PROVIDENT FUND AUDIT

A PRESENTATION ON:

By: Muhammad Yasir ShaikhFaruq Ali & CompanyChartered Accountants

WHAT IS PROVIDENT FUND AND WHY A COMPANY CREATES IT?

WHAT? Provident Fund(PF) is a kind of retirement benefit given from the

Company to its employees. It consists of a fix monthly amount deducted from employee’s salary

and a matching amount contributed by the employer. The PF is treated as a separate entity and it earns its profits through

investment of contribution in various saving schemes.WHY? The Income Tax Ordinance permits companies to have a recognized*

PF into which both employer and employee contribute and proceeds are invested and return on it are distributed to employees at the end of the Year.

Income Tax Ordinance also allows the contributions by employee to a recognized PF as an expense in their profit.

Income earned by a recognized PF is also exempt from tax.

A recognized PF means it is registered with SECP under Income Tax Ordinance, 2001.

Loan

Repayment

MEMBERS’ FUND

INVESTMENTS

e.g. TFCs, DSCs etc.

COMPANYMEMBERS Permanent

Withdrawal

Mem

bers’

Contri

butio

n

Full n Final Settlement

Investment

PurchasedReturn On

Investment

Compa

ny’s

Contri

butio

n

Investment on

Maturity

OUTGOING MEMBERS

EXPENSESBan

k Cha

rges

WHT on

Inco

me

A BRIEF OVERVIEW OF TRANSACTIONS IN A PROVIDENT FUND

BASIC ASPECTS OF PROVIDENT FUND

PF is created by making a Trust Deed, which acts as a Memorandum of Association for the PF, defining relationship with outsiders.

Usually, the CEO and CFO of a company are assigned as trustees along with additional ones as representatives of employees. Number of trustees is governed PF Rules as there is no limit by Law.

The internal workings of a PF is governed by ‘Provident Fund Rules’. They are the collection of regulations under which the fund is recognized.

The Board of Trustees of a PF is responsible for the operation of its activities, observation of PF rules, financial record-keeping, presentation of annual accounts and appointment of auditors.

PROVIDENT FUND ORGANOGRAM

PROVIDENT FUND EMPLOYER COMPANY

Trustee Trustee

Treasurer

Clerical Staff

Clerical Staff

Trustee

There is no limit to the number of Trustees in a

Provident Fund

RELEVANT TERMS AND DEFINITIONS

Provident Fund: A fund in which subscriptions of employees are received and held in their individual accounts and includes their contributions and interest on such contributions under the rules of the Fund .

Members: Employees who are part of the Provident Fund and therefore a particular amount is deducted from their salary.

Contribution: Any amount credited into a provident fund by any authority administering the fund i.e. Trustee or PF management. It’s the same amount of two types: Member’s Contribution (deducted from the Member’s Salary) Company’s Contribution (contributed by the Employer)

Dependent: In case of death of any member of the PF, the people who can claim his/her PF balance includes spouse, parent, child, minor brother, unmarried sister and a deceased son’s widow and child, and, where no parent of the subscriber or depositor is alive, a paternal grand-parent.

Definitions are taken from Provident Fund Act 1925 and are simplified for understanding.

LEGAL ASPECTS OF PROVIDENT FUND

The company who created Provident Fund trust cannot use its balance other than the payment on termination of a member’s contract of employment as per section 227*.

As per Section 227, the company creating the Provident Fund is responsible to deposit the contribution(deducted from the salaries of its employees) into a separate bank account(opened in the name of PF) within 15 days of the next month.

Companies usually create a trust with respect to Provident Fund. Therefore, subsection (3) of the Section 227 puts the responsibility of depositing the contribution on Trustees if company fails to do so.

Section 227 also mentions the schemes and securities in which Provident Fund balance can be invested but SRO 80/2014 now governs the rules of investment in detail.

*The Companies Ordinance 1984.

LEGAL RULES REGARDING INVESTMENT

SRO 80/2014 issued by SECP laid down the rules regarding investment of Provident Fund. Key points are summarized in the table below :

Investment Type Limit Of Investment Other Criteria

Investment scheme i.e. mutual funds

>70% of the PF balance

Listed securities i.e. shares, debentures, mutual fund units

>30% of the PF balance •Operation record for last 3 years.•ROI* = +50 basis points

Listed securities > 50 Million or more than 20% of PF balance

Same as above •Hire an investment advisor for Provident Fund.

Listed debt securities i.e. debentures

Same as above •Company must be rated “AA” by a registered credit rating firm.

Listed Collective Investment Scheme

Same as above •ROI equal or more than the prevailing risk free rate

In a particular company in the form of shares and debentures

> 10% of PF balance •Shares < 5% of paid up capital.•Debentures < 5% of the issue.

LEGAL RULES REGARDING INVESTMENT

Investment can not be made in a listed security if issuer of the security has defaulted or rescheduled any of his financial obligations.

PF must maintain investment policies explaining Investment limit, investment avenues and risk appetite.

Investment Type Limit Of Investmen

t

Other Criteria

Investment in associated companies and undertakings

Less than 10% of PF balance.

Collective investment scheme other than money market

10% of PF balance.

Collective money market investment scheme

30% of PF balance.

Investment in Initial Public Offer (IPO)

5% of PF balance (every

six month)

1. In a single IPO, investment must be lower of :• 1% of paid up capital of that company• 2% of PF balance.2. Shall be made in companies having a

profitable record of at least 3 years3. Must not be underwritten, co-underwritten or

sub-underwritten by group or associated companies.

