is mandatory from that date. The Accounting Standard, however, encourages earlier application.
In respect of intangible items appearing in the balance sheet as on the aforesaid date, i.e., 1‑4‑2003 or 1‑42004, as the case may be, the Standard has limited its application as stated in paragraph 99 of AS 26. From the date of this Standard becoming mandatory for the concerned enterprises, the following stand withdrawn: 
(i) Accounting Standard (AS) 8, Accounting for Research and Development;
(ii) Accounting Standard (AS) 6, Depreciation Accounting, with respect to the amortisation (depreciation) of intangible assets; and
(iii) Accounting Standard (AS) 10, Accounting for Fixed Assets ‑ paragraphs 16.3 to 16.7,37 and 38.
Since AS 26, applies to different entity from different dates, it may happen that certain enterprises, till the date the standard becomes mandatory for them may continue to defer the expenditure incurred on items that normally constitute "miscellaneous expenditure". Once an entity applies AS 26 to account for intangible assets, the expenditure incurred on items that normally constitute miscellaneous expenditure shall be governed by the Standard, except in the case of already appearing miscellaneous expenditure in the balance sheet which is to be accounted for using paragraph 99 of AS 26. 
The following features of miscellaneous expenditure have an impact on the related audit procedures. 
(a) The items of expenditure included under this heading do not represent any tangible asset.
(b) The expenditure on these items is usually of a non‑recurring nature.
(c) There is a justification for deferring the expenditure on the basis that the benefits from the expenditure can reasonably be expected as flowing into the future the amount of such benefits is reasonably determinable, and the amount of deferred expenditure does not exceed the expected future benefits related thereto.
(d) Unless some fresh expenditure is incurred, the balance in these items reduces each year by the amount written‑off in the year.
The auditor's primary objective in audit of items that generally constitute miscellaneous expenditure is to satisfy himself that – 
(a) in case where some items are shown in the balance sheet under the head Miscellaneous Expenditure whether it is proper to defer the expenditure;
(b) in case where some items are shown in balance sheet under the head 'Miscellaneous Expenditure', the period of amortisation of the expenditure is reasonable;
(c) the expenditure shown to have been incurred during the year actually occurred during the year and there is proper authority for the expenditure and for its deferral;
(d) the criteria which previously justified the deferral of the expenditure continue to be met and the expected future revenue/other benefits related to the expenditure continue to exceed the amount of unamortised expenditure;
(e) where the entity has applied AS 26, for accounting for items that normally constitute miscellaneous expenditure, whether the same has been done in accordance with the Standard and the already appearing items under the head miscellaneous expenditure have been dealt with in accordance with paragraph 99 of AS 26.
INTERNAL CONTROL EVALUATION
The auditor should study. and evaluate the system of internal control relating to the various items of miscellaneous expenditure to determine the nature, timing and extent of his other audit procedures. He should particularly review the following aspects. 
(a) There should be a system of control over expenditure incurred on these items. An effective method of exercising such control is budgeting which, apart from ensuring proper authorisation of the expenditure incurred, also shows in general how effectively such expenditure is being controlled. This is accomplished through periodical comparisons of actual with budgeted figures.
(b) Accountability should be established over each item of such expenditure. This can be achieved, inter alia, by up‑to‑date maintenance of proper records.
(c) The system should ensure that reliable information (including reports of experts) is available for assessment of the results achieved against the objectives and estimates of the expenditure determined originally.
VERIFICATION 
The nature, timing and extent of substantive procedures to be performed are matters of professional judgment of the auditor which is based, inter aha, on the auditor's evaluation of the effectiveness of the related internal controls. 
While verifying an item of miscellaneous expenditure in the year in which the relevant expenditure is incurred, the auditor should satisfy himself regarding the amount of such expenditure and its deferral as also regarding the reasonableness of the period of amortisation of the expenditure. Till the amount is fully amortised, the auditor should examine every year that a proper amount is amortised during the year by way of a charge to income for the year (and not as its appropriation). The auditor should also examine every year that the criteria which previously justified the deferral of the expenditure continue to be met. If those criteria no longer apply, the auditor should examine whether the unamortised balance has been charged as expense immediately. Where the auditor finds that the criteria for deferral continue to be met but the amount of unamortised balance of the expenditure exceeds the expected future revenue/other benefits related thereto, the auditor should examine whether such excess has been charged as an expense immediately. 
