Auditing

Auditing Definition: Auditing is the independent and systematic examination of financial books, vouchers, records, and statements of an enterprise by an authorized independent professional (auditor) to ascertain whether they present a true and fair view of its financial position and operating results.

Primary Objective: To determine and report whether the financial statements exhibit a true and fair view of the state of affairs of the business at the close of the financial period and of its profit or loss for that period, in accordance with applicable financial reporting frameworks.

Distinction between Error and Fraud:

1. Intent: An error is an unintentional mistake in financial information (e.g. arithmetic slip, accidental omission), whereas fraud is an intentional deception to gain an unfair or illegal advantage.
2. Concealment: Errors are usually transparent and self-revealing through reconciliation, while frauds involve deliberate concealment, falsification, and management override.

Concept: An Audit Programme is a detailed, written schedule of audit procedures and verification steps to be followed by the audit team during the course of examination.

Two Benefits:

1. It provides clear distribution of work among audit assistants based on capability.
2. It fixes responsibility and tracks the progress of the audit against deadlines.

Concept: Audit working papers are confidential documents, records, schedules, and memos collected and retained by the auditor during the conduct of the audit. They serve as primary evidence supporting the auditor’s opinion and proof that the audit was conducted in accordance with Nepal Standards on Auditing (NSA).

Concept: Internal Check is a system of internal allocation of duties and routine accounting procedures whereby the work of one employee is independently and automatically checked by another employee in the ordinary course of business, preventing fraud and errors without duplication of effort.

Explanation: Vouching is the foundational verification of transactions with authentic documentary evidence (vouchers). If the voucher is authentic, properly authorized, correctly dated, and accurately ledgered, the entire financial accounting pyramid rests on solid factual grounds. Thus, without thorough vouching, no true and fair opinion can be formed.

Distinction:

1. Capital Expenditure: Incurred to acquire long-term fixed assets or enhance their earning capacity; benefits extend over multiple financial years (shown on Balance Sheet).
2. Revenue Expenditure: Incurred for routine day-to-day operations to maintain earning capacity; benefits expire within the current financial year (debited to Income Statement).

Concept: Verification of assets is the process by which the auditor satisfies himself about the existence, ownership, possession, title, valuation, and freedom from encumbrances of the assets appearing in the balance sheet as of the closing date.

Statutory Qualifications: Under the Nepal Companies Act, 2063, an auditor of a limited company must be a Chartered Accountant (CA) or a Registered Auditor (RA) holding a valid Certificate of Practice (COP) issued by the Institute of Chartered Accountants of Nepal (ICAN).

Concept: An Unqualified Report (Clean Report) is issued when the auditor concludes that the financial statements present a true and fair view in all material respects, all accounting standards and statutory regulations have been observed, and there are no material misstatements or scope limitations.

1. Advantages of Auditing:

• Reliability for Stakeholders: Investors, lenders, and creditors place confidence in audited financial statements.
• Detection & Prevention of Fraud/Errors: Regular audit acts as a psychological deterrent against employee embezzlement.
• Tax Assessment: Government tax authorities (IRD) accept audited statements for corporate tax assessment.
• Loan Processing: Commercial banks require audited statements before sanctioning working capital or term loans.
• Settlement of Disputes: Useful for settling insurance claims, partnership disputes, or merger valuations.

2. Inherent Limitations of Auditing:

• Use of Testing & Sampling: Auditor applies test checks rather than examining 100% of transactions.
• Inherent Limitations of Internal Control: Management collusion or override can bypass controls.
• Reliance on Estimates: Many accounting entries (depreciation, provisions) are subjective management estimates.
• Fraud Concealment: Cleverly concealed frauds involving forged documents are difficult to uncover.
• Audit Opinion is Not a Guarantee: The audit report provides reasonable assurance, not an absolute guarantee of company viability.

Essential Qualities of an Auditor:

1. Professional Competence: Complete mastery of financial accounting, taxation, company law, cost accounting, and Nepal Standards on Auditing (NSA).
2. Integrity and Objectivity: Must be completely honest, uninfluenced by external pressure, and objective in assessing facts.
3. Independence: Mental and financial independence from the client enterprise to avoid conflicts of interest.
4. Professional Skepticism: Approaching audit evidence with a questioning mind, alert to conditions indicating possible misstatement.
5. Tact and Discretion: Ability to deal with client staff courteously without compromising audit firmness.
6. Confidentiality: Maintaining absolute secrecy regarding client business affairs unless required by law.
7. Reporting Skills: Clarity in writing audit reports with unambiguous language.

1. Concept of Internal Control: Internal Control comprises the whole system of financial and non-financial controls established by management to carry on the business orderly, safeguard assets, ensure accuracy of records, and promote operational efficiency.

2. Evaluation Process by Auditor:

• Narrative Record: Written description of the client’s internal control procedures.
• Checklists & Flowcharts: Graphical representation of transaction flow from initiation to financial ledgering.
• Internal Control Questionnaire (ICQ): Comprehensive series of structured questions answered by department heads.
• Walk-Through Tests: Tracing representative transactions through every operational and accounting phase.
• Compliance Tests (Tests of Controls): Checking sample vouchers to confirm controls operated effectively throughout the year.
• Letter of Weakness (Management Letter): Reporting identified control deficiencies and recommendations to management.

1. Vouching Cash Receipts:

• Cash Sales: Compare carbon copies of cash memos with daily cash summary and deposit slips in the bank statement.
• Collections from Debtors: Examine counterfoils of official receipts, check discount allowed against credit policy, verify bank deposits.
• Income from Investments: Verify dividend counterfoils, interest warrants, bank credit advices.
• Sale of Fixed Assets: Examine board minutes authorizing sale, sale agreements, auction records, bank credit entries.