SUMMARY OF ACCOUNTING POLICY RELATED TO PROVIDENT FUND

IAS 26(Employee Retirement Benefit Plans) governs the measurement and disclosure principles for the reports of retirement benefit plans.

Statement of net assets available for benefit, showing: Assets at the end of the period Basis of valuation Details of any single investment exceeding 5% of net assets or 5% of any category of investment Details of investment in the employer Liabilities other than the actuarial present value of plan benefits

Statement of changes in net assets available for benefits, showing: Employer contributions Employee contributions Investment income Other income Benefits paid Administrative expenses Other expenses Income taxes Profit or loss on disposal of investments Changes in fair value of investments Transfers to/from other plans

Description of Fund policyGeneral Provident Fund Policy in the form of Provident Fund Rules registered through SECP.

Other details about the planAny other details found material to the Provident Fund Accounts.

Summary of significant accounting policiesSummary of accounting policies just like presented in annual audits of various entities.

Description of the fund plan and of the effect of any changes in the fund plan during the periodAny significant change in the policy from the previous years which has a material effect on the Provident Fund.

SUMMARY OF ACCOUNTING POLICY RELATED TO PROVIDENT FUND

DISCLOSURE REQUIREMENTS AS PER COMPANIES ORDINANCE 1984

The Clause 4 of Part III of The Fifth Schedule of the Companies Ordinance 1984 governs the disclosure requirement of Provident Fund Accounts. Its states as follows:

i. In the case of provident fund/provident fund trust:a. Disclosure with regards to provident fund/trust:

i. size of the fund/trust;ii. cost of the investment made;iii. percentage of the investments made; andiv. fair value of investments.

b. Break-up of investment (in terms of amount and percentage of the size of the fund/trust) in categories as provided in section 227 of the ordinance and rules formulated for this purpose.

c. A statement that investments out of provident fund/trust have been made in accordance with the provisions of section 227 of the companies ordinance and the rules formulated for this purpose.

AN EXAMPLE OF PROVIDENT FUND ACCOUNTS

AN EXAMPLE OF PROVIDENT FUND ACCOUNTS

APPROACH TO PROVIDENT FUND AUDIT

As you have seen that Provident Fund Accounts are some what different than annual accounts of a company. So a confusion arises as to how to start audit procedures on PF. Here is a solution:1. Cash & Bank2. Receivables from company3. Investments4. Return On Investment(ROI5. Members’ Account6. Payables7. Expenses

This order is not mandatory and you can audit in any way that suits you best.

CASH AND BANK BALANCES

Ask if any Bank A/c is closed or opened during the year or any other changes happened related to this particular head. After enquiry, send bank confirmations to all the bank accounts of PF.

Obtain Cash and Bank Ledgers Bank Statement Cash and Bank Receipt and payment vouchers

Match balance of bank ledger with that of bank statement. If they do not match, ask for reconciliation.

Scan Ledgers to make sure there are no unexplained entries. BPVs and BRVs have been recorded into proper accounts and are adequately

authorized and supported. All transactions done in this head are not beyond applicable rules and

regulations. Cheques deposited to the Bank after reporting date have been cleared

subsequently. Unpresented cheques have been encashed. Bank charges occurring in the period have been recorded properly.

RECIEVABLES FROM COMPANY

Make sure employer maintain a separate account of PF in its books. This account is a mirror image* of ‘Receivable from Company’ account of PF. Obtain the ledger of that account from employer.

Match both balances and prepare a reconciliation if necessary and locate the reasons for differences.

Check clearance of cut off cheques.

INVESTMENTS

Classify investments under three categories namely: Investments held for trading: Held to get profit from short term fluctuation in

prices. Any surplus(deficit) is directly taken into P&L. Investment available for sale: Held for indefinite period but may be sold to

resolve liquidity. Surplus(deficit) is shown separately below Members’ Fund. Investments held till maturity: Held till maturity with positive intent.

Re-measurement of Investments to be done properly. All returns on investments have been recorded and reflected properly. Verify investments physically(DSCs) or obtain CDC Statement(TFCs,

Shares). Compute its Fair Value on the basis of investment schedule by using

period rates mentioned thereon. Check out for proper disclosures and classification in books of accounts. In case of shares, obtain ledger from broker and match it with that of

client. Check all sale and purchase transactions and make sure all transactions are routed through control account.

INCOME ON INVESTMENTS

Income on SSC, DSC, TFC is recognized on accrual basis(part of which is taken into Accrued Income), so do your own calculations of income on these instruments with the help of schedules provided, then match with client’s working.

Dividend is often recognized on receipt basis. Make sure its recognized on accrual basis to avoid over/under statement of income.

MEMBERS’ FUND

Obtain monthly contribution sheets of all the members and check it thoroughly: Make sure every member’s contribution is rightly posted in his account. Check for similar names and compare their contributions. Reconcile Payroll with contribution sheets and obtain reasons for all differences. Compare Bank amounts and contribution amounts and document all reasons

pertaining to differences. If possible, make a comprehensive sheet including opening balances,

monthly contributions, closing balances, withdrawals, settlements and profit distributions. It takes time to make one, but it saves you from checking all above mentioned items again and again for a particular query.

Verify permanent withdrawals and full and final settlements. Check settlement evidence and reasons for permanent withdrawals.

Verify weighted allocation of profit to all members.

PAYABLES & EXPENSES

Just like ordinary audit I guess!

LAST TIPS

Don’t feel down if you get a PF audit. Its often the best way to learn workings about investments and other areas you seldom touch in annual audit of other entities.

TEACH OTHERS WHAT YOU LEARN