Company Audit –Schedule III, CARO,

Accounting and Auditing Standards

By:CA. Kamal Garg

[B. Com (H), FCA, DISA (ICAI)][Insolvency Professional]

Disclosure Requirements under Schedule III for AS Compliant Companies

Interest payable to MSME – whether provision

for interest payable required

• Liability of buyer to make payment – agreed date elsebefore the appointed day – provided that period agreedcannot exceed 45 days from acceptance day [S. 15];

• Date from which and rate at which interest is payable –if buyer fails to make payment u/s 15 - the buyer shall,“notwithstanding anything contained in any agreementbetween the buyer and the supplier or in any law forthe time being in force” – liable to pay compound interestp.m. at 3 times the bank rate [S. 16];

• Requirement to specify unpaid amount with interest inthe annual statement of accounts – S. 22 (MSMED Act)as well as Schedule III (Companies Act)

Cash and Cash Equivalents

• Deposits with original maturity of three months or lessonly should be classified as cash equivalents;

• Bank balances held as margin money or security againstborrowings are neither in the nature of demand deposits,nor readily available for use by the company, andaccordingly, do not meet the aforesaid definition of cashequivalents;

• Under Schedule III – Cash and Cash Equivalents alsocomprise of:“Balances with banks held as margin money orsecurity against borrowings, guarantees, etc. andbank deposits with more than 12 months maturity.”

Cash and Cash Equivalents

• Question: How to deal with this apparent conflict between therequirements of the Schedule III and the AS with respect to whichitems should form part of Cash and cash equivalents

• Answer:1) AS would prevail over the Schedule III;2) Company to make necessary modifications in the F.S.;3) Accordingly, the conflict should be resolved by changing the

caption “Cash and Cash Equivalents” to “Cash and BankBalances,” which may have two sub-headings:a) “Cash and Cash Equivalents” andb) “Other Bank Balances.”

4) The former should include only the items that constitute Cashand cash equivalents defined in accordance with AS 3 (andnot the Schedule III), while the remaining line-items may beincluded under the latter heading

Dividends• The Schedule III, requires proposed dividend to be

disclosed in the notes. Does this mean that proposeddividend is not required to be provided for when applyingthe Schedule III

• The Old Schedule VI of 1956 Act specifically requiredproposed dividend to be disclosed under the head“Provisions.” In the Schedule III of 2013 Act, this needs to bedisclosed in the notes;

• AS-4 (Revised) requires that if dividends are declared afterthe balance sheet date but before the financial statementsare approved for issue, the dividends are not recognisedas a liability at the balance sheet date because noobligation exists at that time unless a statute requiresotherwise. Such dividends are disclosed in the notes.

KGMA

Secured Loans• How should we disclose the nature of security in

respect of long term borrowings

• Schedule III also stipulates that the nature of security shall

be specified separately in each case;

• The words "shall be specified separately in each case"

means that the disclosure of security must be made for

each category of borrowing;

• A blanket disclosure of security covering all loans

classified under the same head such as ‘all Term Loans

from Banks’ will not suffice

• It also covers the type of asset given as security e.g.

inventories, plant and machinery, land and building, etc.

KGMA

Default in repayment of loans• How should we comply the Note 6(c)(vii) of Schedule III

requirement that under the head “Borrowings,” period and

amount of “continuing default” (in case of long-term

borrowing) and “default” (in case of short-term borrowing)

as on the Balance Sheet date in repayment of loans and

interest shall be specified separately in each case.

• The word “loan” has been used in a more general

understanding;

• Hence, the disclosures relating to default should be made for

all items listed under the category of borrowings such as

bonds/ debentures, deposits, deferred payment liabilities,

finance lease obligations, etc. and not only to items classified

as “loans” such as term loans, or loans and advances ,etc.

KGMA

• A company need not disclose information for defaults other

than repayment of loan and interest, e.g., compliance with

debt covenants;

• The Schedule III requires specific disclosures only for default in

repayment of loans and interest and not for other defaults;

• Though two different terms, viz., continuing default (in case of

long term borrowing) and default (in case of short-term

borrowing) have been used, the requirement should be taken to

disclose default “as on the balance sheet date” in both the

cases;

• Any default that had occurred during the year and was

subsequently made good before the end of the year does

not need to be disclosed.