The applicability of AS 26 on items that generally constitute miscellaneous expenditure and special considerations in audit of various items of miscellaneous expenditure when AS 26 is applied are discussed in subsequent paragraphs of this Guidance Note. 
Preliminary Expenses
Preliminary expenses are the expenses relating to the formation of an enterprise. For example, in the case of a company, preliminary expenses would normally include the following. 
(a) Legal cost in drafting the memorandum and articles of association.
(b) Fees for registration of the company.
(c) Cost of printing of the memorandum and articles of association and statutory books of the company.
(d) Any other expenses incurred to bring into existence the corporate structure of the company.
Paragraph 55 of AS 26 requires that expenditure on an intangible item should be recognised as an expense when it is incurred unless: 
(a) it forms part of the cost of an intangible asset that meets the recognition criteria laid down in paragraphs 19‑54 of AS 26; or
(b) the item is acquired in an amalgamation in the nature of purchase and cannot be recognised as an intangible asset. If this is the case, this expenditure (included in the cost of acquisition) should form part of the amount attributed to goodwill (capital reserve) at the date of acquisition.
Paragraph 56 ofAS 26 provides some examples where the expenditure is recognised as an expense when it is incurred. The examples given include, expenditure on start‑up of activities (start‑up costs), unless the expenditure is included in the cost of an item of fixed asseet under AS 10. Start-up costs may consist of preliminary expenses incurred in establishing a legal entity such as legal and secretarial costs, expenditure to open a new facility or business (pre‑opening costs) or expenditure for commencing new operations or launching new products or processes (pre‑operating costs). 
Preliminary expenses, therefore, incurred on or after, the date on which the Standard becomes mandatory for an enterprise or the preliminary expenses incurred on or after the date on which the enterprise opts to apply the Standard in the preparation and presentation of financial statements would be written off in the year in which they are incurred. The expenditure on preliminary expenses shall not be carried forward in the balance sheet to be written off in subsequent accounting periods. 
Preliminary expenses already shown in the balance sheet on the date the Standard is first applied would be required to be accounted for in accordance with the requirements laid down by paragraph 99 of AS 26. 
The auditor should verify these expenses with reference to supporting documents such as invoices and contracts relating to these expenses. In the case of a company, auditor should also examine that the reimbursement of such expenses to promoters is in accordance with disclosures made in the prospectus. Compliance with legal provisions regarding reimbursement of the promoters' expenses should he specifically examined. In addition to the audit procedures mentioned above, auditor should also apply the following audit procedures with regard to preliminary expenditure: 
(a) The auditor should verify whether the preliminary expenses incurred on or after the date Standard is applied by the enterprise are entirely charged to the profit and loss account in the year in which they are incurred.
(b) In the case of preliminary expenses already appearing in the balance sheet on the date the Standard is applied, the auditor should satisfy himself that the estimate made by the management of the enterprise of the useful life preliminary expenses is appropriate.
(c) The auditor should verify whether the carrying amount of the preliminary expenses appearing in the balance sheet is eliminated with a corresponding adjustment to the opening balance of the revenue reserve in case the amortisation period determined under paragraph 63 of AS 26 has already expired.
(d) The auditor should satisfy himself that the preliminary expenses already appearing in the balance sheet are being amortised in accordance with the requirements of AS 26 in case the amortisation period determined under paragraph 63 of AS 26 has not expired.
Expenses Related to Subscription or Issue of Shares
Expenses related to subscription or issue of shares include commission or brokerage on underwriting or subscription of shares or debentures, discount allowed on issue of shares or debentures. AS 26 excludes from its scope certain activities or transactions which are so specialised that they give rise to accounting issues that may need to be dealt with in a different way. Such accounting issues, inter alia, are accounting for discount or premium relating to borrowings and ancillary costs incurred in connection with the arrangement of borrowings, share issue expenses and discount allowed on the issue of shares.

