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GNDU Question Paper-2021
Bachelor of Commerce
(B.Com) 5
th
Semester
AUDITING
Time Allowed: Three Hours Max. Marks: 50
Note : Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTION — A
1. Describe the qualities of an auditor. Highlight the advantages of auditing for different
stakeholders.
2. Give the examples of errors which are not revealed by trial balance, and state the steps
an auditor would take to detect these errors.
SECTION — B
3. What do you understand by Internal Control? Discuss the need for internal control.
Also, explain the elements of a good internal control system.
4.(i) How does Internal check differ from Internal audit?
(ii) What are the essential characteristics of a good system of Internal check?
SECTION — C
5. (i) What are the duties of an auditor in connection with sales & sales returns?
(ii) How would you discover fictitious sales in the course of an audit?
6. (i) What is the objective of verification of assets? How would you verify the following:
• (a) Goodwill
• (b) Freehold property
• (c) Motor Vehicles
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• (d) Trademarks
• (e) Cash-in-hand
(ii) How would an auditor vouch for the wages paid to workers?
SECTION — D
7. Describe the provisions of Companies Act, 2013 regarding appointment and
remuneration of the Auditors.
8.(i) Discuss the civil liability of an auditor under Companies Act, 2013.
(ii) Explain the various types of Audit Report.
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GNDU Answer Paper-2021
Bachelor of Commerce
(B.Com) 5
th
Semester
AUDITING
Time Allowed: Three Hours Max. Marks: 50
Note : Attempt Five questions in all, selecting at least One question from each section. The
Fifth question may be attempted from any section. All questions carry equal marks.
SECTION — A
1. Describe the qualities of an auditor. Highlight the advantages of auditing for different
stakeholders.
Ans: The Story of the Honest Watchman: Understanding Auditors and Auditing
Imagine you are living in a big house. You have many rooms, lots of cupboards, a safe full of
valuables, and even some hidden corners that you rarely check. Now, because of the size of
the house, you hire a watchman. But this watchman isn’t just guarding your gates — he also
inspects whether everything inside is safe, whether no one is secretly stealing, and whether
the people working in the house are handling things properly.
This watchman, my friend, is like an auditor in the world of business. His duty is not to own
the house or interfere in the work of family members, but to carefully and honestly check
whether everything is in order.
Now, let’s walk through this “story of the watchman” to deeply understand:
1. Qualities of an Auditor (what makes the watchman trustworthy and effective).
2. Advantages of Auditing for Different Stakeholders (how everyone benefits from his
work — not just the owner, but also the family, neighbours, and even outsiders).
Part 1: Qualities of an Auditor
For someone to play the role of a fair and effective watchman (auditor), certain qualities are
essential. Let’s explore them one by one:
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1. Honesty and Integrity
The most important quality is honesty. Imagine if your watchman secretly helps a thief —
would you ever sleep peacefully? Similarly, an auditor must be truthful and ethical, never
hiding mistakes or joining hands with corrupt managers. Integrity is the foundation of his
profession.
2. Independence
Suppose your watchman always listens to your mischievous cousin who sometimes hides
money in his pockets. Can the watchman be trusted then? No! An auditor must be free from
personal influence. He should not be pressured by managers, directors, or shareholders.
Independence ensures his judgment is unbiased.
3. Professional Knowledge and Competence
A watchman who cannot recognize the difference between a valuable diamond and a piece
of glass is of no use. Similarly, an auditor must have strong knowledge of accounting
principles, auditing standards, and legal requirements. Competence allows him to detect
errors, frauds, and mismanagement effectively.
4. Skepticism and Alertness
A good watchman doesn’t just trust what everyone says — he double-checks. If a worker
says, “I locked the cupboard,” the watchman verifies it. Likewise, an auditor should not
blindly believe the information given by management. He must be alert, question suspicious
entries, and verify evidence before forming an opinion.
5. Patience and Attention to Detail
Auditing involves going through long records, ledgers, vouchers, and statements. Just like a
watchman carefully checks each lock, the auditor must patiently review every entry. Missing
small details can lead to big losses.
6. Confidentiality
A watchman should never gossip about the valuables in your safe. Similarly, auditors often
access sensitive information like profits, trade secrets, or future business strategies. He
must keep everything confidential, disclosing it only when legally required.
7. Communication Skills
After completing his inspection, a watchman must explain clearly what is safe and what is at
risk. If he mumbles or confuses the family, his work loses value. Similarly, an auditor must
present his findings in a clear, structured, and understandable audit report, so that
stakeholders can make decisions.
8. Impartiality and Fair Judgment
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Finally, an auditor must treat all parties equally. He should not favor the management or the
shareholders. His job is to present the truth as it is, even if it is uncomfortable.
So, in short, the auditor is like a watchman with honesty, independence, knowledge,
patience, alertness, confidentiality, and strong communication. These qualities make him
reliable.
Part 2: Advantages of Auditing for Different Stakeholders
Now, let’s shift to the second part: why is this “watchman’s work” (auditing) so valuable,
and to whom?
1. For Owners/Shareholders
In big companies, the owners (shareholders) are usually not managing the business
themselves. They appoint managers, but how do they know whether managers are handling
money honestly?
• Advantage: Auditing assures owners that accounts are true, money is safe, and there
is no fraud.
• It builds trust between owners and managers.
• It also helps them assess the financial health of the business before making
investment decisions.
2. For Management
Managers may feel auditing is like being spied on, but in reality, it helps them too.
• Auditors point out errors or inefficiencies that management may have overlooked.
• Their recommendations improve internal controls and financial discipline.
• This enhances the reputation of managers as reliable leaders.
3. For Employees
Employees also benefit indirectly.
• When auditing ensures financial stability, employees feel secure about their salaries
and bonuses.
• It also increases their trust in the fairness of the organization. For example, if profit-
sharing or incentives are calculated, auditing guarantees transparency.
4. For Creditors and Banks
Suppose you lend money to your neighbor. Wouldn’t you want assurance that he is capable
of returning it? Similarly, banks and creditors look at audited financial statements before
granting loans.
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• Auditing assures them of the company’s creditworthiness.
• It reduces the risk of default.
5. For Government and Tax Authorities
The government relies heavily on company accounts for tax collection.
• Auditing ensures accounts are accurate, preventing tax evasion.
• It also helps in policy-making, as reliable financial data is the backbone of economic
planning.
6. For Investors
New investors hesitate to put money into a business without credible proof of its stability.
• Auditing gives them confidence by verifying profits, assets, and liabilities.
• It reduces the risk of being misled by inflated or false figures.
7. For the Public and Society
Large businesses affect the economy and society at large. Imagine if a company manipulates
figures, declares false profits, and then suddenly collapses — thousands of people could lose
jobs.
• Auditing builds public trust in companies.
• It assures society that organizations are being run transparently and ethically.
A Balanced View: Why Auditing Truly Matters
If we connect back to our watchman story — his presence not only makes the owner
confident but also reassures the family, visitors, neighbors, and even local authorities. The
watchman may not directly generate income, but his honesty and diligence protect
everyone’s interests.
That’s exactly what an auditor does. He is the silent guardian of trust in financial matters.
His qualities ensure that he performs his duties fairly, and his work benefits every
stakeholder — from a small employee to the largest shareholder.
Conclusion
In conclusion, the auditor is much more than a person who “checks accounts.” He is a
protector of truth, a watchdog of honesty, and a bridge of trust between the company and
its stakeholders. His qualities — honesty, independence, knowledge, skepticism, patience,
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confidentiality, and clear communication — make him a professional whose work is
invaluable.
