Chapter 11. Audit Report and Certificate – Auditing: Principles and Techniques

Chapter 11

Audit Report and Certificate

CHAPTER OUTLINE
11.1 DEFINITION OF REPORT

A report is a statement of collected and considered facts, so drawn up as to give clear and concise information to persons who are not in possession of full facts of the subject matter of the report.

According to Joseph Lancaster, “a report is a medium of expressing an opinion to persons concerned in order to give a clear and summarised information based on collected facts and figures”.

In short, a report is a statement of opinion regarding an event or series of events.

11.2 DEFINITION OF AUDIT REPORT

The document through which the auditor conveys his opinion about the fairness of the financial statements is called auditor’s report. An auditor, under Section 227(2) of the Companies Act, 1956, is required to make a report to the shareholders of the company whether the books of accounts examined by him exhibit ‘true and fair’ view of the state of affairs of the business.

The auditor submits his report to his client giving clear and concise information of the result of audit performed by him. The fact or information contained in the auditor’s report is not available from any other source. Auditor’s report is the end product of his audit work. By submitting the report, the auditor completes his duty as imposed by the respective statutes.

The statutory auditor of a company has to express his professional opinion about the truth and fairness of the state of affairs of the company as shown by the balance sheet and of the profit or loss as shown by the profit and loss account in addition to several other information in his report.

An auditor’s report is, therefore, a written statement of the auditor, containing his independent professional opinion about the truth and correctness of accounts and financial statements examined by him and other specific information, which the auditor submits to his client at the conclusion of audit.

11.3 VALUE OF AUDIT REPORT

The auditor’s report is of great value not only to the members of the company, i.e. the shareholders, but also to those persons who are interested in the affairs of the business, i.e. investors, creditors, employees, government and other financial institutions that require the audited balance sheet and profit and loss account for the purpose of granting loans and for a number of reasons beneficial to them. The most important value of the auditor’s report is reflected through its checking and verifying procedure as to accuracy and fairness of the facts and figures that appear in the books of account of the company. The audit report does not add anything more than what is inserted.

The basic purpose of audit is to secure the interest of different groups of people in the organisation. Based on the audit report, these groups of people such as shareholders, bankers, creditors etc. can decide their course of action in respect of the organisation with which they are concerned. In fact, these groups of people are all outsiders and they have no other alternatives but to rely upon the auditor’s report to know the actual state of affairs of the company. So, the auditor’s report is extremely important to these groups of people. It serves their interest in the following ways:

  • The shareholders can have the idea from audit report about how well their company is being managed by their representatives, i.e. the Board of Directors.
  • The creditors and the bankers can understand from audit report how far their loan to the business is safe and secure.
  • The prospective investors and creditors can know from auditor’s report whether it would be prudent to invest in the organisation.
  • The management can also take various decisions for more efficient running of the organisation based on the auditor’s report.
  • The determination of purchase consideration in case of purchase or sale of the organisation is facilitated by the auditor’s report.
  • Very often the government grants and subsidies are based on the auditor’s report.
  • To settle insurance claim, the insurance companies generally want audited financial statements along with the auditor’s report.
  • The income tax authority very often depends upon the auditor’s report in respect of various income tax matters.

In view of changing socio-economic conditions where the society demands more disclosure of accounting information, the auditor should insist on more disclosure by his clients to appraise the actual financial position of the business. It is a fact that the auditor makes his report on the available information supplied to him. So, his tests and examinations are confined to available information supplied to him. He has nothing to do, but to report if certain items appear suspicious to him.

11.4 ESSENTIALS OF GOOD AUDIT REPORT

The essentials of good audit report are as follows:

1. Simplicity

Simplicity should be one of the important characteristics of good audit report. It should be as clear as understandable. It implies that ambiguous terms and facts should not be included in the audit report.

2. Clarity

The term ‘clarity’ implies cleanness in audit report. This indicates that the audit report should not conceal material information which are required in evaluating and appraising the performance of the business.

3. Brevity

The term ‘brevity’ signifies the conciseness in audit report. Repetition of facts and figures should be avoided in order to control the length of the report.

4. Firmness

The report should clearly indicate the scope of work to be done and should cleary indicate whether the books of account exhibit ‘true and fair’ view of the state of affairs of the business.

5. Objectivity

The report should be based on objective evidence. Opinion formed on the basis of information and evidences which are not measured in terms of money should not be incorporated in the audit report.

6. Consistency

Consistency in presenting accounting information is the basis of good audit report. A good audit report should take into consideration whether consistency, as to the method of stock valuation and depreciation charges, has been adhered to.

7. Accepted principles

The audit report should be based upon the facts and figures that are kept in accordance with generally accepted accounting and auditing principles.

8. Disclosure principles

The audit report should be unbiased. It should disclose all the facts, all the truth.

9. Relevance

The report should disclose all relevant information, which are supposed to be known by the users, but are not included in the financial statements disclosures.

10. Reference to AAS

It should preferably state the auditing standards and practices adopted by the auditor while conducting audit. Such a reference in the report will assure the users that the audit has been carried out in accordance with Auditing and Assurance Standards.