KGMA

Property, Plant and Equipment –AS 10 (Revised) and Schedule III

On 1.4.2018, X Limited acquired a machine for Rs. 50 lakhs. Thedown payment is 20% and balance shall be paid over 5 equalannual instalments. Incremental borrowing rate is 11%. Find outthe cost of machine.

Acquisition cost = PV of cash flows @ 11% = Rs. 39.57

Year Cash Flows

PVF PV FinanceCost

Creditors

0 10 1 10.00 0 29.57

1 8 0.9009 7.21 3.25 24.82

2 8 0.8116 6.49 2.73 19.55

3 8 0.7312 5.85 2.15 13.70

4 8 0.6587 5.27 1.51 7.21

5 8 0.5935 4.75 0.79 0.00

50.00 39.57 10.43

The finance cost shall be recognised over the period of deferred credit

Date Particulars Dr. Cr.

1.4.2018 PPE – Machine A/c Dr. 39.57

To Trade Payables A/c 29.57

To Bank A/c 10.00

31.3.2019 Finance Costs A/c Dr. 3.25

To Trade Payables A/c 3.25

31.3.2019 Trade Payables A/c Dr. 8.00

To Bank A/c 8.00

Illustrative list of disclosures required under

the Companies Act 2013

• Section 69 - Transfer of certain sums to CRR account when

company buys back the shares;

• Section 129 - Financial Statements – the company shall disclose

the deviation from the accounting standards, the reasons for

such deviation and the financial effects, if any;

• Section 131 - Voluntary revision of financial statements - the

detailed reasons for revision of such F.S. shall be disclosed;

• Section 182 - political contributions - disclose in its profit and

loss account;

• Section 186 - Loan and investment by company - disclose to

the members in the F.S. full particulars and purpose of the loans

given, investment made or guarantee given or security provided

Certain Matters to be looked into by the Auditors

Certain Matters

• Tally Software permissibility under the Co. Act, 2013;

• Cash Flow Statement in Form GSTR 9C – how to getaudited statement when its not applicable on the dealer;

• Reporting about ICoFR – whether mandatory in all cases;

• Consolidation of Section 8 Co. – considerations thereof;

• Consolidation of Associates and JVs in the absence ofsubsidiary – considerations thereof;

• Key Audit Matter – precautionary documentation;

• Information in Directors’ Report different fromInformation in Auditors’ Report – considerations thereof;

Certify that

Cash Flow

Statement

Books of account, etc.,

to be kept by company [Section 128]

• The books of account and other relevant books and papers

shall be retained completely in the format in which they were

originally generated, sent or received, or in a format which shall

present accurately the information generated, sent or received and

the information contained in the electronic records shall

remain complete and unaltered – Rule 3(2) of Companies

(Accounts) Rules, 2014.

Certain Matters

• For the companies which are doing interim periodreporting – how to assess whether an employee benefit isshort term or long term;

• Advance Tax Audit Fees – implications as a statutoryauditor and tax auditor;

• Difference of opinion in between partners during anaudit – considerations thereof;

• Communication with previous auditor – no reply frompredecessor – whether its in nature of NOC;

• Letter head of the auditor – mentioning ISO Certified Firm/Names of Other Firms;

frequency of an enterprise's reporting should not affect the measurement of its annual results –

Para 27 and 28

Certain Matters

• Obtaining audit evidence and written representations –whether mandatory under the Companies Act, 2013;

• CARO, 2016 was applicable in preceding year but notapplicable in the current year – still reporting underCARO, 2016 was made – whether any implications;

• Attendance at AGM by auditor – whether mandatory;

• Preceding year’s report was Qualified – what to do in thecurrent year;

• Share application money – considerations while reportingunder CARO, 2016;

• Non-current investments vs. Long-term investments –any distinction

Certain Matters

• Auditor has mentioned his membership number “F” is

prefixed to Auditor’s Report;

• Opening paragraphs of the Auditors Report states to have

“examined the attached Balance Sheet….”;

• Report was not addressed to anyone;

• Membership Number of auditor was only mentioned in

Audit Report – what about CARO, Balance Sheet, Statement

of Profit and Loss

Certain Matters under CARO

• None of the fixed assets have been revalued during the year;

• In our opinion and according to the information and explanations

given to us, the Company has not defaulted in repayment of dues

to financial institutions or banks;

• “The management has conducted physical verification of the

fixed assets during the year and we are informed that

discrepancies noticed were not material”;

• “Programme of physical verification is reasonable, though all the

assets not verified. Management is in process of identifying

discrepancies, if any, on such verification.”