And the advantages of auditing spread far and wide: shareholders gain assurance, managers
gain guidance, employees gain security, creditors gain confidence, governments gain
reliable data, investors gain trust, and society gains transparency.
So, whenever you hear the word auditor, don’t just think of someone with spectacles
flipping through balance sheets. Think of him as the honest watchman of the financial
world, quietly guarding everyone’s interests, ensuring fairness, and keeping the system
healthy.
2. Give the examples of errors which are not revealed by trial balance, and state the steps
an auditor would take to detect these errors.
Ans: Errors Not Revealed by Trial Balance & Auditor’s Steps to Detect Them
Imagine this:
You are the captain of a ship (the business). The ship’s logbook (the trial balance) is neat,
tidy, and balanced. The figures on the left side equal the figures on the right side. At first
glance, it feels like everything is perfect — the ship is sailing smoothly, no leaks, no
imbalance.
But wait. Beneath the surface of this calm ocean, some hidden rocks are waiting. The ship
might still hit them if the captain doesn’t check carefully. That is exactly how errors in
accounting work. A trial balance only tells us whether total debits equal total credits. But
equal totals do not guarantee correct records. Mistakes may still hide inside, invisible to
the naked eye.
And here comes the role of the auditor — the sharp-eyed detective of the financial world.
The auditor’s job is not just to check if the trial balance is matching, but to uncover those
“invisible errors” that quietly sit behind the scenes.
So, let’s dive deeper into these hidden errors first, and then we’ll walk through the auditor’s
toolkit to catch them.
Errors Not Revealed by Trial Balance
Even though a trial balance balances, the following errors may remain undetected:
1. Errors of Omission
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This is like forgetting to invite someone important to a party. Suppose a company paid rent
of ₹5,000, but the accountant completely forgot to record it in the books. Since both debit
and credit entries are missing, the trial balance still looks perfect.
Example: Rent paid but not recorded in cash book or ledger at all.
2. Errors of Commission
These are mistakes in which something is entered, but in the wrong place. Imagine giving
your friend’s gift to the wrong person. For example, instead of debiting “Ram’s account,”
the accountant debits “Shyam’s account.” Totals still balance, but the transaction is wrong.
Example: Cash received from Mr. A wrongly credited to Mr. B’s account.
3. Errors of Principle
These are mistakes in following accounting rules. Think of it like wearing formal shoes to a
cricket match — not illegal, but certainly inappropriate. For instance, if money spent on
buying furniture is wrongly debited to “Repairs” instead of “Furniture,” the books balance,
but the nature of the account is violated.
Example: Treating capital expenditure as revenue expenditure.
4. Compensating Errors
Sometimes, two wrongs do make a right — at least on paper! Suppose one account is
overstated by ₹1,000 and another is understated by ₹1,000. Both mistakes cancel each
other, and the trial balance looks fine, but the truth is hidden.
Example: Sales overstated by ₹500 and purchases also overstated by ₹500.
5. Errors of Duplication
Imagine recording the same cricket score twice. Similarly, if a transaction is entered two
times, the trial balance still tallies. But the business books are misleading.
Example: Salary payment of ₹10,000 recorded twice.
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6. Errors of Wrong Amount in Both Accounts
If the wrong amount is posted equally on both sides, the trial balance will still balance, but
the actual figures are incorrect.
Example: Payment of ₹7,000 recorded as ₹700 in both accounts.
So, these are the “hidden passengers” sitting quietly inside the books of accounts. The trial
balance will smile innocently, but inside, the truth will be twisted.
Steps an Auditor Would Take to Detect These Errors
Now let’s step into the shoes of an auditor. Think of the auditor as Sherlock Holmes, walking
into a case where the “trial balance” says, “Everything is fine.” But Sherlock doesn’t trust
faces; he looks deeper.
Here are the key steps an auditor would take:
1. Thorough Vouching of Transactions
The auditor checks every important transaction with its supporting documents (vouchers,
invoices, bills, receipts).
• If rent payment is missing, the voucher for rent will reveal it.
• If furniture purchase is wrongly shown as repairs, the purchase bill will expose the
truth.
Vouching is like matching the story told in books with the real-world evidence.
2. Ledger Scrutiny
The auditor carefully goes through ledger accounts to see whether entries are recorded in
the right account.
• If money received from Ram is credited to Shyam, the auditor will catch it by
matching entries with supporting documents.
This is like cross-checking the names on wedding cards with the actual guest list.
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3. Analytical Review
The auditor compares figures with past years, industry averages, or logical expectations.
• If “Salary Expense” suddenly doubles without a reason, the auditor gets suspicious.
• If “Furniture” is unusually low but “Repairs” is unusually high, that signals a
misclassification.
Think of it as connecting the dots in a detective puzzle.
4. Confirmation from Third Parties
Auditors don’t just trust the company’s word. They directly confirm balances from debtors,
creditors, and banks.
• If Ram says, “I paid my dues,” but the books wrongly show it under Shyam, this
confirmation will reveal the mistake.
It’s like calling a friend directly instead of relying on gossip.
5. Test Checking & Sampling
Auditors can’t check every single entry in big organizations. So they use sampling — picking
random entries to test. If errors appear, they dig deeper.
• This helps detect duplications, omissions, or compensating errors.
Imagine checking a few apples from a basket to see if the whole lot is fresh.
6. Tracing & Cross-Casting
The auditor traces figures from one book to another — from journal to ledger, from ledger
to trial balance. They also check totals (casting) and cross-totals.
• This ensures no amounts were wrongly carried forward.
It’s like checking a long math problem step by step, not just the final answer.
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7. Observation & Inquiry
Sometimes, numbers don’t tell the whole story. The auditor observes processes, asks
employees questions, and tries to understand how entries are passed. This can reveal if
there’s an error or even fraud.
Just like a teacher asks a student to “explain how they solved a problem” to ensure it’s
correct.
Why This Is Important
Errors not revealed by trial balance may look small, but they can seriously mislead financial
statements. For example:
• If capital expenditure is treated as revenue, profits will look artificially low.
• If transactions are omitted, the financial picture becomes incomplete.
• If compensating errors exist, management may wrongly believe everything is fine.
This is why the auditor’s role is like a safeguard — ensuring the financial “ship” doesn’t hit
hidden rocks.
Conclusion
So, let’s wrap this up like a story.
The trial balance is like a polite student who always dresses neatly and says, “Everything is
fine, sir.” But behind that smile, mistakes may be hiding. Some entries are forgotten, some
are in the wrong place, some are dressed in the wrong outfit, and some are doubled or
cancelled out.
Here enters the auditor, the detective, the truth-seeker. With his magnifying glass of
vouchers, confirmations, scrutiny, and analytical review, he uncovers what the trial balance
tried to hide.
In simple words: A trial balance ensures arithmetic accuracy, but only an auditor ensures
truth and fairness.
That’s why errors not revealed by trial balance are so important to understand — and the
auditor’s steps are the sword and shield that protect the financial health of the business.
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SECTION — B
3. What do you understand by Internal Control? Discuss the need for internal control.
Also, explain the elements of a good internal control system.