11.5 SCOPE OF AUDIT REPORT

Sub-sections (2) and (3) of Section 227 of the Companies Act, 1956 provide that it is the duty of the auditor to report to the members of the company on the accounts examined by him and on the balance sheet and profit and loss account and every other document declared by the act to be part of or annexed to the balance sheet and the profit and loss account, laid before the company in general meeting during the tenure of his office, also that the report shall confirm the position, envisaged in the undermentioned manner in which the requirements are to be met.

Sub-section (2) specifically requires that the auditor should report whether in his opinion and to the best of his information and according to the explanations given to him, the said accounts give the information required by the Companies Act, 1956 in the manner so required and the balance sheet gives a true and fair view of the company’s affairs at the end of the financial year and the profit and loss account gives a true and fair view of the profit and loss for the financial year.

Sub-section (3) requires that the auditor shall report on the following matters:

  • Whether he has obtained all the information and explanations which to the best of his knowledge and belief were necessary for his audit
  • Whether in his opinion, proper books of accounts as required by law have been kept by the company, so far as appears from his examination of those books and proper returns adequate for the purpose of his audit have been received from branches not visited by him
  • Whether in his opinion, the balance sheet and the profit and loss account comply with the accounting standards referred to in Sub-section (3C) of Section 211 of the Companies Act, 1956
  • Whether the company’s balance sheet and profit and loss account dealt with by the report are in agreement with the books of accounts and returns
  • Whether the report on the accounts of any branch office audited under Section 228 by a person other than the company’s auditor has been forwarded to him as required by Section 228(3)(c) and how he has dealt with the same in preparing the auditor’s report

The duty of any auditor for making a report on the statement of account also extends to matters reported upon by the Directors to the shareholders in so far as information which is required to be given by the Act in the statements of account or can be given in a statement annexed to the accounts are contained in the report of Directors (Provision in Section 222). For instance, the opinion of the Board of Directors as regards current assets, loans and advances, when contained in the Director’s report, must be considered by the auditor.

11.6 SIGNING OF THE AUDIT REPORT

According to Section 229 of the Companies Act, only the person appointed as the auditor of the company or where a firm is so appointed, only a partner in the firm practising in India may sign the auditor’s report.

The Department of Company Affairs, Government of India, in a communication dated 29th July, 1972 has expressed the view that when a single chartered accountant is practising, there cannot be any question of any firm name. Further, it is stated that Section 229 of the act clearly provides that if a firm of chartered accountants is appointed as auditor, only a partner in the firm may sign the auditor’s report or sign or authenticate any other document required by law to be signed by the auditor. The practice of merely affixing the ‘firm name’ on the report or such other document is the correct approach in the eye of law.

According to Section 233 of the Companies Act, if an auditor’s report or any document of the company is signed or authenticated otherwise than in conformity with the requirements of Section 229, the auditor concerned and the person, if any, other than the auditor who signs the report or signs or authenticates the document shall, if the default is wilful, be punishable with a fine which may extend upto Rs. 10,000.

According to Section 230 of the Companies Act, the auditor’s report must be read before the shareholders of the company in general meeting and should be kept open for the inspection to every member of the company.

According to Section 232, it is no part of duty of the auditor either to send a copy of his report to or allow inspection thereof by each member of the company individually, or to see that the report is read before the company in general meeting. For non-compliance with any of the requirements of Section 225 to 231, the company and every officer of the company who is in default, will be liable to a fine, which may extend upto Rs. 5,000.

11.7 CONTENTS OF AUDIT REPORT

As per the provisions of Section 227 of the Companies Act, 1956 the following matters are required to be included in the auditor’s report of a company:

  1. Whether in his opinion and to the best of his information and according to the explanations given to him:
    1. The accounts of the company examined by him give the information required by the Companies Act in the manner so required.
    2. The accounts give a true and fair view of the state of company’s affairs as at the end of its financial year in the case of the balance sheet.
    3. The accounts also give a true and fair view of the profit or loss of the company for its financial year in the case of the profit and loss account.
  2. Whether he has obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his report.
  3. Whether in his opinion, proper books of accounts as required by law have been kept by the company so far as appears from his examination of those books.
  4. Whether proper returns adequate for the purpose of his audit have been received from branches not visited by him.
  5. Whether the report on the accounts of any branch office audited by a person other than the main auditor of the company has been forwarded to him.
  6. The method used to deal with the branch auditor’s report in preparing his audit report.
  7. Whether the profit and loss account and balance sheet of the company are in agreement with the books of accounts and returns.
  8. Whether in his opinion the balance sheet and the profit and loss account comply with the accounting standards.
  9. Where any of the matters in the auditor’s report is answered in the negative or with a qualification, the reasons for such should also be stated.
  10. A statement on such matters as may be specified in the central government orders. Presently the company auditors are required to make a statement on the matters specified in the CARO, 2003 issued by the central government, so far as they are applicable to a particular class of company.
11.8 COMPANIES (AUDITOR’S REPORT) ORDER, 2003

In addition to the provisions regarding Auditor’s Report in Section 227 of the Companies Act, in respect of certain types of companies, the Companies (Auditor’s Report) Order (CARO), 2003 issued by the central government is applicable. These orders have been issued by the central government in exercise of its power under Section 227(4A) of the Act.

