For Private Circulation Only • January 2012 • Vol 6 Issue 1
S U B S TA N C E OV E R F O R M
Society of Auditors
Chennai Inside this Issue... •
From the desk of the President
From the Edit Pad
Income Tax in India — In the sands of time
Income Tax Timeline in India
Audit Process: Sample Selection
Recent Judicial Decisions Reported
Messages for Auditor
FROM THE DESK OF PRESIDENT Dear Member, Greetings and Best Wishes for a Happy, Prosperous and Healthy 2012. When the editor called me up and asked for the President's message, I had a doubt whether I should call myself as the First of the executants of the job that is expected of the Society and therefore take the opportunity of putting forth an agenda or just be a figure head and give a formal communication. Soon enough I got the clarity and decided that I would prefer the former and therefore expect every one of our members to have the same level of commitment to keep the Society's flag at a high pedestal and on the rise. That I would strive to make ourselves more resolved and committed to do something to this premier Institution. If there is an official view, there should be an alternative view. Only then, the problems facing the profession in its entirety can be well understood. We hear from various sources about the steps taken to control the profession, especially its functioning in certain administrative matters which make us to ponder whether the correct view has been projected to the powers that matter. This means all of us should be involved and that forums like ours will have to play important roles. Hence, I would only request you through these columns to be active with the Society matters and air your views which will be democratically considered and acted upon. As we have many forums of similar nature, you may think what is that we are going to do differently. “Think Big and Think Differently” is what people call the mantra for success. So in th this 80 Year, let us put our heads together and as true professionals set aside our individuality and collectively make this organization bigger and stronger to face the challenges of the future. I may not correspond through these columns in the near future as the Editor takes over with full liberty and responsibility to see through the magazine. I wish you express your views/concerns with reference to Society to me through voice/mail and whatever can be done democratically will be done. Let us pull this wonderful Chariot together to achieve Greater heights. With Regards, P. Anand
A periodical from Society of Auditors Chennai CA P S Prabhakar, Editor Society of Auditors “Platinum Chambers” 33, TNHB Complex, 4, Luz Church Road, Mylapore, Chennai - 600 004. Phone : 044-2498 6979 E-mail : firstname.lastname@example.org email@example.com
CA B Ramanakumar CA Mahesh Krishnan CA Subramania Sarma CA P Anand, President, Ex-officio Member CA R Sivakumar, Vice President, Ex-officio Member CA S Ramakrishnan, Vice President, Ex-officio Member CA B K Moorthy, Secretrary, Ex-officio Member
The views and opinions expressed by the authors / contributors are their own and may not be in agreement with that of the Society’s.
AUDITOR • January 2012
FROM THE EDIT PAD
AUDITOR, which was discontinued after almost
discuss in open. Third, the costs of running an
5 years of running, has now taken a re-birth.
audit office are escalating what with the ICAI
The Society’s new team headed by Mr P. Anand
constantly meddling with the education and
has decided not only to give the magazine a
training pattern of the students and clients
fresh lease of life but also to revitalise it. The
reluctant to pay right fee for the services.
responsibility of editorship has once again
Lastly, the regulator of the profession viz., ICAI
fallen on my shoulders and I am taking it as a
remaining hardly infallible with most of the
pleasurable encroachment on my time!
council members merrily carrying on their
When this newsletter or journal (as I would like to call it) was started, I had written in my editorial that it will not be a 'yet another pious, non-controversial, feel-good publication' among the plethora of professional publications and had meant it to be somewhat different. It
private agenda and remembering other members only in election years. The journal will keep a tab on such disturbing happenings and voice its criticism, without fear or favour. The nicer activities (if any) will get unfiltered appreciation (Sigh!).
was also made clear that “there will be no
The journal will have place for opinionated and
dearth of informative journalism, hard facts,
generic articles on matters of importance. For
poignant issues, satire & sarcasm,
example, it was at the request of the editor,
of ecstasy and dismay, words of caution and
two articles one on the journey of the income
advice, manifestations of dreams and visions,
tax legislation from pre-1922 versions to the
news & matters of professional interest and so
proposed DTC and another on the views of our
on”. The good and bad news of this revival is
sister institution ICWAI on the perceived
that we are not planning to swerve from the
'kolaveri' of ICAI on the proposal for the name
said avowed objectives. The look might be
change by renowned members appear in this
different but not the feel.
issue. There will be some regular columns on
There are so many things happening around us, the 'middle class and upper middle class' professionals (forming the chunk of the membership of the Society). First, there is a
“interesting judicial decisions” and happenings “elsewhere”. I am also proposing to have some interviews from celebrities from our profession in due course.
constant pressure on us to keep travelling the
We are planning to put the e-version of the
learning curve. What with accounting standards
journal in the Society's website, about a week
to IFRS to Ind AS or the new Schedule VI or the
later than the printed version gets circulated.
new Companies Bill or the proposed DTC or the
The usual disclaimer that the writers' views are
XBRL monster………..the buck seems to never
their own and may not necessarily reflect the
stop. Second, on the professional opportunities
editor's or of the Society's is a permanent one!