Ans: Internal Control – Explained Like a Story
Imagine you are the captain of a large ship sailing across the ocean. The ship is full of
valuable goods, and there are many crew members handling different responsibilities – one
is steering, another is managing the engine, some are looking after food supplies, and others
are guarding the ship. Now, as a captain, you cannot personally keep an eye on every small
task at every moment. But at the same time, you must ensure that the ship moves in the
right direction, no goods are stolen, no mistakes are made, and everyone performs their
duty honestly and carefully.
So, what do you do?
You design a system. A system where responsibilities are clearly divided, rules are set,
checking mechanisms are introduced, and everyone knows that their work might be
reviewed. This way, even when you are not watching, the ship sails smoothly and safely.
This “system of checks, rules, and controls” that the captain builds for the ship is exactly
what Internal Control means for a business.
Meaning of Internal Control
In simple words, Internal Control is the system of rules, procedures, and checks designed
by management to make sure that the organization’s work runs smoothly, assets remain
safe, frauds are prevented, records are accurate, and goals are achieved efficiently.
It is not just about “catching mistakes” or “finding frauds.” It is more about creating an
atmosphere where errors and frauds become very difficult to happen in the first place.
The Institute of Chartered Accountants of India (ICAI) defines internal control as “the plan of
organization and all the methods and measures adopted within a business to safeguard
assets, check the accuracy and reliability of accounting data, promote operational efficiency
and encourage adherence to prescribed managerial policies.”
So, in short:
• Internal Control is preventive (to stop mistakes/frauds),
• It is detective (to find if something goes wrong), and
• It is corrective (to take action and improve).
Need for Internal Control – Why Is It Important?
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Let’s continue with our ship example. Imagine if the captain did not set up any rules or
system. Crew members might become careless, some may misuse resources, food could get
wasted, or worse, some dishonest crew may steal goods. The ship might even lose its route
due to poor coordination. In the same way, in an organization, the absence of internal
control can create serious problems.
Here are the main reasons why internal control is needed:
1. Safeguarding of Assets
Every business owns cash, goods, machinery, furniture, etc. Without internal control,
these can be misused, stolen, or wasted. Controls ensure that assets are used only
for business purposes.
2. Accuracy of Records
Wrong records mean wrong decisions. Internal control makes sure that transactions
are properly authorized, recorded, and reported.
3. Prevention of Errors and Frauds
When responsibilities are divided and work is checked, fraud and errors are less
likely to occur. Even if they occur, they are detected quickly.
4. Efficiency of Operations
Internal control ensures that everyone knows their duty, follows rules, and avoids
duplication of work. This saves time and cost.
5. Compliance with Laws and Policies
Businesses have to follow tax laws, company laws, and internal policies. Internal
control ensures compliance.
6. Reliability of Financial Information
Management, investors, and government all depend on financial statements.
Internal control ensures that these statements are reliable.
7. Building Trust and Confidence
Strong internal controls give confidence to stakeholders that the business is
managed properly.
In short, without internal control, a business is like a ship without navigation – risky,
unsafe, and uncertain.
Elements of a Good Internal Control System
Now, let us look at what makes an internal control system effective. Just like a strong ship
requires good parts – engine, radar, crew discipline, and safety measures – an organization
needs certain elements to build a good internal control system.
Here are the key elements:
1. Clear Organizational Structure
o Everyone should know their role and responsibility.
o Authority and duties must be clearly defined.
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o For example, in a company, cashier handles cash, storekeeper handles
inventory, and accountant records transactions.
2. Segregation of Duties
o No single person should handle a transaction from start to finish.
o Work should be divided so that one person’s work automatically checks
another’s.
o Example: Person who prepares a cheque should not be the same person who
signs it.
3. Proper Authorization of Transactions
o Every important activity must be approved by the right person.
o For instance, payments above a certain amount should require the manager’s
approval.
o This ensures that nothing happens without knowledge of the authority.
4. Documentation and Records
o Proper documents (like vouchers, bills, receipts) should support every
transaction.
o Documents act as proof and help in cross-checking.
o Without documents, frauds can easily be hidden.
5. Safeguards and Physical Controls
o Assets like cash, stock, machinery, and confidential data must be physically
protected.
o Examples: Lockers for cash, CCTV in warehouses, passwords for computers.
6. Independent Checks and Internal Audit
o Regular checking by supervisors, and periodic internal audits, keep everyone
alert.
o Surprise checks are also useful.
o These checks build accountability.
7. Competent and Honest Staff
o Even the best system fails if staff are not honest or capable.
o So, recruitment, training, and ethical culture are important.
8. Evaluation and Improvement
o Internal control is not static. It must be reviewed and improved with time.
o For example, with digital payments rising, cyber-security controls must also
be strengthened.
Putting It All Together – Like a Story
Think again about our ship. The captain ensures that:
• Duties are divided among crew members,
• Each activity is authorized,
• Logs are maintained for everything,
• Treasures are locked safely,
• Random checks are done,
• And only skilled and loyal crew members are hired.
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As a result, the ship sails smoothly, avoids dangers, and reaches its destination safely.
In exactly the same way, internal control in business ensures that:
• Assets are safe,
• Work is efficient,
• Records are accurate,
• Fraud is prevented,
• And objectives are achieved.
Conclusion
Internal Control is not just about rules or restrictions – it is the backbone of good
governance and efficient management. A business without internal control is like driving a
car without brakes, or sailing a ship without direction. It ensures safety, reliability, and
smooth functioning.
The need for internal control arises because organizations handle valuable resources and
deal with numerous transactions daily. Without proper control, errors, frauds, and
inefficiencies can destroy trust and financial stability.
Finally, a good internal control system rests on elements like clear structure, segregation of
duties, authorization, documentation, safeguards, internal audits, competent staff, and
continuous improvement.
So, whenever you hear the word Internal Control, just picture the captain of a ship carefully
designing systems that make sure the ship – or in our case, the business – always stays on
the right course.
4.(i) How does Internal check differ from Internal audit?
(ii) What are the essential characteristics of a good system of Internal check?
Ans: A Story to Begin With
Imagine you are the owner of a small but growing bakery called Sweet Crumbs. At first, you
were the baker, the cashier, and even the cleaner—all in one. Life was simple, but as your
bakery got popular, you hired more people. Now you have someone to handle the cash
counter, someone to bake, someone to manage supplies, and someone to deliver cakes.
With more people working, you realize a danger: What if money is miscounted? What if
flour is stolen? What if bills are misplaced?
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You don’t want your business to sink because of small errors or someone’s dishonesty. So,
you decide to create systems that make your bakery run smoothly, fairly, and honestly.
That’s where two important tools come in:
1. Internal Check – like setting up rules so that no single worker has full control. For
example, the person who takes orders doesn’t handle cash, and the person who
handles cash doesn’t deliver cakes.
2. Internal Audit – like calling in an inspector who occasionally comes and reviews
whether everyone is following the rules properly.
Now let’s dive deeper into these two concepts with this bakery example running alongside.
Part (i) – How does Internal Check differ from Internal Audit?
Although both sound similar, they serve very different purposes. Let’s break it down:
1. Meaning
• Internal Check is a system of dividing work in such a way that no single person is
responsible for an entire process. Each person’s work automatically gets checked by
another.
In the bakery: One person prepares bills, another collects cash, and another
issues receipts. So, errors or fraud become harder.
• Internal Audit is an independent review of the activities and records of a business,
conducted by the internal auditor, to ensure policies are followed and mistakes or
frauds are detected.
In the bakery: An auditor (maybe a trusted senior employee or external expert)
reviews the sales records, stock register, and receipts weekly to see if all is fair and
correct.