The new order of 2003 has further enlarged the scope of audit of the companies replacing the previous order of 1988. The order is reproduced as follws:

Title   This order may be called the Companies (Auditor’s Report) Order, 2003.

Area of application   It shall apply to every company including a foreign company as defined in Section 591 of the Companies Act, 1956.

It shall not apply to the following.

  1. A Banking Company as defined in Clause (C) of Section 5 of the Banking Regulation Act
  2. An Insurance Company as defined in clause (21) of Section 2 of the Act
  3. A company licensed to operate under Section 25 of the Act
  4. A private limited company with a paid up capital and reserves of not more than fifty lakh rupees and one which has not accepted any public deposit and does not have loan outstanding ten lakh rupees or more from any bank or financial institution and does not have a turnover exceeding five crore rupees

Effective date   It came into force on the 1st day of July 2003.

Matters to be included in auditor’s report:

1. Re: Fixed assets

  1. Records of fixed assets   Whether the company is maintaining proper records showing full particualrs, including quantitative details and situation of fixed assets.

     

  2. Physical verification   Whether these fixed assets have been physically verified by the management at reasonable intervals, whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of accounts.

     

  3. Disposal of fixed assets   If a substantial part of the fixed assets have been disposed off during the year, whether it has affected the going concern.

2. Re: Stock-in-trade

  1. Regular physical verification   Whether physical verification of inventory has been conducted by the management at reasonable intervals.

     

  2. Adequate physical verification   Are the procedures of physical verification of stock followed by the management reasonable and adequate in relation to the size of the company and the nature of its business? If not, the inadequacies in such procedures should be reported.

     

  3. Material discrepancies   Whether the company is maintaining proper records of inventory and whether any material discrepancies were noticed on physical verification of stocks as compared to book records, and if so, whether the same have been properly dealt with in the books of accounts.

3. Re: Loan obtained/granted

  1. Terms and conditions of loan   Has the company either granted or taken any loans, secured and unsecured, to/from companies, firms or other parties covered in the register maintained u/s 301 of the Companies Act, 1956? If so, give the number of parties and amount involved in the transactions.

     

  2. Terms and conditions of loan   Whether the rate of interest and other terms and conditions of loans given or taken by the company, secured or unsecured, are prima facie prejudicial to the interest of the company.

     

  3. Regularity   Whether payment of the principal amount and interest is also regular.

     

  4. Recovery of loan   If overdue amount is more than one lakh, whether reasonable steps have been taken by the company for recovery/payment of the principal and the interest.

4. Re: Adequacy of internal control

Is there an adequate internal control procedure commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods? Whether there is a continuing failure to correct major weaknesses in internal control.

5. Re: Special transactions

  1. Recording   Whether transactions that need to be entered into a register in pursuance of Section 301 of the Act have been so entered.

     

  2. Reasonable prices   Whether each of these transactions has been made at prices which are reasonable having regard to the prevailing market prices at the relevant time.

This information is required only in case of transactions exceeding the value of five lakh rupees in respect of any party and in any one financial year.

6. Re: Acceptance of deposits

In case the company has accepted deposits from the public, whether the directives issued by the Reserve Bank of India and the provisions of Sections 58A and 58AA of the Companies Act and the rules framed there under, where applicable, have been complied with. If not, the nature of contraventions should be stated.

7. Re: Internal audit system

In the case of listed companies and/or other companies having a paid up capital and reserves exceeding Rs.50 lakhs as at the commencement of the financial year concerned, or having an average annual turnover exceeding five crore rupees for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business.

8. Re: Maintenance of cost records

Where maintenance of cost records has been prescribed by the central government u/s 209 (1) (d) of the Companies Act, 1956 whether such accounts and records have been made and maintained.

9. Re: Statutory obligations

  1. Provident fund and employees state insurance etc   Is the company regular in depositing undisputed statutory dues including provident fund, investors’ education and protection fund, employees’ state insurance, income tax, sales tax, wealth tax, custom duty, excise duty, cess and any other statutory dues with the appropriate authorities? If not, the extent of arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated by the auditor.

     

  2. Pending disputes   In case dues of sales tax/income tax/custom tax/wealth tax/ excise duty/cess have not been deposited on account of any dispute, then the amount involved and the forum where the dispute is pending may please be mentioned.

10. Re: Accumulated loss/cash loss

Whether in case of a company which has been registered for a period not less than five years, its accumulated losses at the end of the financial year are not less than fifty percent of its net worth and whether it has incurred cash losses in such financial year and in the financial year immediately preceding such financial year also.

11. Re: Default in repayment

Whether the company has defaulted in repayment of dues to financial institutions or bank or debenture holders. If yes, the period and the amount of default to be reported.

12. Re: Secured loans and advances

Whether adequate documents and records are maintained in cases where the company has granted loans and advances on the basis of security by way of pledge of shares, debentures and other securities. If not, the deficiencies to be pointed out.

13. Re: Chit fund

Whether the provisions of any special statute applicable to chit fund have been duly complied with.