• “The company has maintained proper records of inventory. No

material discrepancies were noticed on physical verification of

inventory except as recorded by excise department as per note….”;

Certain Matters under CARO

• “(a) The parties to whom loans have been given by the company are

repaying the principal amounts as stipulated and interest thereon

wherever applicable;

(d) In case of overdue amounts exceeding Rs.1 Lakh reasonable

steps have been taken by the company for recovery of principal

amount and interest thereon and necessary provisions have been

made wherever such amounts appear to be doubtful of recovery”;

• “The company is regular in depositing undisputed statutory dues

including provident fund, investor education and protection fund,

employee state insurance, income tax, sales tax, wealth tax, custom

duty, excise duty, Cess and other statutory dues with the appropriate

authorities. Late deposit if any has been attached in the Form

3CD attached.”

Certain Matters under CARO

• “According to the information and explanations given to us,

no fraud on or by the company has been noticed or

reported during the course of our audit”;

• Physical verification of the fixed assets is covered under

a scheme of verification over a period of three years. No

serious discrepancy was noticed on such verification during

the period.”

Certain Issues observed or opined by ICAI

Issue 1: Inventory

While preparing its financial statements and while framingits accounting policies, Company ‘X’, has used thefollowing words:

'Inventories are valued using weighted average costmethod or specific identification method as applicable'.

Whether the accounting policy has been disclosed properly.

Issue 2: Commission and Cash Discount

A company is engaged in the business of manufacturing and sale ofpharmaceuticals. For marketing it generally involves a distributor (sayagent) or a stockiest.

The agent will get commission (various percentages) based oncollection period (various period buckets). The sooner the collection, themore the commission percentage.

The company also provides cash discount to its customers. The earlierthe payment, more the cash discount.

Commission and cash discount shall be payable upon realization ofsale proceeds.

The accounting policy of the company is to make provision forcommission/ cash discount when the revenue is booked.

The present obligation in respect of commission and cashdiscount to agents and customers, respectively, arises onlyupon realization of sale proceeds. Hence, the correctaccounting policy is to recognize liability for commission andcash discount once sale proceeds are realized. There is noneed to create a provision for cash discount and thecommission when revenue is booked - EAC opinion Query 5Volume 23

Issue 3: Revenue Recognition

An entity has stated in its financial statement that revenue has beenrecognized in accordance with AS 9. Whether the disclosure is inaccordance with AS.

No. The entity should separately disclose the accounting policy fordifferent type of incomes as explained in AS 9 i.e. sales, royalty,dividend and interest. In case of other type of incomes, anexplanation pertaining to method of recognizing revenues shouldbe explained in its accounting policies - AS 9 – Para 14 and AS 1 –Para 23

Issue 4: Inventories valued and certified by Management

• "as taken, as valued and certified by the management"

An auditor has mentioned in Auditor's Report in respect of inventories as follows:

Whether an auditor can use these words in his report?

No. As per Guidance on Inventories Audit, use of words "as valued

and certified by the management" in the Auditor's Report may result in

belief that the auditor has relied on the valuation and certification of

management without performing any other audit procedure to verify

valuation and existence of inventories. So, such words indicate

existence of disclaimer for inventories.

Therefore, an auditor should avoid usage of words "as valued and

certified by the management" in the Auditor's Report - January 2010

edition of "A Study on Compliance of Financial Reporting

Requirements" issued by ICAI

Issue 5: Revaluation of Inventory

In the books of a leading real estate developer (say "X"), thereare residential complexes which are constructed but not sold atthe end of financial year. X has shown them as inventory. For thepurpose of valuation of inventory of residential complexes, it hasrevalued cost of land on which those complexes are constructed.Ultimately, X has revalued cost of inventory of complexes.

Whether, inventory valuation policy of X is correct or not?