2. Nature of Work
• Internal Check is preventive—it aims to stop errors and fraud before they happen.
• Internal Audit is detective—it finds mistakes or frauds after they have already
happened.
In our bakery:
• Internal Check = Setting rules like “two people must sign every supply invoice.”
• Internal Audit = Later, the auditor checks if all invoices actually have two signatures.
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3. Who Does It?
• Internal Check is done by the staff themselves while doing daily work. It’s built into
the workflow.
• Internal Audit is done by a specially appointed person or team (internal auditor) who
is independent of routine work.
4. Timing
• Internal Check happens simultaneously with the work—it is continuous.
• Internal Audit happens afterwards—weekly, monthly, or quarterly.
5. Objective
• Internal Check wants to ensure accuracy and honesty in the first place.
• Internal Audit wants to review and confirm that accuracy and honesty were actually
maintained.
A Simple Table for Clarity
Point of
Difference
Internal Check
Internal Audit
Meaning
Division of work to automatically
check errors
Review of records to detect
mistakes/frauds
Nature
Preventive
Detective
Done by
Staff themselves
Independent auditor
Timing
Continuous, during work
Periodic, after work
Objective
Prevent fraud/errors
Detect fraud/errors
Control level
Part of routine system
Independent verification
So, in short: Internal Check = stop problems before they happen. Internal Audit = find
problems after they happen.
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Part (ii) – Essential Characteristics of a Good System of Internal Check
Now, let’s go back to the bakery story. Suppose you set up an internal check system. If the
system is weak, it won’t work. For example, if the same person who collects cash also
prepares accounts, it’s easy to cheat.
So, what makes a good internal check system? Let’s explore.
1. Proper Division of Work
The foundation of internal check is dividing tasks among employees so no one controls
everything.
In bakery: The person who bakes doesn’t handle cash. The cashier doesn’t order flour.
Each task is separate.
2. Automatic Checking
Work should be arranged so that one employee’s work naturally checks the other’s.
Example: The person who prepares the sales bill isn’t the one who collects cash. The
cashier has to match the bill with the receipt before taking money.
3. Clarity in Duties
Each worker must know exactly what he/she has to do. Confusion leads to loopholes.
Example: If both the cashier and delivery boy think the other is collecting money from
home-deliveries, the customer might not be billed at all.
4. Rotation of Duties
If the same person does the same task forever, they may form bad habits. Rotating duties
reduces this risk.
Example: This week Ravi handles stock, next week Priya does it.
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5. Responsibility and Accountability
Every worker should feel responsible for their task, and if something goes wrong,
accountability should be clear.
Example: If flour is missing, the storekeeper must explain.
6. Supervision
Even with internal checks, supervision by seniors is essential.
Example: The bakery manager occasionally cross-checks bills and receipts.
7. Use of Documents and Records
Proper vouchers, receipts, and registers should support every transaction.
Example: Every purchase of flour has a purchase order, supplier invoice, and receipt
note.
8. Prompt Recording
Transactions should be recorded immediately to avoid manipulation.
Example: When a cake is sold, the bill should be issued right away—not hours later.
9. Limited Authority
No one should have unlimited power. Authority must be defined and restricted.
Example: Only the owner can approve expenses above ₹5,000.
10. Mechanical Devices / Technology
In modern times, using POS machines, barcodes, or software reduces errors and fraud.
Example: A computerized billing system in the bakery automatically updates stock when
a cake is sold.
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11. Co-operation Among Staff
The system works only when staff co-operate. A hostile environment makes people careless
or dishonest.
Example: If the cashier and baker don’t communicate, orders might get lost.
12. Regular Review and Improvement
Business keeps changing, so the internal check system must be reviewed and improved
regularly.
Example: During festival season, more temporary staff may be hired, so rules need
updating.
Wrapping It All Up – A Humanized Summary
Think of Internal Check as a safety net woven into daily work. It ensures that no single
person has unchecked control, reducing the chances of fraud or error.
Think of Internal Audit as a watchdog that comes in later, examines everything, and ensures
that the safety net is intact and effective.
For a good Internal Check system, you need clear division of duties, automatic checking,
proper records, accountability, supervision, rotation, limited authority, and cooperation
among staff.
So, going back to our bakery story—by applying these principles, your bakery Sweet Crumbs
can run smoothly. Customers get their cakes on time, cash balances match every night,
stock is safe, and you can sleep peacefully knowing your system is strong.
And that’s the beauty of understanding internal check and internal audit—not as boring
textbook concepts, but as living practices that keep any organization, big or small, healthy
and trustworthy.
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SECTION — C
5. (i) What are the duties of an auditor in connection with sales & sales returns?
(ii) How would you discover fictitious sales in the course of an audit?
Ans: A Different Beginning: The Auditor’s Detective Story
Imagine you are watching a mystery movie. The hero is not a police officer, not a spy, not
even a lawyer. The hero is… an auditor. Yes, the person who checks the books of accounts in
a company.
Now, in our story, the auditor is like a detective. He doesn’t carry a gun or wear a trench
coat, but he carries something much more powerful: a sharp eye, a questioning mind, and
the skill to uncover the truth hidden behind numbers.
The company he is auditing shows a long list of sales and also many sales returns.
Everything looks neat on the surface, but our auditor knows: “Numbers can lie if people
want them to. My duty is to make sure they speak the truth.”
From here begins the journey into understanding:
1. What exactly are the duties of an auditor when it comes to sales and sales returns?
2. How can the auditor discover if some of these sales are fake, also called fictitious
sales?
Let’s explore this as a story, but also as a deep learning journey.
Part I: Duties of an Auditor in Connection with Sales & Sales Returns
Think of a company as a factory that produces goods and sells them. Sales are the lifeline of
the business. If sales figures are wrong, the entire financial statement becomes misleading.
An auditor’s responsibility here is very much like a traffic police officer managing a busy
junction—he has to make sure every car (sale transaction) is genuine, properly recorded,
and moving in the right direction.
Let’s break down the auditor’s duties one by one:
1. Checking the Internal Controls
Before diving into the sales ledger, an auditor first checks the system of the company:
• How are sales recorded?
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• Is there proper segregation of duties? (For example, the person making invoices
should not be the same person collecting cash.)
• Are there checks to ensure no fake sales slip through?
This is like a detective first studying how the locks and doors of a house work before
checking if something was stolen.
2. Verification of Sales Invoices
Every sale should be supported by a valid invoice. The auditor verifies:
• Date of invoice (Is it within the correct financial year?)
• Name of customer
• Quantity and price of goods sold
• Whether the invoice matches with dispatch records or delivery challans
Example: If the books say 100 chairs were sold to “Mr. X”, but no delivery challan exists,
then it smells like a possible fictitious sale.
3. Cross-checking Sales with Dispatch/Shipping Records
Sales aren’t real unless goods are actually delivered. The auditor compares:
• Sales invoices with goods outward register
• Bills with lorry receipts, courier records, or transport documents
This ensures that sales are not just “on paper” but also in reality.
4. Checking Sales Returns
Sales returns are like the reverse gear in a car. Sometimes customers return goods due to
defects, wrong supply, or other reasons.
The auditor must check:
• Are the returns genuine?
• Is there a proper goods inward note for returned items?
• Is the sales return properly recorded in accounts?
Example: If a company is inflating its sales by recording large sales in March and then
quietly showing sales returns in April, the auditor should catch this trick.