14. Re: Nidhi/mutual benefit fund/societies

In respect of nidhi/mutual benefit fund/societies:

  1. Whether the net-owned funds to deposit liability ratio is more than 1:20 as on the date of the balance sheet.
  2. Whether the company has complied with the prudential norms on income recognition and provisioning against sub-standard/default/loss assets.
  3. Whether the company has adequate procedures for appraisal of credit proposal/ request, assessment of credit needs and repayment capacity of the borrowers.
  4. Whether the repayment schedule of various loans granted by the nidhi is based on the repayment capacity of the borrower and would be conducive to the recovery of the loan amount.

15. Re: Investments

If the company deals or trades in shares, securities, debentures or other investments, whether proper records of the transactions and contracts have been maintained and also whether timely entries have been made therein, whether the shares, securities, debentures, and other investments have been held by the company in its own name extent to the exemption, if any, granted under Section 49 of the Companies Act.

16. Re: Guarantee for loans

Whether the company has given any guarantee for loans taken by others from bank or financial institutions, the terms and conditions whereof are prejudicial to the interest of the company.

17. Re: Term loan

Whether term loans were applied for the purpose for which the loans were obtained.

18. Re: Uses of fund

Whether the funds raised on short-term basis have been used for long-term investment and vice versa; if yes, the nature and amount is to be indicated.

19. Re: Preferential allotment

Whether the company has made any preferential allotment of shares to parties and companies covered in the register maintained under Section 301 of the Companies Act and if so whether the price at which shares have been issued is prejudicial to the interest of the company?

20. Re: Creation of securities

Whether securities have been created in respect of debentures issued.

21. Re: Public issue

Whether the management has disclosed on the end use of money raised by public issues and the same has been verified.

22. Re: Fraud

Whether any fraud on or by the company has been noticed or reported during the year. If yes, the nature and amount involved is to be indicated.

23. Re: Reasons for qualifications

Reasons to be stated for unfavourable or unqualified answers where, in the auditor’s report, the answer to any of the questions referred to above points (1 to 22) is unfavourable or qualified, the auditor’s report shall also state the reasons for such unfavourable or qualified answer, as the case may be. Where the auditor is unable to express any opinion in answer to a particular question, his report shall indicate such fact together with the reasons why it is not possible for him to give an answer to such question.

11.9 FORMS OF AUDIT REPORT

International Auditing Guidelines issued by the International Federation of Accountants (first issued in 1983 and revised in 1989) provide guidance on the form and content of the auditor’s report to be issued after the examinations of financial statements.

As per the guidelines, the basic elements of the report are as follows.

1. Title

An appropriate title such as ‘Auditor’s Report’ helps the reader to identify the report and to distinguish it from reports issued by others.

2. Address

The report should be properly addressed. Like in the case of a statutory audit of a company, the report is addressed to the shareholders and in case of special audit, it is addressed to the government.

3. Identification of financial statements

The financial statements can be identified by including the name of the entity and the date and period covered by the financial statements.

4. Reference to auditing standards and practices

Such a reference ensures the compliance of the resolution of the ICAI and assures the readers that the accounting and auditing standards have been complied with.

5. Opinion on the financial statements

The report should clearly state the auditor’s opinion on the financial position and operational result of the entity.

6. Signature

The report should be signed in the name of the firm or personal name of the auditor or both.

7. Address of the auditor

The report should give the address of the firm.

8. Dating of the report

It should be properly dated.

11.10 AUDIT REPORT AND AUDIT CERTIFICATE

When an auditor certifies a financial statement, it implies that the contents of the statement are reliable as the auditor has vouched the exactness of the data. The term ‘certificate’ is, therefore, used to mean confirmation of the truth and correctness of something after a verification of certain exact facts. An auditor may therefore, certify the circulating figures of a newspaper or the value of imports and exports of a company.

Thus, auditor’s certificate confirms the correctness of the statements prepared by the client. By certifying the statements, the auditor gives guarantee about the genuineness of the statements. So, before certifying a statement, an auditor is required to be thorough and meticulous in examining the truthfulness of each and every content in it. If it is revealed subsequently that the statement certified by the auditor is not correct, he will be held responsible regardless of utmost care and skill exercised by him in checking its contents.

The term ‘certificate’ should not be confused with the term ‘report’. A report is a statement of opinion regarding an event or series of events. So, an auditor’s report is his expression of opinion regarding the fairness of financial statements in reflecting the financial result and the financial position of the organisation. The auditor only draws his conclusion about the general reliability of financial statements. He does not give guarantee in his report that the accounts are free from errors and frauds. He does not owe any responsibility while reporting on accounts, provided he exercises reasonable skill and care in his audit work.

So, while a certificate affirms the truth and correctness of a fact, figure or a statement, a report is generally a statement of facts or an expression of opinion regarding the truth and fairness of the facts, figures and statements.

11.11 TYPES OF AUDITOR’S REPORT

Auditor’s report can be of the following types:

1. Clean report

An audit report is clean, when there is no qualified or adverse opinion or disclaimer of opinion in the report. A clean report indicates that the auditor is satisfied with all the points required to be stated in his report and states them in the affirmative, adding no reservation anywhere.

An auditor makes a clean or unqualified report when he is satisfied with various matters, such as follows:

  • He has got reasonable evidence in support of all material transactions.
  • All entries have been passed according to generally accepted accounting principles.
  • The financial statements correspond to the books of accounts.
  • All relevant information have been disclosed.