There is no provision is given under AS 2, "Valuation of Inventories" to

revalue cost of items of inventory. As well, as per AS 2, inventories should

be valued at the lower of cost and net realisable value. Therefore, in

respect of both aspects inventory valuation policy followed by X is not

correct.

Issue 6: Cash Flow Statement

In the cash flow statement an entity has categorised its cashflows during a particular period into four categories, which are,Cash flow from Operating Activities, Cash flow From InvestingActivities, Cash Flow from Financing Activities and Cash flowfrom Other Activities.

Whether the entity has categorised its cash flows correctly as per AS 3, Cash Flow Statements?

Issue 7: Provision for Bad Doubtful Debts

• "Provision for doubtful debts, if any, would be made at the appropriate time."

A company (X Ltd.) has disclosed in the financial statement its accounting policy in respect of creation of provision for doubtful debts as follows:

Whether above accounting policy regarding provision is appropriate?

As per Para 16(b) of AS 4, "Contingencies and Events Occurring After

the Balance Sheet Date" in respect of a contingency, the

uncertainties which may affect the future outcome should be

disclosed in the financial statement.

So, an entity should disclose the event or time when provision for

contingency of non-recoverability of debts should be made. In the

given case, X Ltd. has disclosed that "Provision for doubtful debts, if

any, would be made at the appropriate time". It should disclose the

event or time when provision would be made. Thus, accounting policy

disclosed by X Ltd. is contrary to AS 4.

Issue 8: Cheques in Hand

A company is engaged in the business of setting-up hydro-power plant, generating and selling hydro-power. Thecompany receives revenue and govt. support throughcheques.

As per the company's current accounting policy, as at theyear-ending 31 March 20X1, cheques/ drafts in handreceived on or before 15th April 20X1 are accounted for as'cheques-in-hand' for the year ending 31 March 20X1(irrespective of whether such cheque or draft is dated 31March or before).

According to paragraph 49 of the "Framework for the preparation and

presentation of financial statements" as issued by ICAI, an asset is a

"resource controlled by the enterprise as a result of past events from

which economic benefits are expected to flow to the enterprise".

Hence, cheques in hand to be considered as assets as on the

Balance Sheet date should be in possession and control of the

company in such a way that these can be used based on

company's directive.

Therefore, the company's policy of treating such cheque/ drafts which

are received after 31 March 20x1 but dated on or before 15 April

20X1 as 'cheques-in-hand' is not correct. Such cheques should be

accounted in the subsequent period accordingly - EAC opinion Query

15 Volume 24

Issue 9: Tax paid pursuant to demand

A company (Y Ltd.) is engaged in the business of providing works contract service. Few days back, it had received a notice from tax authority raising a demand of tax on works contract services provided by it of Rs. XXXX.

Y Ltd. paid this demand and in the books such payment is being recorded as extra ordinary expenditure.

Whether payment of tax demand raised by the taxation authority can recognise as extra ordinary item?

As per Para 4.2 of AS 5, "Net Profit or Loss for the Period, Prior

Period Items and Changes in Accounting Policies" –

“extraordinary items are income or expenses that arise from

events or transactions that are clearly distinct from the ordinary

activities of the enterprise and, therefore, are not expected to

recur frequently or regularly”

In the given case, providing works contract service is ordinary activity

of Y Ltd. Thus, tax paid either pursuant to the demand raised by the

tax authority or otherwise in this connection is also a part of ordinary

activity of Y Ltd.

Recognising such payments as extra ordinary item is contrary to Para

4.2 of AS 5 - January 2010 edition of "A Study on Compliance of

Financial Reporting Requirements" issued by ICAI

Issue 10: Interest u/s 234B and 234C

Short payment of advance tax installments invites levy ofinterest under sections 234B and 234C of the Income Tax Act.The company has following questions in regard to theclassification of interest levied u/s 234B and 234C of the IncomeTax Act:

Should the company classify interest u/s 234B and 234C astax expense in the financial statements

Is such interest an 'extraordinary item' in accordance withAS 5

Issue 10: Forex Gain

A company (A Ltd.) has prepared its financial statements. Inthe financial statement, foreign exchange gain on salestransactions (like gain on subsequent recognition of closingforeign debtors) have included in sales revenue. But otherexchange gains have disclosed as other income.