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5. Cut-off Testing
This is a very important duty. Cut-off means checking whether sales recorded at the end of
the year truly belong to that year.
• Sales made after March 31 should not be recorded in that year’s accounts.
• Returns after March 31 should not reduce sales of the previous year.
This prevents manipulation of year-end profits.
6. Checking Credit Sales and Debtors
If sales are made on credit, the auditor ensures:
• The customer really exists.
• The sale is recoverable (not made to a fake or non-existent party).
• Proper debtor records are maintained.
Example: If the company shows ₹10 lakhs of sales to “ABC Traders” but no such firm
exists, that’s a classic fictitious sale.
7. Ensuring Proper Disclosure
The auditor’s job is not only to check but also to ensure transparency. He must confirm that
sales and sales returns are shown properly in the Profit & Loss Account and that net sales
are reported truthfully.
Summary of Auditor’s Duties
In short, the auditor:
• Examines sales invoices, returns, and supporting documents.
• Matches them with dispatch and inward registers.
• Checks the cut-off dates.
• Ensures no fictitious sales or fake returns.
• Confirms proper disclosure in financial statements.
Like a detective, he pieces together the evidence and ensures the sales figures in the books
reflect the real story of the business.
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Part II: How to Discover Fictitious Sales
Now comes the real thriller part of our story. Companies sometimes try to inflate sales to
show higher profits and attract investors, or to get bank loans. These fake entries are called
fictitious sales.
How does our auditor-detective catch them? Let’s see.
1. Checking Supporting Documents
Fictitious sales usually lack strong supporting evidence.
• No delivery challan
• No transport receipt
• No customer acknowledgment
The auditor carefully checks whether every sale has these supporting papers. If missing,
it’s suspicious.
2. Verification with Debtors’ Accounts
The auditor cross-checks sales with debtors.
• Do the debtors actually exist?
• Can we trace their address, phone, or GST number?
• Is the payment being received?
Example: If sales worth ₹5 lakhs are shown to “XYZ Enterprises”, but the address is fake,
the auditor knows it’s fictitious.
3. Sending Confirmations
Auditors often send letters to customers (called debtors’ confirmation letters) asking them
to confirm balances.
• If customers reply “We never purchased these goods,” the fraud is exposed.
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4. Analytical Procedures
The auditor also applies his brain like Sherlock Holmes:
• Are sales unusually high compared to production capacity?
• Are sales suddenly spiking at year-end?
• Is the gross profit margin realistic?
If a company usually makes ₹1 crore sales a year, but suddenly shows ₹5 crore in March
alone, it is a red flag.
5. Checking Cash Sales Carefully
Cash sales are easiest to manipulate because no debtor confirmation is involved. The
auditor checks:
• Cash book entries
• Whether the cash is actually deposited in bank
• If not, it could be fictitious.
6. Tracing Sales Returns
Sometimes fictitious sales are later reversed through sales returns. The auditor compares:
• Sales return records with original sales
• Whether the goods were actually returned
• Whether returns are being misused to hide fake sales
7. Surprise Checks and Enquiries
An auditor may make surprise visits to warehouses or call customers directly. This personal
inquiry often exposes sales that exist only on paper.
Real-Life Style Example
Suppose a furniture company shows sales of ₹50 lakhs in March.
• The auditor checks invoices—okay, invoices exist.
• He checks dispatch records—oops, no trucks moved on those days.
• He calls the “customers”—half of them don’t exist.
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Bingo! The auditor discovers that ₹20 lakhs worth of sales were fictitious, entered only to
make profits look higher.
Wrapping it All Together
An auditor in connection with sales and sales returns is like a guardian of truth in numbers.
His duties include verifying invoices, checking dispatches, confirming returns, testing cut-
offs, and ensuring genuine reporting.
To discover fictitious sales, he uses multiple tools—document checking, debtor
confirmation, analytical review, and sometimes even detective-style inquiries.
Without auditors, companies could easily mislead investors, banks, and even the
government. With auditors, the truth has a much higher chance of shining through.
So, next time you hear the word “audit,” don’t imagine it as a boring activity with endless
papers. Think of it as a mystery investigation where the auditor is the unsung detective,
ensuring that every sale and every return tells the truth.
6. (i) What is the objective of verification of assets? How would you verify the following:
• (a) Goodwill
• (b) Freehold property
• (c) Motor Vehicles
• (d) Trademarks
• (e) Cash-in-hand
Ans: A Fresh Start: The Detective Story of Assets
Imagine you are a detective. Not the kind who solves crimes, but one who solves financial
mysteries. Your client is not a person but a company. This company owns many things—
some visible like buildings and cars, and some invisible like goodwill or trademarks. Your
mission is simple: make sure whatever the company claims to own actually exists, is
properly valued, and truly belongs to them.
This mission, in the world of auditing, is called verification of assets. Just like a detective
confirms whether evidence is real, an auditor confirms whether assets in the balance sheet
are genuine, correctly valued, and still owned by the business.
Objective of Verification of Assets
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Before we jump into the details of each asset, let’s first answer: Why do we verify assets at
all? What’s the objective?
The objectives can be understood by imagining a company presenting its balance sheet like
a résumé. Just like people sometimes exaggerate their achievements on a CV, companies
might also unintentionally (or intentionally) overstate or understate their assets. Verification
ensures that:
1. Existence: The asset is real and not just a number written on paper.
Example: A company shows a car worth ₹10 lakh in its books. The auditor must
ensure the car is actually there.
2. Ownership: The company truly owns the asset and has rights over it.
Example: A building shown in the balance sheet should not secretly belong to the
director personally.
3. Valuation: The asset is recorded at the correct value, neither inflated nor
understated.
Example: Machinery bought for ₹5 lakh should not be shown as ₹15 lakh just to
impress investors.
4. Presentation & Disclosure: Assets must be properly classified and disclosed
according to accounting standards.
Example: Land should not be clubbed under “Plant and Machinery.”
So, in short, verification protects shareholders, investors, creditors, and even the general
public from being misled. It keeps the company honest and transparent.
Now, the Interesting Part: How to Verify Specific Assets
Let’s take the five assets mentioned in your question—Goodwill, Freehold Property, Motor
Vehicles, Trademarks, and Cash-in-hand—and examine how a detective-like auditor verifies
each one.
(a) Verification of Goodwill
Now, goodwill is a very peculiar asset. Unlike land or a car, you can’t touch it, see it, or park
it in a garage. It’s invisible but extremely valuable. Goodwill is basically the reputation of a
business, the trust of its customers, and its brand value.
How do we verify goodwill?
• Purchase vs. Self-generated Goodwill:
o If goodwill is purchased (say Company A buys Company B and pays more than
the net asset value), the auditor should check the purchase agreement to
confirm how the goodwill arose.
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o If goodwill is self-generated, it should not be recorded in the books as per
modern accounting standards, because it’s too subjective.
• Valuation: The auditor checks whether goodwill has been valued properly and
whether any impairment (loss of value) has been recorded, as per accounting rules.
• Disclosure: Goodwill must appear under “Intangible Assets” in the balance sheet
with proper notes.
So, goodwill is verified not by physically checking it, but by examining documents, purchase
agreements, and compliance with accounting standards.
(b) Verification of Freehold Property
Freehold property is something solid and real—like land or buildings owned by the business.
How does an auditor verify it?
• Title Deeds: The first step is to inspect the original title deeds (ownership
documents). This proves that the property truly belongs to the company.
• Valuation: Freehold property is usually shown at cost price, but auditors must also
look at revaluation records if the company follows revaluation methods.