2. Qualified report

When an auditor expresses an opinion in his report with a reservation or states anything in the negative, but its nature is such that it does not materially affect the true and fair picture shown by the accounts, then the auditor’s report is said to be a qualified report.

3. Adverse report

When the auditor expresses an adverse or negative opinion in his report about the principal point in the report for which audit is mainly intended, the report is called an adverse report. So, an adverse report is the report in which the auditor categorically states that the profit and loss account and the balance sheet do no exhibit a true and fair view of the state of affairs and working results of the concern. An adverse report should be given by the auditor, only when he has strong and convincing evidence to support his conclusion. He should disclose all the reasons of adverse report. Generally in extreme cases like excess provision for depreciation, charging fictitious expenses etc. compel the auditor to give negative or adverse report.

4. Disclaimer of opinion

When an auditor is unable to express an opinion due to certain reasons and states this in his report, it becomes a report with a disclaimer of opinion. A disclaimer of opinion is always required to be supported by the justified facts.

It may not be possible for an auditor to collect all information, which are necessary for expressing an opinion on the financial statements. Though these situations are rare, it may arise because of incomplete accounts submitted by the client or negligence on the part of the client to furnish the required information or explanations. When the auditor is to submit such inconclusive audit report because of reasons beyond his control, such report is called a report with disclaimer.

5. Piecemeal report

Auditor’s opinion in his report may not be on the entire financial statements. Such opinion may relate to some of the items contained in the statements on which only he can satisfactorily express opinion after audit. Such an opinion as a part of the financial statement is a piecemeal opinion and the auditor’s report containing such opinion is called a piecemeal report.

11.12 QUALIFIED AUDIT REPORT

When the auditors are satisfied with the truth and correctness of the financial statements of accounts without any qualifications, they give a clean, clear or unqualified report. In some cases, the auditor is unable to give such an opinion for one or more of a large variety of reasons. In these cases an auditor is said to give a qualified report.

When an auditor expresses his opinion in his audit report subject to some observations, he is said to have qualified his report. In other words, his assertions in the qualified report regarding fairness of financial statements depend upon some conditions. As for example, if the auditor does not agree with his client regarding treatment of an item such as grant received or provision for gratuity, he may qualify his report stating ‘subject to above, we report the balance sheet shows a true and fair view--------’. While qualifying his report, the auditor should keep in his mind the materiality of the matter. Unless the amount is significant, the auditor need not qualify his report. The reasons of qualification should always be clearly stated in the report.

The principal source materials on qualified auditor’s reports are:

  • The Companies Act, 1956
  • Auditing and Assurance Standards
  • Accounting Standards

A qualified audit report is a disadvantage to a concern for several reasons.

  • It has legal consequences, notably in restricting dividend payments.
  • It may lead to the accounts being seen as less reliable by contact groups such as banks and other lenders and potential buyers of the business.
  • It reflects badly on the Directors.

There are several types of qualifications. These include the following:

1. Limitation of scope

Limitation of scope means a limitation of scope of the auditors’ work that prevents them from obtaining sufficient evidence to express an unqualified opinion. Consider the following examples:

  1. A limitation imposed on the auditor—for example, if he were not permitted to carry out an audit procedure considered necessary. The Directors may not permit a debtors’ circulation or may not allow the auditor to attend a stock take.
  2. A limitation outside the control of both the auditors and the directors. Perhaps necessary records existed but have been destroyed by fire or the auditor was prevented from attending stock take by a breakdown.

2. Disagreement

It means that the auditors do not agree with the accounting treatment or disclosure of some item in the accounts. The financial statements may have an accounting policy, e.g. inclusion of overheads in finished goods stock on a global percentage of overheads to prime cost, when the auditor considers that a more complex apportionment is essential for true and fair view.

3. Material and pervasive

This term applies when the possible effect of the limitation of scope is so material or pervasive that the auditors are unable to express an opinion on the financial statements. Similarly when the matter giving rise to the disagreement is so material and pervasive that the financial statements are seriously misleading.

4. Less material

Less material means when the effect of the limitation is not so material or pervasive as to require a disclaimer. Similarly when the disagreement is not so material or pervasive as to require an adverse opinion.

5. Adverse opinion

An adverse opinion is one where the auditors state that the financial statements do not give a true and fair view.

6. Disclaimer

A disclaimer of opinion occurs when the auditors conclude that they have not been able to obtain sufficient evidence to support, and accordingly are unable to express, an opinion on the financial statements.

7. Possible adjustments

The wording of the opinion should indicate that it is qualified as to the possible adjustments to the financial statements that might have been determined to be necessary had the limitation not existed.

8. Exclusion of certain points

The opinion is qualified by stating that the financial statements give a true and fair view except for the effects of any adjustments that might have been found necessary, had the limitation not affected the evidence available to the auditors.

11.13 TYPES OF AUDIT CERTIFICATE

The professional accountants are sometimes required to issue certificates on many occasions. In fact, the types of certificates depend on the purpose for which they are intended. The major types of certificates include the following:

1. Certificate for tax computation

The chartered accountants are sometimes required to certify certain incomes and expenses for obtaining exemptions from income tax, which is computed on the basis of provisions as contained in the Income Tax Act, 1961. The forms and contents of these types of certificates are usually provided under income tax rules, as the appropriate wordings of the certificate depend on the nature and circumstances of individual cases.