2. Vouching Cash Payments:

• Payment to Creditors: Match payments against supplier original invoices, statements of account, and stamped payment receipts.
• Payment of Wages/Salaries: Inspect approved payroll sheets, clock cards, biometric attendance, tax deduction (TDS) receipts.
• Capital Expenditure: Examine title deeds, architect certificates, machinery purchase invoices, board authorization.
• Revenue Expenses: Check supporting bills, authorization by responsible officer, compliance with budget.

1. Rights of an Auditor (Companies Act 2063):

• Right of Access to Books: Right to inspect all books of accounts, vouchers, registers, and documents at all times.
• Right to Obtain Information: Right to require explanation and information from directors, managers, and officers.
• Right to Visit Branch Offices: Right to examine branch accounts and obtain branch audit reports.
• Right to Attend General Meetings: Right to receive notices of and attend annual general meetings (AGMs) and be heard on audit matters.
• Right to Remuneration: Right to receive statutory remuneration fixed by the appointing authority.

2. Statutory Duties of an Auditor:

• Duty to Report: Duty to prepare and submit an audit report to shareholders on accounts examined.
• Duty of Truth & Fairness: Duty to state whether balance sheet and profit & loss exhibit a true and fair view.
• Duty to Inquire: Inquire whether loans/advances are secured, transactions adhere to company interest, personal expenses are debited.
• Duty to Comply with Auditing Standards: Ensure compliance with Nepal Standards on Auditing (NSA).
• Duty to Report Irregularities: Promptly report illegalities, misappropriation, or company losses to directors and regulatory bodies.

Key Differences:

1. Nature: An Audit Report expresses an opinion on whether financial statements show a true and fair view. An Audit Certificate confirms absolute facts (e.g. circulation of a newspaper, export turnover).
2. Basis: A report is based on test checks, sample estimates, and professional judgment. A certificate is based on 100% verification of specific data.
3. Guarantee: A report provides reasonable assurance, not a guarantee. A certificate guarantees the complete accuracy of certified figures.
4. Responsibility: In a report, the auditor is liable only for professional negligence. In a certificate, the auditor is strictly liable for any inaccurate statement.

1. Concept of Verification: Verification goes beyond vouching to ensure that assets and liabilities shown in the Balance Sheet actually exist, belong to the enterprise, are free from undisclosed charges, and are properly valued per accounting standards.

2. Verification Procedures:

(a) Freehold Land and Buildings:

• Examine title deeds, purchase contracts, and conveyance deeds to confirm legal ownership in the company name.
• Check whether the property is mortgaged by obtaining an encumbrance certificate from the Land Revenue Office (Malpot Karyalaya).
• Verify that land is shown at historical cost (not depreciated) and buildings are depreciated systematically.
• Inspect the physical existence or obtain management representation for remote sites.

(b) Sundry Debtors:

• Check ledger balances with sales ledger control accounts.
• Send direct balance confirmation requests (positive/negative) to sample debtors.
• Review aged debtors analysis to assess debts overdue beyond credit periods.
• Verify adequacy of Provision for Doubtful Debts in compliance with NAS/NFRS.
• Examine post-balance-sheet cash collections to confirm recoverability.

(c) Trade Creditors:

• Reconcile individual creditor ledger balances with monthly supplier statements.
• Inspect purchases made immediately before and after year-end to verify cut-off procedures.
• Send external confirmations to major suppliers.
• Check payments made in the subsequent period to identify unrecorded liabilities.

1. Concept of Divisible Profit: Divisible Profit is that portion of the net profit of an enterprise which can legally and prudently be distributed to shareholders as dividends without impairing the capital or solvency of the company.

2. Principles Governing Dividend Payment:

• No Dividend out of Capital: Capital must remain intact to protect creditors; dividends must strictly be paid out of accumulated revenue profits.
• Depreciation Provision: Current and accumulated arrears of depreciation on fixed assets must be provided for before declaring dividends.
• Writing Off Past Losses: Past accumulated losses must be set off against current earnings before declaring dividends.
• Transfer to Reserves: Mandatory statutory transfer to general reserves where required by law or articles.

3. Provisions under Nepal Companies Act, 2063:

• Dividends can be declared only on the recommendation of the Board of Directors and approved by shareholders in AGM.
• Dividends must be paid within 45 days of declaration to registered shareholders.
• Unclaimed dividends must be transferred to the Investor Protection Fund after statutory period (5 years).
• Interim dividends can be declared by directors if authorized by Articles of Association.

1. Constitutional Position: Under Part 22, Articles 240 and 241 of the Constitution of Nepal, the Auditor General is an independent constitutional authority appointed by the President on the recommendation of the Constitutional Council.

2. Scope of Government Audit: Auditor General audits the accounts of: Office of President, Vice-President, Supreme Court, Federal Parliament, Provincial Assemblies, Ministries, Constitutional Bodies, Nepal Army, Police, Armed Police, Courts, Provincial Governments, Local Levels, and Public Enterprises (majority government ownership).

3. Key Functions & Audit Methodology:

• Audits Regularity, Economy, Efficiency, Effectiveness, and Propriety (Panch-Shila audit criteria).
• Inspects all financial transactions, revenue receipts, expenditures, stores, and development contracts.
• Submits an Annual Audit Report directly to the President (for Federal level) and Provincial Governors (for Provinces), which is tabled in Parliament.

4. Role of Public Accounts Committee (PAC):

• The Parliamentary PAC reviews the Auditor General’s annual report in detail.
• PAC summons ministry secretaries, project directors, and accounting officers to answer for audit irregularities (Beruju).
• PAC issues directives to recover misappropriated funds, regularize expenditures, and initiate Anti-Corruption (CIAA) actions.