Whether above treatment of foreign exchange gains is correct

As per Para 4.1 of AS 9, "Revenue Recognition", Revenue is thegross inflow of cash, receivables or other consideration arising in thecourse of the ordinary activities of an enterprise from the sale ofgoods, from the rendering of services, and from the use by others ofenterprise resources yielding interest, royalties and dividends.Further Para 13 of AS 11 provides that exchange differences arisingon settlement of monetary items or on subsequent recognition ofmonetary items at the end of the accounting period should berecognised as income or expense.From Para 4.1 of AS 9 and Para 13 of AS 11, A Ltd. is correct intreatment of exchange gains other than exchange gains on salestransactions. Exchange gains on sales transactions should not beincluded in sales revenue, it should be included in other income

Issue 11: Tax paid u/s 56(2)(viia)

During the current year, company Y has acquired 100% shareholding ofcompany X. Y has made the transaction at an agreed per share priceand, accordingly, made the payment to other shareholders. The pershare price paid by Y is less than the per share fair value of X.

As per the current provisions of section 56(2)(viia) of the Income-taxAct, 1961 in case consideration paid is less than fair value thendifference is to be deemed as income of the company. Accordingly,company Y has certain deemed income which is taxable as 'otherincome'. As per Y, this tax expense is incurred solely due to thetransaction.

Whether taxes paid would form part of cost ofinvestment; if not then what should be the treatment ofsuch tax expense.

As per AS 13 investment includes acquisition charges

which are incurred on acquisition of shares.

In the current case, profit (deemed income) itself is a result of

acquisition and is not an element without which the transaction

could not have happened. Taxes on such profit cannot be

considered as acquisition related costs so it will not form part

of cost of investment.

Hence, it cannot be capitalized.

Y should charge such tax to statement of profit and loss in the

year in which it is incurred.

Issue 12: Related Party Disclosures

A company (C Ltd.) entered into transactions with various relatedparties including key management personnel and their relatives. Inthe financial statement the company has disclosed thesetransactions by dividing related parties into three categories, i.e.,'key management personnel (KMP), 'relatives of KMP' and 'otherrelated parties'.

Whether related party transactions have been properly disclosed?

As per Para 23 of AS 18, "Related Party Transactions“, if there

have been transactions with related parties, during the

existence of a related party relationship, the entity should

disclose a description of the relationship between the

parties.

In the instant case, C Ltd. has disclosed description of

relationship only in case of transactions with KMP and their

relatives, but has not disclosed the type of relationship in case

of transactions with other related parties.

Therefore, related party transactions in this case have not

been properly disclosed.

Issue 13: Leasehold and Freehold Properties

The company following its past practices has shown leasehold and freehold buildings under the sub-head 'Buildings' under head 'Fixed assets'. The company has not sub-classified 'buildings' into 'freehold' and 'leasehold'.

Whether there is any statutory requirement as per the Companies Act, 2013 to show buildings as leasehold and freehold separately

Issue 14: Earning Per Share

A company (company Z) has prepared its financial statements forthe year ended March 31, 20XX. During the year April 1, 20XX toMarch 31, 20XX, Company Z has issued new equity shares. Thecompany has computed Basic Earnings Per Share (BEPS) bydividing the net profit for the period attributable to the equityshareholders by number of equity shares outstanding at the end ofthe year.

Whether Company Z has computed BEPS correctly

Para 15 of Accounting Standard 20, "Earnings Per Share", requires

that BEPS should be calculated by dividing net profit for the

period attributable to the equity shareholders by weighted

average number of equity shares outstanding during the period.

From the above Para 15 of AS 20, an entity should use weighted

average number of equity shares outstanding during the period. It

can't use number of equity shares outstanding either at the beginning

or at the end of the year, except when there is no increase/

decrease in equity share capital during the period.

Referring to above, in the instant case Company Z has not computed

BEPS correctly.

Issue 15: Revenue recognition for destination

based contracts

A company is engaged in the manufacture of goods (such as networksolutions, mobile equipments, etc.) used in telecom industry. Sale of goodsgenerally happens via applying and winning tenders. From revenuerecognition standpoint, significant portion of sale is destination basedcontracts. The company generally uses Railway as carrier mode. Thecompany has adopted following policy to recognize revenue:

"Revenue from sale of goods/other sale of goods is recognized when thegoods are dispatched from company's premises. From revenue recognitionstandpoint, sales for destination based contracts and sales made near periodend are recognized within the period if the entity reasonably expects thatgoods shall reach destination within or before the period end. Further, salesis also recognized for goods ready for dispatch but kept in company'spremises due to customer's specific request."