The auditor should examine whether the payment of brokerage, commission, etc., is authorised by articles of association or other rules/regulations and is in accordance with the provisions of the relevant statute.

The auditor should also examine whether the rates of commission paid or payable to brokers and underwriters are in accordance with the disclosures made in the prospectus. The auditor should verify the commission with reference to the agreements with brokers and underwriters.

The auditor should examine the certificate issued by the merchant bankers with regard to commission payable to underwriters, and ensure that the payment made to underwriters is in accordance with such certificate.

Other expenses on issue of shares or debentures, such as fees of the managers to the issue, fees of the registrars to the issue including mailing and handling charges, fees of the advisors to the issue, advertisement expenses, expenses on printing and supply of prospectus and application forms, expenses on printing of share/debenture certificates, etc., should be verified with reference to supporting documents such as invoices, agreements, etc. The auditor should also examine whether the Emits on such expenses as laid down in the applicable statute have been complied with. 
Research and Development Expenditure
Entities generally incur expenditure on research and development activities. Paragraph 41 of AS 26, Intangible Assets provides that no intangible asset arising from research or from the research phase of an internal project should he recognised and should therefore, be charged as an expenses, as and when incurred. According to AS 26, expenditure incurred, in the development or during the development phase of an enterprise is required to be recognised as an intangible asset if, and only if, the requirements of paragraph 44 of AS 26 are met. It may be noted that the expenditure incurred on research or incurred during the research phase of an enterprise are required to be recognised as an expense when such expenses are incurred. 
The expenditure, therefore, incurred in the development or during the development phase of an enterprise on or after the date on which the Standard becomes mandatory for an enterprise or the preliminary expenses incurred on or after the date on which the enterprise opts to apply the Standard in the preparation and presentation of financial statements would be recognised as an asset if the requirements of paragraph 44 of AS 26 are met. Where the expenditure qualifies to be recognised as an intangible asset then the requirements, related to carrying amount of the intangible asset, its amortisation and disclosures, laid down by AS 26 shall apply to the development expenditure. 
The development expenditure shown in the balance sheet on the date on which the Standard is first applied shall be accounted for in accordance with the requirements of paragraph 99 of AS 26 from that date. If any expenditure incurred on the research or during the research phase of an enterprise already appears in the balance sheet, the same shall also be required to be accounted for in accordance with paragraph 99 of AS 26 from the date the Standard is first applied by the enterprise. 
The auditor should perform the following audit procedures with regard to research and development expenditure: 
(a) The auditor should verify the research expenditure and development expenditure with reference to supporting documents such as purchase invoices, agreements with third parties etc. A variety of expenses may be incurred by an enterprise during the research phase or development phase of an enterprise. The auditor should apply the procedures mentioned in the Guidance Note on Audit of Expenses with regard to the items of expenditure covered therein.
(b) The auditor should verify that the expenses incurred on research incurred on research or incurred during the research phase of an internal project on or after the date the Standard is first applied by the enterprise are entirely charged to the profit and loss account in the year in which they are incurred;
(c) In the case of research and development expenses already appearing in the balance sheet on the date the Standard is first applied, the auditor should satisfy himself that the estimate made by the management of the enterprise of the useful life of such expenses is appropriate;
(d) The auditor should verify whether the carrying amount of the research and development expenses already appearing in the balance sheet is eliminated with a corresponding adjustment to the opening balance of the revenue reserve in case the amortisation period determined under paragraph 63 of AS 26 has already expired.
(e) The auditor should satisfy himself that the research and development expenses already appearing in the balance sheet are being amortised in accordance with the requirements of As 26 in case the amortisation period determined under paragraph 63 of AS 26 has not expired.
(f) The auditor should also examine that the intangible asset recognised is accounted for in accordance with the requirements of AS 26.
(g) Where an intangible asset has been recognised, the auditor should verify whether the asset so recognised is tested for impairment in accordance with Accounting Standard (AS) 28, Impairment of Assets. The auditor should examine whether the test of impairment is appropriate and where impairment has occurred, an impairment loss has be provided for in the financial statements.
OTHER ITEMS
Expenditure during construction period includes a variety of expenditure. Some of the expenditure during construction period may also constitute rniscellaneous expenditure. Where an enterprise applies AS 26 to account for intangible assets, either voluntarily or is required to do so by operation of the accounting standard itself, the accounting treatment of some of the items of expenditure during construction period might be governed by the principles enunciated in AS 26. The auditor, in such cases, should verify the expense incurred during the construction period with reference to the supporting documents, such as, invoices, contracts, etc., relating to those expenses. The auditor should also verify that the requirements of AS 26 have been complied with in accounting for such items. 
30. In case where an enterprise does not apply AS 26 to account for intangible assets because it is not required to do so, the auditor apart from verifying the expense incurred during the construction' period with reference to the supporting documents, such as, invoices, contracts, etc., relating to those expenses should also examine whether the deferral and the amortisation of expenditure incurred during the construction period are in accordance with recognised accounting policies and practices (see, for example, Guidance Note on Treatment of Expenditure During Construction Period, issued by the Institute of Chartered Accountants of India). Where the entity incurs heavy expenditure of a revenue nature during the year, the benefits of which are likely to extend beyond that year, the expenditure may sometimes be deferred and written‑off over the number of years for which the benefits are expected to be derived by the entity. Some instances of such expenditure are removal of business from one location to another and massive advertisement in one year to introduce a product or develop a market. In such cases, the auditor should examine whether the deferred of the expenditure meets the relevant criteria and whether the amount of periodic write‑off of the expenditure is appropriate.
DISCLOSURES
The auditor should examine whether the financial statements contain adequate disclosures as required by AS 26. The auditor should also examine that the financial statements disclose the accounting policy with regard to miscellaneous expenditure. On the first occasion when AS 26 is applied by an enterprise for accounting for items of miscellaneous expenditure, the financial statements should also disclose the change in accounting policy with regard to miscellaneous expenditure. in accordance with the requirements of paragraph 32 of Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. 

*Issued in September, 2003. The Guidance Note on Audit of Miscellaneous Expenditure shown in the Balance Sheet shall stand withdrawn in respect of audit of financial statements of enterprises for which AS 26, "Intangible Assets" has become mandatory, and in respect of entity that has chosen to apply AS 26 to account for intangible assets.