• Physical Inspection: Unlike goodwill, here the auditor can actually visit the site,
check the building, or at least review confirmation reports.
• Charges: Sometimes, companies mortgage their property to banks for loans. The
auditor should ensure that such charges are disclosed in the balance sheet.
In short, the auditor becomes like a land registry officer here—checking papers, ownership,
and whether the property is free from hidden liabilities.
(c) Verification of Motor Vehicles
Motor vehicles, unlike freehold property, are movable and depreciable assets. Cars, trucks,
vans—all come under this.
Steps of verification:
• Registration Certificates: The auditor checks the RC book or registration certificate
issued by the transport authority to confirm ownership.
• Insurance Policies: Vehicles must be insured, so auditors examine insurance
documents as supporting evidence.
• Valuation: Vehicles depreciate quickly. The auditor ensures that proper depreciation
has been charged as per accounting policies.
• Existence: Sometimes, a physical inspection of the vehicles is carried out. The
auditor can even note down the model numbers and verify them against records.
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So, for vehicles, the audit is like checking someone’s driving license, RC, and insurance—
making sure everything is in order.
(d) Verification of Trademarks
Trademarks are again intangible, like goodwill, but they are more legal in nature. A
trademark is a brand’s logo, design, or phrase legally protected from being copied.
How are trademarks verified?
• Registration Certificates: The auditor checks registration certificates issued by the
trademark registry. This proves legal ownership.
• Renewal Status: Trademarks must be renewed periodically. The auditor ensures that
renewals are up to date.
• Valuation: Like goodwill, trademarks may have been purchased at a price. The
auditor ensures they are valued properly and shown under “Intangible Assets.”
• Litigation Check: Sometimes, trademarks are disputed in courts. If so, the auditor
must ensure proper disclosure of pending cases.
Here, the auditor acts like a legal advisor, cross-checking ownership and protection of the
company’s identity.
(e) Verification of Cash-in-hand
Cash-in-hand is the trickiest, because it is highly liquid and prone to fraud or manipulation.
How do auditors verify it?
• Physical Count: On the date of verification, the auditor may conduct a surprise visit
and count the cash physically.
• Cash Book vs. Actual Cash: The auditor compares the cash book balance with actual
cash in the cash box. Any difference must be explained.
• Petty Cash: Even small petty cash amounts should be verified.
• Internal Controls: The auditor checks whether proper controls are in place, like dual
custody or limits on cash holdings.
• Certificates: Sometimes, if cash is lying in branch offices far away, a certificate from
the branch manager may be taken.
Cash is like the most vulnerable player on the field, so it demands extra caution.
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Wrapping Up: The Bigger Picture
If you look at all these examples—goodwill, freehold property, vehicles, trademarks, and
cash—you’ll notice a pattern. The auditor acts like a detective with different strategies
depending on the asset:
• For intangible assets like goodwill and trademarks: rely on documents, agreements,
and legal papers.
• For tangible assets like freehold property and vehicles: check ownership documents,
inspect physically, and verify valuation.
• For cash-in-hand: depend on surprise checks, control systems, and reconciliation.
The overall goal remains the same: make sure the company’s balance sheet tells the truth
and nothing but the truth.
Final
Think of verification as if a company’s balance sheet were a storybook. Every asset is a
character—goodwill is the reputation hero, freehold property is the solid elder, vehicles are
the hardworking workers, trademarks are the stylish brand ambassadors, and cash is the
restless child who needs constant supervision. The auditor’s role is to interview each
character, confirm their identity, and make sure no impostor sneaks into the story.
That way, investors, shareholders, and the public can read the company’s story with trust,
knowing it’s not a fairy tale but a true and honest account.
(ii) How would an auditor vouch for the wages paid to workers?
Ans: The Story of How an Auditor Vouches Wages
Imagine for a moment that you are an auditor, stepping into a large factory where hundreds
of workers are busy on the floor. Machines are whirring, supervisors are walking around
with clipboards, and the accounts department has just handed you a thick bundle of wage
sheets. Your task? To make sure the wages paid to the workers are fair, correct, and
genuine.
This might sound simple at first glance, but if you think deeply, wages are one of the most
sensitive expenses in any business. Why? Because it’s a recurring payment made to a large
number of employees. If there is even a small error or manipulation, it could lead to a huge
loss for the company. For example, if fake workers (called “ghost employees”) are shown on
the payroll, or if someone is overpaid due to carelessness, the company loses money
unnecessarily. That’s why an auditor treats the vouching of wages with great care.
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Let us walk step by step, like a detective on a mission, to understand how an auditor
vouches wages.
Step 1: Understanding the System
The auditor doesn’t just jump into checking numbers. First, he or she must understand how
the organization calculates and pays wages. In most companies, wages are based on two
systems:
1. Time Wages – Workers are paid according to hours or days they work.
2. Piece Wages – Workers are paid based on the number of units or pieces they
produce.
Once the auditor knows the system, it becomes easier to see what kind of records should
exist. For time wages, there should be attendance registers, biometric records, or punch
cards. For piece wages, there should be production records showing how much each worker
has produced.
This first step gives the auditor a map to follow.
Step 2: Checking the Attendance and Work Records
Now imagine the auditor walking into the time office of the factory. There, an attendance
register is kept. In modern companies, it might be a biometric machine showing when each
worker enters and exits. This is a very important record, because wages are usually linked to
attendance.
The auditor checks whether these attendance records are reliable. For example:
• Are there signatures or thumb impressions of workers on the muster roll?
• Are there supervisors’ signatures confirming that the entries are correct?
• If it is a biometric system, is there any chance of manipulation?
By verifying attendance, the auditor ensures that wages are not being paid to “ghost
workers” who never actually worked.
Step 3: Verifying Wage Sheets or Payroll
After attendance, the auditor moves to the wage sheets or payroll register. This is like the
heart of the wage system. It contains the names of workers, their basic pay, overtime,
deductions, and the net amount payable.
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Here, the auditor carefully checks:
• Whether the wage sheets are prepared properly and authorized by responsible
officials.
• If the calculations are correct (for example, total hours × wage rate = gross wages).
• Whether overtime is recorded properly and not exaggerated.
• If statutory deductions (like Provident Fund, ESI, Income Tax, etc.) are made
correctly.
It’s almost like cross-checking a bill at a restaurant. Just as you would ensure that the waiter
hasn’t charged you for extra items you didn’t order, the auditor ensures that no wrong
payments are included in the payroll.
Step 4: Ensuring Proper Authorization
In auditing, authorization is key. The auditor checks whether the wage sheets were signed
and approved by responsible officers—such as the HR manager or the factory manager. This
prevents the possibility of one person secretly adding fake workers or altering figures.
It is similar to how a school requires a principal’s signature on important documents.
Without such authorization, records cannot be trusted fully.
Step 5: Payment Procedure
Now comes the most interesting part: the actual payment of wages. Traditionally, wages
were paid in cash, but nowadays many companies pay directly into bank accounts. Both
methods need careful auditing.
• If wages are paid in cash:
The auditor checks the “Cash Book” to ensure that the total cash withdrawn for
wages matches the wage sheet total. Then, the auditor ensures that workers have
signed or thumb-marked the wage sheet when they received their money. If
signatures are missing, it may indicate fraud or non-payment.
• If wages are paid through bank transfers:
The auditor verifies the bank statements and ensures that the exact amounts shown
in the wage sheet were credited to the correct workers’ accounts. This prevents
cases where money is transferred to wrong or fake accounts.