2. Certificate of import and export

Import and Export Trade Control Rules and Procedures provide that the applicant applying for import or export licence must furnish a certificate of import and/or export from a qualified accountant in practice. These certificates include the value of goods imported or exported, goods consumed by the entity out of imported goods, goods supplied by the entity for export out of own source and from other sources and the unutilised value of licence on hand.

3. Certificate of circulation

The Audit Bureau of Circulations Ltd. which is an association of advertisers and publishers, gives report of circulation figures of publication of its members. The association issues circulation certificate on the basis of audit report of the member. The auditor has to certify the circulation figure on the basis that he has checked and verified the books regarding newsprint consumption, distribution and unsold stock of publications as per the guidelines issued under A.B.C. Audit Procedure.

11.14 AUDITOR’S REPORT AND ‘TRUE AND FAIR VIEW’

The expression ‘true and fair view’ is central to auditing and yet it is an abstraction whose meaning is far from clear. In fact, the true and fair view is a Companies Act concept and is therefore a legal notion. However, neither the Companies Act nor the court has ever attempted to define it.

Investigation and discovery of anything is assisted by breaking down or classifying the thing into parts. We therefore will breakdown true and fair view into parts, beginning with true.

1. Truth

In practice the word ‘true’ is difficult to pin down as it also incorporates a high level of abstraction. However in accounting terms we can consider synonyms like—in accordance with fact or reality, not false or erroneous, representing the thing as it is.

Numerous accounts items can be seen in this light. For example, ‘freehold land at cost Rs.2, 00,000.

It is either true or false that

  • Freehold land exists
  • The freehold land is the property of the company that holds a good title
  • The freehold land did cost the company Rs.2, 00,000
  • All the freehold land belonging to the company is included

On the other hand, the matter may not be as simple as it seems. For example,

  1. Good title may be a matter of opinion.
  2. Historical cost may be a matter of opinion—is legal cost included? Subsequent costs (drainage, fencing) may be considered capital or revenue.

A dictionary definition of true also includes ‘in accordance with reason or correct principles or received standard’ which brings us back to generally accepted accounting principles and the accounting standards.

2. Fair view

The word view is important in that accounts cannot give a view in an abstract way. The view given cannot be divorced from the perceptions of a reader/user of the accounts. Again, the idea of fairness involves a number of thoughts including the following:

  1. Expectation   Any user has certain expectations from a set of accounts. He presumes that the accounts will conform to generally accepted accounting principles and the accounting standards.

     

  2. Relevance   The fair view from the point of view of a user must mean that the view given by the accounts will be relevant to the informational needs of the user.

     

  3. Objectivity   It consists of extremely verifiable facts, rather than subjectively considered opinions. In practice, as we have seen under ‘truth’, most accounting figures are subjective or contain a substantial subjective element.

     

  4. Freedom from bias   The producer of accounts (directors, managers) should not allow personal preferences to enter into their accounts preparation work. For example, a desire to show a favourable profit should not influence a manager’s assessment of the expected life of the fixed assets, or the saleability of stock. In practice, all human activities are influenced by personal experience and prejudice. The important thing is to be aware of this and for an auditor to be aware of the tendency to bias in all financial reporting.

3. Beyond simple conformity

The users of accounts expect accounts to conform to generally accepted accounting principles and accounting standards. However, simple rigid conformity can give a misleading view. For example, inclusion of profit from overseas branches may mislead shareholders when those profits are not available to the shareholders because of exchange control restrictions.

4. Least as good

At one time the prudence convention was so highly esteemed that shareholders and auditor’s expectations went no further than making sure that the true position was at least as good as that shown by the balance sheet. Despite modern insistence on fairness up and down, the least-as-good syndrome lurks in every accountant’s subconscious.

5. Accounting principles

The accounting principles and policies used should be

  • in conformity with accounting standards
  • generally accepted
  • widely recognised and supported
  • appropriate and applicable in the particular circumstances.

In most areas, more than one policy will satisfy these criteria. For example, there are several different acceptable methods for depreciation and therefore several different measures of profit, all of which may give a true and fair view.

6. Disclosure

Accounting is an aggregating and summarising process. A thousand transactions in a year can be summarised in a relatively few lines in a setting of accounts. The overall results and final position can only be appreciated by aggregating transactions and balances into suitable classes and categories. Too much aggregation can hide individual figures or subclasses that ought properly to be disclosed. On the other hand, too much disaggregation causes confusion between the wood and the trees and a general indigestibility.

7. Materiality

The elusive accounting principle of materiality is intimately bound up with the true and fair view. An item is material if its disclosure or non-disclosure would project any difference to the view received by the user of the accounts. Fairness is therefore a function of materiality.

The Companies Act, 1956 has introduced the words “true and fair” in place of the words “true and correct” as appearing in the Companies Act, 1913. This is an important change and has far-reaching effects.

The phrase “true and correct” means that the financial statements are arithmetically correct and that they correspond to the figures in the books of accounts. But it does not specifically mean that the financial statements are representing the actual state of affairs and actual working results. In fact, at present the auditor is supposed to verify whether the books of accounts show a true and fair view of the state of affairs of the company as well as the true and fair view of the financial result of the company.