- Bank branch audits are getting dearer and
I will put my best foot forward to connect with
threaten to get extinct, Central statutory
you regularly through this journal. Do write in
audits of banks are obtained by means that
with your views to enable us to shape this
everybody knows how but nobody wants to
journal better and better in the days to come.
AUDITOR • January 2012
Renaming ICWAI The name of an organisation is what it represents. The name of person does not change in her life time unless under some numerological or other social compulsions.. But that of an organisation changes as it evolves to reflect the new environment and the evolutionary process it undergoes. We have seen the changes get reflected in many organisations in India. The metamorphosis of Confederation of Indian Industry from a root Confederation of Engineering industry is a classic example. We see the reflection of the new realities in the change in the name of federal states or even countries. The Ministry of Corporate Affairs, very appropriately recommended the name of The Institute of Cost and Works Accountants of India be changed to The Institute of Cost and Management Accountants of India, when they introduced the Bill No. XXVI of 2010. The Ministry which introduced the name change through the Bill itself had undergone a transformation in name from Company Affairs to Corporate Affairs. Such changes reflect what the entity wants to profess or it stands for. The International Federation of Accountants (IFAC) does not classify the world of accountants into Management Accountants and Chartered Accountants. Instead it looks at Pr o f e s s i o n a l A c c o u n t a n t s i n Pr a c t i c e a n d Pr o f e s s i o n a l accountants in Business (PAIB). The overall description is professional Accountant. Now, what title a professional accountant in a particular context is dependant upon the specialisation the professional accounting organisation seeks to build in its accounting education. The title is reflective of that. IFAC clearly recognises that in its strategy documents. For example , the members of CIPFA UK go through an accounting education process which is heavily oriented with Government/ Public Sector requirements. It is a renowned global practice to title the competencies represented by the cost and management accounting as a CMA and those specializing in the field of financial accounting as a C PA o r a C A ( p a r a 1 3 4 o f I FA C d o c u m e n t o n establishing a professional accountancy organization). Both Cost & Management Accounting and Financial Accounting have different goals/purposes, different tools/techniques, different tasks & services, different rules of measurement & reporting, different focus/emphasis, different time span and behavioral implications. Therefore, under no stretch of imagination, Cost & Management Accounting and Financial Accounting can be combined as one 4
A.N. Raman, Past President, SAFA discipline and thus, the titles 'CA' and 'CMA' have distinct meaning and connotations. The tag profession(al) comes to any subject only when that body of knowledge assumes that scale that requires extensive focus and study. Thus when a person belongs to or identifies himself with a profession advocated by an assessing body the following roles and responsibilities of that body is of paramount importance; • The body of knowledge has been so structured for education and training so that deeper nuances and skills are built. • The professional entity itself constantly researches and repositions the body of knowledge with its material findings. For example the depth of research to be done by a dental education institute on dental domain which will be much deeper than a general medical college doing research on the same area. • The professional entity becomes a public figure in expressing certain public opinions regarding that field of knowledge. • Updates its members with emerging horizons on the subject so that the skills are constantly honed. Keeping the above background in mind consider that the cost and management accounting (CMA) subject is entering into a new and exciting phase in the Indian economy. We need humongous levels of capacity building in CMA as the conventional knowledge practiced by the business in this field was more relevant to a controlled economy and not to a globally competing economy. CMA refers to a field for sustainable way of managing business by providing the relevant information internally for decision making. The DNA of such information can emanate only from a cost accounting orientation. This is because a cost accounting orientation takes into account the business strategy, the processes, and the organizational structure where as these are not parts of the financial accounting. In furtherance of specialization in Cost and Management Accounting and the need for aligning with the global framework, the ICWAI restructured its syllabus by defining the competency framework of CMA by establishing four pillars of knowledge such as Strategy, Management, Accountancy and Regulatory Framework. The syllabus contents in various papers were mapped through these pillars so that the student rises to the highest level of proficiency in Cost and Management Accounting comparable to the best in the world. The need for the members of ICWAI AUDITOR • January 2012
(continued from previous page)
to be titled as CMA and the name of the Institute as Institute of Cost and Management Accountants of India therefore stems from this perspective of capacity building of CMA field for the competitive advantage of the nation. Cost and Management Accounting discipline will have to develop in India so that it becomes a soft infrastructure for the national economic development. This becoming a specialized body of knowledge lot of practical insights will be possible only if an entity constantly works on that domain and hones up an accounting education process. It is totally different from financial accounting, financial reporting, tax assessments, auditing standards, etc. The current developments in the field of cost and management accounting led by management schools have brought in more of strategy and excellence into the subject rather than accounting and taxes. ICWAI could have worked on that platform and honed the national
Elsewhere Rule Change would shift Loan-Loss Accounting: U.S. and international accounting rule makers have agreed in principle on a new standard for recording loan losses that may require banks to book some losses more quickly. Under the new plan, banks and other financial companies would shift to an "expectedloss" model, under which they would book losses and set aside loan-loss reserves based on future projections of losses. That would differ from the current system, known as an "incurred-loss" model, which requires evidence that a loss has occurred before the loss can be recorded. A move to using future loss projections would have the effect of accelerating the booking of losses. This could change the current system which led banks to record losses on a “too-little-too-late” basis during the financial crisis. In response, the U.S. Financial Accounting Standards Board and the International Accounting Standards Board in January proposed a shift to the expected-loss model. They reached agreement on their approach in a joint meeting in late December in London.