Issue 15: Revenue recognition for destination

based contracts

The company states that the above policy "….reasonably expects that goodsshall reach destination within or before the period end …" but it is creating apractical difficulty since excise duty and/or sales tax has to be paid once thegoods move out, however sales sometimes, is not recognized because goodsmay not have reached destination. This is causing problems with otherregulatory departments.

Question 1: Whether the accounting policy is correct and if yes, how thecompany should assess reasonable expectation that goods would havereached the destination?

Question 2: Whether in case of destination based contracts, sale can berecognized by the company based on the dispatch of materials to carrier?

In accordance with AS 9, revenue should be recognized at the time

of transfer of significant risks and rewards and after fulfilling other

conditions as laid out in AS 9. Thus, the Revenue should be recognized

as soon as the significant risk and rewards of ownership of goods have

been passed on to the buyer and other conditions as stipulated in AS 9

are satisfied. The company has to assess the transfer of significant

risks and reward based on facts, circumstances, contractual terms with

consumers, who will bear the loss in case goods are lost in transit etc.

The date of dispatch of goods to carrier has to be assessed in light of

the transfer of significant risks and rewards.

Note: The above suggested treatment is for accounting purposes only

and does not address the perspective from excise duty/sales tax.

Issue 16: Disclosure for Impairment Testing

In the F.S, a company has not disclosed any information toindicate that it has conducted any impairment test of itsassets during the financial year. Is it correct?

No. As per Para 6 of AS 28, "Impairment of Assets“, an entity shouldassess at each balance sheet date whether there is any indicationthat an asset may be impaired. So, an entity should disclose eitherits accounting policy in respect of impairment of assets or whetherthe entity has conducted impairment test during the financial year. I

Issue 17: Disclosure about EPS

A Company (C Ltd.) has disclosed Earnings Per Share (EPS) on the faceof Statement of profit or loss, but omitted to disclose any otherinformation related to EPS as required by AS 20. Is it correct?

• basic and diluted EPS excluding extraordinary items (net of tax expense)

• the amounts used as the numerators in calculating basic and diluted earnings per share

• a reconciliation of those amounts to the net profit or loss for the period

• the weighted average number of equity shares used as the denominator

• a reconciliation of these denominators to each other

• the nominal value of shares along with the earnings per share figures.

Specimen Key Audit Matter Paragraph Reporting

Practical

Considerations

Control design

Personnel interviews

Historical comparisons

Benchmarking assumptions

Sensitivity analysis

Assessing transparency

Tests of details

Specimen Other Information Paragraph Reporting

Auditor’s Liabilities under various Statutes

Nature of Liabilities

civil liability for

negligence or misfeasance

criminal liability

liability arising from

professional misconduct

liability for unaudited statements

• authorised the issue of prospectusas an expert and such prospectuscontained misstatements – Section35 of Companies Act, 2013

Civil liability for negligence or misfeasance

• prospectus includes any statement which isuntrue or misleading in form or context in which it isincluded or where any inclusion or omission of anymatter is likely to mislead – Section 34;

• auditor’s duties non compliance of the Sections139, 143, 144 and 145 – Section 147;

• punishment of fine and imprisonment for an offenceof fraud – Section 447;

• deliberate act of commission or omission in thebalance sheet, report, certificate, return etc. –Section 448;

• punishment for false evidence – Section 449

Criminal liability under Co. Act, 2013

• issuing or signing false certificate –Section 197;

• falsification of books, papers,valuable security or account – Section447A

Criminal liability under IPC, 1860

• Falsification of books of account or document,etc. – Section 277A;

• abetment to make a false statement or declaration -rigorous imprisonment and fine, for giving falseinformation in the Return prepared by him in hisrepresentative capacity or where false report orstatement is furnished on the basis of his examinationof client’s records – Section 278 read with Rule 12A

Criminal liability under Income Tax Act, 1961