The phrase “true and fair” thus signifies in the auditor’s report that the financial statements are representing a fair and actual financial position of the company and profit and loss for the period. It means that the financial statements are disclosing all the relevant information as are required by various provisions of the Companies Act.

The major criticism of the phrase ‘true and correct’ was that in an accounting sense, there was insufficient distinction between the words ‘true’ and ‘correct’. As such, every figure in the accounts could be justified and substantiated as both true and correct but, at the same time, the figures together could present a view to the reader of the accounts which could be misleading or even totally false when the accounts were read as a whole.

It was for this reason that the word ‘fair’ was used to replace ‘correct’, despite the inherent vagueness and absence of precision that the former word implies. The word ‘fair’, by definition, requires a judgement which can only be determined subjectively. This subjectivity and the related exercising of judgement provide the term with its true strength, at the same time it provides the auditor with his greatest challenge.

An auditor’s assessment of whether accounts give a true and fair view, lacking as it does any legal or professional definition, necessitates a consideration of the accounts as a whole and the forming of an opinion concerning the overall impression conveyed by the accounts to the auditor and therefore to a reader. It also involves consideration of the substance of the information disclosed in the accounts as well as its form. In fact, the phrase ‘true and fair’ attempts to explain that accounts cannot be exact in all aspects due to the subjectivity of certain items, such as the valuation of closing stock and the provision for doubtful debts. The word ‘fair’ implies that the user should take an overall view of the financial statements and base interpretations on the figures as a set rather than an individual item. The word ‘true’ implies that the figures are decided on the facts as seen by the directors and the auditor but that other persons may draw different conclusions from the same facts. There is no attempt to make accounts precise in terms of mathematical accuracy as this is not possible due to need of estimation in certain cases. However, an attempt is made to ensure that the financial statements fairly reflect the company’s result for the period and its state of affairs at the balance sheet date.

In view of this discussion, it can be stated that the concept ‘true and fair’ that are used in the auditor’s report is not appropriate in present day dynamic and complex nature of business environment. So, it is advocated that the audit report which should be free from criticism as to nature and pattern of disclosing material information should not use these equivocal words ‘true and fair’. It is expected that the Companies Act should be duly amended for taking special care in this matter.

11.15 SPECIMEN OF CLEAN AUDIT REPORT

To

The Shareholders

XYZ Co. Ltd., Kolkata

Dear Members,

I/we have audited the annexed balance sheet of XYZ Co. Ltd. as at 31st March, 200x and also the profit and loss account of the company for the year ended on that date and report that—

I/we have obtained all the information and explanations which to the best of my/our knowledge and belief were necessary for the purpose of audit.

In my/our opinion proper books of accounts as required by law have been kept by the company so far as appears from my/our examination of such books and proper returns adequate for the purpose of my/our audit have been received from the branches not visited by us.

The accounts of Chennai branch office have been adudited u/s 228 of the Companies Act by Subrata Renuka and Co. The report of the said accounts which has been forwarded to us has been dealt with by us, in the manner we have considered necessary, while preparing this report.

The balance sheet and the profit and loss account dealt with in this report are in agreement with the books of accounts.

In my/our opinion and to the best of my/our information and according to the explanations given to me/us, the said accounts, together with the notes thereon, give the information required by the act in the manner so required and give a true and fair view:

  1. In the case of the balance sheet of the state of the affairs of the company as at 31st March, 200X and
  2. In the case of profit and loss account of the profit of the company for the year ended on that date.

For. G. G. Basu & Co.

Chartered Accountants

Kolkata

Signature

Date

B. B. Basu (Partner)

11.16 SPECIMEN OF QUALIFIED AUDIT REPORT

To

The Shareholders

ABC Co. Ltd. Mumbai

Dear Members,

We have audited the annexed balance sheet of the ABC Co. Ltd. as at 200X and also the profit and loss account for the year ended on that date. We report that—

We have obtained all the information and explanations, which to the best of our knowledge and belief were necessary for the purpose of audit.

In our opinion, proper books of accounts as required by law have been maintained by the company, kept in accordance with the accounting standards, so far as it appears from our examination of the books subject to the comments given here under:

  1. The stocks of the company have been valued at a current replacement price, which is higher than the cost price to the extent of Rs. 1,03,000.
  2. Provisions for bad and doubtful debts has not been taken into consideration which should have been taken in view of the fact that some of the debts are quite old and time-barred.
  3. In the absence of stock registers, adjustments relating to the balances on the register have been accepted on the basis of the decisions of the management.

The balance sheet and profit and loss account dealt with by the report are in agreement with the books of accounts and returns.

Subject to the qualifications given above, in our opinion and to the best of information available and according to the explanations given to us, the said accounts, with the notes thereon and documents attached thereto give the information required by the law and accounting standards and gives a true and fair view:

  1. in the case of the balance sheet of the state of affairs of the company as at 200x and
  2. in the case of the profit and loss account of the profit for the year ended on that date.

Mumbai

For S. K. Basu & Co.