Step 6: Watching Out for Red Flags
An auditor’s eyes must always be open for suspicious patterns. Some common red flags in
wage payments are:
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• Ghost Workers – Names of workers who don’t actually exist.
• Dummy Overtime – Showing inflated overtime hours to increase wages.
• Double Payments – Paying the same worker twice.
• Unclaimed Wages – If wages remain unclaimed, they should be deposited back, not
pocketed by someone.
The auditor must investigate these issues carefully, almost like a detective solving a mystery.
Step 7: Checking Compliance with Laws
Wages are not just a matter of company policy—they are also governed by laws like the
Minimum Wages Act, Payment of Wages Act, and labor welfare laws. The auditor checks
whether the company is:
• Paying at least the minimum wages prescribed by law.
• Deducting Provident Fund, ESI, and Income Tax properly.
• Following rules for overtime and bonus payments.
By doing this, the auditor ensures that the company is not only accurate in accounts but also
legally compliant.
Step 8: Reporting the Findings
Finally, after all these checks, the auditor prepares his report. If everything is fine, the
auditor expresses satisfaction. If there are irregularities, they are reported to the
management for correction.
This final step is like giving a clean chit—or raising an alarm—depending on what was found.
Why is This Important?
Vouching of wages is one of the most important duties of an auditor because:
1. Wages form a large portion of the company’s expenses.
2. Errors or frauds in wages are very common if controls are weak.
3. Workers’ livelihood depends on fair payment, so accuracy is also a matter of ethics.
By carefully vouching wages, the auditor protects both the company’s resources and the
workers’ rights.
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Wrapping It Up Like a Story
So, to put it all together—picture the auditor as a wise guardian standing at the gates of
fairness. He checks attendance like a teacher taking roll-call, verifies payroll like a cashier
balancing bills, ensures authorization like a principal signing off, and inspects payments like
a detective chasing clues. Every step is meant to answer one simple question:
“Are the wages genuine, fair, and properly recorded?”
If the answer is yes, the auditor’s job is done, and both the company and the workers can
breathe easy. If not, the auditor’s observations help in correcting the system before bigger
losses or legal troubles occur.
In this way, vouching wages is not just a mechanical task of ticking numbers—it is a story of
trust, fairness, and responsibility, where the auditor ensures that every worker gets what he
deserves, and the company spends only what it should.
SECTION — D
7. Describe the provisions of Companies Act, 2013 regarding appointment and
remuneration of the Auditors.
Ans: Appointment and Remuneration of Auditors under Companies Act, 2013
Imagine a company as a big ship sailing in the ocean of business. The captain (Board of
Directors) is busy steering it, the crew (employees) are working hard to keep it moving, and
the passengers (shareholders and investors) are watching their money invested in the
journey. But one important question always remains in the mind of passengers:
“Is the ship safe? Is the captain handling money honestly? Or is there any leakage
happening under the deck?”
Here comes the Auditor – like an independent inspector, not part of the crew, not related to
the captain, but someone officially appointed to check whether the accounts of the
company are true, fair, and reliable.
The Companies Act, 2013, lays down clear provisions about who can be appointed as an
auditor, how they are appointed, how long they stay, how they are paid, and even how they
can be removed. Let’s explore this step by step, almost like reading chapters of a story.
1. Who Can Become an Auditor?
Before we even talk about appointment, the law tells us who is eligible.
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• Only a Chartered Accountant (CA) who holds a valid certificate of practice can be
appointed as an auditor.
• A firm of Chartered Accountants can also be appointed, and any partner in the firm
can act in the name of the firm.
• Certain people are disqualified, such as:
o A body corporate (company) cannot be appointed.
o An officer or employee of the company.
o A person who is a partner or relative of a director or key managerial
personnel.
o Anyone holding securities in the company.
o Anyone who owes money to the company.
The idea is simple: the auditor must be independent, neutral, and free from any conflict of
interest.
2. First Appointment of Auditor
Now, let’s say a new company has just been born. Who will check its first year’s books?
• The Board of Directors has the duty to appoint the first auditor within 30 days of
incorporation.
• If the Board fails, then the shareholders in the general meeting must appoint the
auditor within the next 90 days.
• This first auditor holds office until the conclusion of the first Annual General
Meeting (AGM).
This is like hiring the first inspector for your new ship, making sure everything is correct
before the first voyage ends.
3. Appointment of Subsequent Auditor
After the first AGM, the company must appoint another auditor (or reappoint the same) for
the long term.
• The members of the company (not the directors) appoint the auditor at the AGM.
• The tenure: 5 years (from the end of that AGM until the conclusion of the sixth
AGM).
• But there’s a catch: The appointment must be ratified at every AGM by the
members.
This means shareholders get a chance every year to decide if they still trust the auditor.
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4. Rotation of Auditors (for Big Companies)
Now, imagine if the same inspector stays forever on the same ship. He might get too
friendly with the captain and stop being strict. To avoid this, the Act introduces rotation of
auditors.
• Applicable to listed companies and certain large public/private companies meeting
thresholds (like high paid-up share capital, borrowings, etc.).
• An individual auditor can hold office for a maximum of one term of 5 years.
• An audit firm can hold office for two terms of 5 years each (total 10 years).
• After completing the term, there must be a cooling-off period of 5 years before the
same auditor/firm can be reappointed.
This ensures fresh eyes review the accounts periodically.
5. Casual Vacancy in the Office of Auditor
Life is uncertain. Sometimes, an auditor may resign, die, or be disqualified before
completing his term. This creates a casual vacancy.
• If the vacancy arises for any reason other than resignation, the Board of Directors
can fill it within 30 days.
• If the vacancy is due to resignation, then the Board must first approve it, but the
appointment of a new auditor requires approval of shareholders in a general
meeting within 3 months.
This ensures that the company is never left without an auditor.
6. Remuneration of Auditor
Now comes the practical question – who pays the inspector?
• The remuneration of the auditor is decided by the shareholders in the general
meeting or in a manner they authorize.
• In the case of the first auditor appointed by the Board, the Board decides the
remuneration.
• Remuneration includes not just salary/fees, but also expenses incurred in the course
of audit work.
But remember: even though the company pays, the auditor’s duty is to shareholders and
the law, not to directors.
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7. Removal, Resignation, and Special Cases
The Act also provides checks on how an auditor may leave or be removed.
• Removal before expiry of term:
o The company must take approval of the Central Government, pass a special
resolution in the general meeting, and follow due process.
• Resignation:
o The auditor must file a statement of reasons with the Registrar and the
company.
• Special powers of Tribunal:
o If the auditor acts fraudulently, the Tribunal may even order his removal and
declare him ineligible for reappointment for 5 years.
This ensures accountability and prevents misuse of the auditor’s position.
8. Auditor’s Report and Duty
Appointment and payment are important, but the real essence lies in the auditor’s report.
• The auditor examines books, vouchers, and financial statements.
• He must state whether they give a “true and fair view” of the company’s affairs.
• He reports to shareholders, not to directors.
• If he finds fraud, he must immediately inform the Central Government.
So, in a way, the auditor is like the “whistleblower” of corporate India.
9. Why Such Provisions?
You might wonder – why does the law go into so much detail? The answer is simple:
• Shareholders are scattered and cannot check accounts themselves.
• Directors manage the company, but sometimes they may mismanage or hide facts.
• An independent auditor creates trust and transparency, which is essential for
smooth running of business and protection of public money.
Conclusion
The Companies Act, 2013 weaves a very balanced framework for appointment and
remuneration of auditors. From eligibility to first appointment, from rotation to resignation,
from fixing fees to filing reports – every step is carefully crafted to keep auditors
independent, accountable, and fair.
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So, if we look back at our story of the ship, the auditor is not part of the crew, nor the
captain, but the trusted inspector who assures passengers that the ship is seaworthy, the
accounts are honest, and their investment is safe.
That’s why, in corporate governance, auditors are often called the “watchdogs of
shareholders”. They don’t run the company, but they make sure it runs honestly.
8.(i) Discuss the civil liability of an auditor under Companies Act, 2013.
(ii) Explain the various types of Audit Report.
Ans: Part I: Civil Liability of an Auditor under Companies Act, 2013
The Beginning: Who is an Auditor?
Imagine a company as a giant ship sailing in the ocean of business. The owners
(shareholders) can’t be on the ship every day, so they appoint a captain (the Board of
Directors) to steer it. But how will the owners know if the captain is being honest about the
cargo, the fuel, and the direction of the ship?
That’s where the auditor comes in. The auditor is like a trusted inspector, appointed not by
the captain but by the owners, to check whether the captain’s logbook (financial
statements) truly reflects the condition of the ship.
So, an auditor’s job is trust-based. He doesn’t run the ship, but he makes sure the records
are genuine and free from tricks.
Now the Twist: What if the Auditor Fails?
Suppose the auditor becomes careless or worse—joins hands with the captain to hide the
truth. The ship may look perfect on paper, but in reality, it might be sinking. When the
owners later discover the fraud, the first person they’ll question is the auditor.
This is where civil liability comes into play.
Meaning of Civil Liability
Civil liability simply means that if the auditor’s negligence, misrepresentation, or misconduct
causes loss to someone (shareholders, creditors, company, or government), then he can be
sued in a civil court and made to pay compensation.
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It is not about punishment or jail (that’s criminal liability), but about making good the loss
suffered by others.
Provisions under the Companies Act, 2013
The Companies Act, 2013 lays down clear rules about auditor’s responsibilities and the
consequences of failing them:
1. Section 143(12) – If an auditor discovers fraud but does not report it, he is guilty of
professional misconduct.
2. Section 147(2) – If an auditor contravenes provisions of Sections 139 (appointment),
143 (duties), 144 (services not to be rendered), or 145 (signing of reports), then he is
liable to pay a penalty.
o For an individual auditor: fine of ₹25,000 to ₹5,00,000.
o For an audit firm: fine of ₹1,00,000 to ₹25,00,000.
3. Section 147(3) – If the auditor knowingly or recklessly makes a false statement in his
report, he must refund the remuneration received and also pay damages to the
company, shareholders, or creditors.
4. Civil suits for damages – Apart from the Act, anyone who suffers loss because of
auditor’s negligence can file a case in civil court to recover damages.
Cases that Illustrate Civil Liability
• London and General Bank Case (1895) – The auditor certified accounts showing
good profits even though huge bad debts existed. Shareholders suffered losses. The
court held the auditor negligent and liable for damages.
• Kingston Cotton Mills Case (1896) – The court said, “An auditor is a watchdog, not a
bloodhound.” This means he need not be suspicious all the time but must exercise
reasonable care and skill. If he fails, he will be held liable.
To Whom is the Auditor Liable?
• To the Company: for losses due to his negligence.
• To Shareholders: because they rely on his report for investment decisions.
• To Creditors: since banks and lenders depend on audited statements before giving
loans.
• To Government: for incorrect tax filings or fraudulent disclosures.
So, the auditor’s civil liability is broad, covering anyone who suffers financial harm because
of his work.
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In Simple Words:
Civil liability is like saying, “If you break someone’s trust and they suffer a loss, you must fix it
by compensating them.”
Part II: Types of Audit Reports
The Opening: Why Audit Reports?
Now imagine you are a shareholder sitting far away. You cannot meet the company’s
managers daily or peek into their books. The only thing you truly rely on is the audit
report—the auditor’s signed statement that tells you whether the financial statements are
reliable.
Think of the audit report as the verdict after a long investigation. Just like a judge’s decision
tells whether someone is guilty or innocent, the audit report tells whether the company’s
financial statements are true and fair.
But here’s the fun part: audit reports are not all the same. Depending on what the auditor
finds, the report can wear different colors.
Types of Audit Reports
1. Unqualified Report (Clean Report)
o This is the dream report every company wants.
o It means the auditor found everything in order: accounts are properly
maintained, rules are followed, and financial statements give a true and fair
view.
o Example: Like a doctor saying, “You are perfectly healthy.”
2. Qualified Report
o Here, the auditor generally agrees with the accounts but points out a specific
issue that isn’t right.
o For example, the company didn’t follow a particular accounting standard or
didn’t value inventory correctly.
o It’s like a doctor saying, “You are healthy, but you need to cut down on
sugar.”
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3. Adverse Report (Negative Report)
o This is the worst kind of report for a company.
o It means the auditor believes the financial statements do not present a true
and fair view at all.
o Example: Like a doctor saying, “You are seriously ill, and your health report is
unreliable.”
o Such a report can shake investor confidence and crash the company’s
reputation.
4. Disclaimer of Opinion
o Sometimes, the auditor feels he cannot give an opinion at all. Why? Because
he didn’t get enough evidence or records were missing.
o Example: Like a doctor saying, “I cannot diagnose you because the test results
are incomplete.”
o This shows the auditor is honest enough not to sign blindly.
5. Modified Report
o This is a broader term that includes qualified, adverse, and disclaimer
reports.
o Whenever the auditor modifies (changes) his clean report to highlight an
issue, it falls under modified reports.
Why are These Reports Important?
• For Shareholders: to make investment decisions.
• For Creditors: to decide whether to lend money.
• For Government: to ensure compliance with tax and company law.
• For Management: to identify weaknesses and improve operations.
Example to Make it Clear
Suppose you want to invest in a company. You open its annual report and see an
“Unqualified Report.” You feel safe.
But if you see a “Qualified” or “Adverse” Report, you’ll think twice. This is why audit reports
are like a signal light:
• Green = Go (Unqualified)
• Yellow = Caution (Qualified)
• Red = Stop (Adverse)
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• No Light = Confusion (Disclaimer)
The Bigger Picture
If we tie both parts together, it looks like this:
• Civil liability of an auditor is about what happens when he fails in his duty and
causes harm.
• Types of audit reports are about the different ways he communicates his findings
when he does his duty properly.
One side is about accountability, the other side is about communication.
Conclusion (Story Wrap-Up)
Think of the auditor as a bridge of trust between a company and its stakeholders.
• If he builds this bridge carefully, people can safely cross and rely on the company’s
financial statements.
• But if he builds it carelessly, the bridge may collapse—and then he must rebuild it at
his own cost (civil liability).
On the other hand, his audit report is like the traffic signal guiding people on whether to
proceed with confidence, proceed with caution, or stop completely.
So, the Companies Act, 2013 ensures that auditors remain responsible (through civil
liability) and transparent (through audit reports).
And as future professionals, students, or exam candidates, we must remember that the
auditor’s role is not just about numbers—it’s about trust, honesty, and responsibility.
“This paper has been carefully prepared for educational purposes. If you notice any mistakes or
have suggestions, feel free to share your feedback.”