Date

Chartered Accountants

 

Signature
S. K. Basu (Partner)

11.17 LEGAL VIEWS AS REGARDS AUDIT REPORT

Case Study

  1. Case: Allen Craig & Co. (London) Ltd. (1934)

    Fact of the Case: The company made loss in each year of its existence, and there was a deficiency of assets to meet liabilities of over £ 40,000. In submitting the accounts for the year to 30th June, 1924 the auditor sent a letter to the company drawing attention to the serious position of the company, this being quite apart from the normal audit report. In 1927, in submitting the accounts for the years to 30th June, 1925 and 1926 respectively, the auditor sent further letters, showing that there was a deficiency as regards creditors of nearly £ 11,000.

    The liquidator of the company took out a summon for misfeasance against the former managing director and the auditors asking for a declaration that such parties were liable for the debts of the company incurred after 30th June, 1925.

    Legal View: It was held that the duty of the auditors, after having signed the report to be annexed to a balance sheet, is confined only to forwarding that report to the secretary of the company. It will be for the secretary or the directors of the company to convene a general meeting and send the balance sheet and report to members entitled to receive it. The auditor, in no way, will be held liable in this situation.

  2. Case: London and General Bank Ltd. (1895)

    Fact of the Case: The company, in this case, had not made adequate provision for bad debts. The auditor had discovered that the debts were doubtful and had clearly reported the situation to the directors. But when the directors failed to make provisions, instead of reporting the fact equally clearly to the shareholders, he simply made the statement that “the value of the assets is dependent upon the realisation.” It was held that the auditor had failed in his duty to convey information clearly in his report and he was made liable for certain dividend improperly paid. Legal view: This case underlined the dangers of equivocal statements in audit report. In the course of his judgement, Justice Lindley, L. J. said, “information ‘and means of information are by no means equivalent terms. An auditor who gives shareholders means of information does so at his peril and runs the very serious risk of being held, judicially, to have failed to discharge his duty”.

    It was held in this case that an auditor has a duty to convey facts clearly to shareholders. The auditor whose duty it is to convey information to others does not discharge that duty by simply giving them so much information as is calculated to induce them or some of them to ask for more.

POINTS TO PONDER
  • A report is a statement of collected and considered facts, so drawn up as to give clear and concise information to persons who are not in possession of full facts of the subject matter of the report.
  • An audit report is a written statement of the auditor containing his independent professional opinion about the truth and fairness of accounts and financial statements examined by him.
  • The essentials of good audit report include simplicity, clarity, brevity, firmness, objectivity, consistency, relevance and reference to auditing and assurance standards.
  • Only the person appointed as the auditor of the company or where a firm is so appointed, only a partner in the firm practicing in India may sign the audit report.
  • In addition to the provisions regarding auditor’s report in section 227 of the Companies Act, in respect of certain types of companies, The Companies (Auditor’s Report) Order, 2003 issued by the central government is also applicable.
  • The basic elements of the audit report are title, address, identification of financial statements, reference to the auditing standards, opinion on the financial statements, signature, address of the auditor and dating of the report.
  • Audit certificate should not be confused with the audit report. Audit certificate confirms the correctness of the statements prepared by the client. But audit report is the auditor’s expression of opinion regarding the fairness of the financial statements in reflecting the financial result and the financial position of the organization.
  • Audit report can be basically of four types, which are clean report, qualified report, adverse report and disclaimer of opinion.
  • When the auditors are satisfied with the truth and correctness of the financial statements of accounts without any qualifications, they give a clean report. In some cases, the auditors are unable to give such an opinion for one or more of a large variety of reasons. In these cases, an auditor is said to give a qualified report.
  • The concept ‘true and fair’ view that are used in the auditor’s report is not appropriate in present day dynamic and complex nature of business environment. So, the audit report, which should be free from criticism as to nature and pattern of disclosing material information, should not use these equivocal words ‘true and fair’.
  • The audit report is of great value not only to the shareholders of the company, but also to those persons who are interested in the affairs of the business, i.e., the employees, investors, creditors, government and other financial institutions.
  • The auditor should report whether in his opinion and to the best of his information and according to the explanations given to him, the balance sheet gives a true and fair view of the company’s affairs at the end of the financial year and the profit and loss account gives a true and fair view of the profit and loss for the financial year.
REVIEW QUESTIONS

Short-answer Questions

  1. What do you mean by ‘auditor’s report’?
  2. What is piecemeal report?
  3. Distinguish between auditor’s report and auditor’s certificate.
  4. Is there any difference between an adverse and a qualified report?
  5. “Information and means of information are by no means equivalent terms.” Explain.
  6. What are the contents and format of an audit report?

Essay-type Questions

  1. What is meant by Auditor’s Report? Discuss the characteristics of a good audit report. What is the value of Auditor’s Report?
  2. State the matters required by the Companies Act, 1956 to be stated in auditor’s report to the shareholders on the accounts of a company audited by such auditor.
  3. What is a Clean Report? Give a specimen of a clean report of the auditor.
  4. What is a Qualified Report? Give a specimen of a qualified report of the auditor.
  5. How many types of audit reports may be submitted by a company auditor and in what circumstances? Discuss briefly.
  6. Under Section 227 (4A) of the Companies Act (1988), some additional information is to be given by the auditor in his report to the shareholders. State those matters.
  7. What are the events that may occur after the preparation of balance sheet? Do you think that those events should be incorporated in auditor’s report?