US watchdog: corporate auditors should bare doubts: U.S. auditors would have to tell corporate boards' audit committees of any doubts the auditors may have about a company's prospects for survival, under a standard proposed on Tuesday by the U.S. watchdog group that polices the audit industry. The Public Company Accounting Oversight Board's (PCAOB) proposal would also require auditors to discuss with the audit committee any significant unusual transactions discovered in an audit, as well as the rationales for the transactions.
AUDITOR • January 2012
competency on Cost and Management Accounting. It is not about reserving an area of practice for an accountant. Seen that way , in big consulting firms most of the management consulting are perhaps being done by engineers and management school graduates. It is not therefore renaming the body is with reference to mandating an area of practice. It is all about the specialization of the accounting education process operated by the professional accounting body. Unfortunately the entire debate on the name change has been pummeled and pilloried on de - reserving or reservation of an area of practice rather than the specialization of the accounting education process. The irony is that in other SAFA member bodies they all have the Cost and Management Accounting Institutes formed by an Act of Parliament and peacefully coexisting with CA institutes. (We are attempting to get ICAI’s version and response to these views. – Editor)
Compiled by B. Ramanakumar, FCA UK introduces draft revised CFC rules: The UK Govt has published draft legislation for CFC reform. The new code is slated to be more sophisticated than the old one, but at the cost of complications. The Code is still under debate and will likely be introduced mid to late 2012. The code would be of relevance to India as we expect the CFC provisions very soon.
Irish Accountants warned to value bonds properly: Accountants in major Irish companies have been warned they must properly value European sovereign bonds they are holding on their balance sheets. The Irish Auditing & Accounting Supervisory Authority -which promotes standards in the auditing and accountancy profession -- has issued its observations on financial reporting issues which featured in 2011, among them the eurozone debt crisis.
Accounting firm Weaver is pursuing growth via mergers: Fort Worth-based accounting firm Weaver LLP is absorbing via a merger, a locally based accounting firm John R. Hannah & Co. LLP which provides audit and tax, estate-planning and financial-planning services. All of its 10 employees are expected to stay on in the wake of the merger, including the firm's owner, John Hannah, who has been named a senior managing director for Weaver. This is Weaver's third merger deal in the San Antonio area over the past three years. The regional firm absorbed locally based accounting firms Polansky McNutt Perry & Co. in December 2008 and Edelman earlier.
Income Tax in India — In the sands of time The history of Income-Tax in modern India dates back to 1860 when the first Income Tax Act was introduced by James Wilson who became (British) India's first finance member. This Act lapsed in 1865. Thereafter Act-II of 1886 was the next landmark. The Indian Income Tax Act, 1922 came into being following the r e c o m m e n d a t i o n s o f t h e A l l I n d i a I n c o m e Ta x Committee. The Indian Income Tax Act, 1922 was the first attempt to bring the income tax administration within the ambit of Central Government, which earlier used to be with the Provincial Governments. This Act applied to all incomes accruing or arising or received or deemed to accrue or arise or received in India. This was also the first time when the charge in respect of the income of the previous year was established to be in the year of assessment. The earlier Income Tax legislations had schedules specifying the rates of taxation, but for the first time, the 1922 Act left the rates of tax to be fixed by the Annual Finance Act, thus eternally allowing uncertainty to rule and making the Finance Minister to become the most important person in the month of February. The 1922 Act was also extremely illogical in the arrangement of sections thus resulting in great difficulty and inconvenience in understanding and administering the law. The 1922 Act gave specific nomenclatures to various income tax authorities. In 1924, the Central Board of Revenue Act constituted the Board as a statutory body with functional responsibilities for administration of the Act. The amendments in 1939 created an appellate structure as separated from the administrative structure by bringing in a class of officers known as Appellate Assistant Commissioners. In 1941, the Income Tax Appellate Tribunal came into existence. In 1952, the Directorate of Inspection (Investigation) was set up. This gave rise to a new breed of officials. The 1922 Act was also the beginning when the provisions relating to the levy of super tax which till then was a separate tax became an additional duty of income tax. To purportedly overcome the illogicality in the Indian Income Tax Act, 1922 and to remedy the several unjust provisions that probably were in tune with the British regime, the 1961 Act was brought into being in independent India. However little or no attempt was made to reddress any of the grievances or injustices which were contained in the 1922 Act and simply
T. Banusekar, FCA
foreign logicality was replaced by the native illogicality! st
The 1961 Act came into force from 1 April, 1962 based on the recommendations of the Law Commission's Twelfth Report 1958 and the Direct Taxes Administration Enquiry Committee's Report, 1959. The discussions in th the Lok Sabha in relation to this Act went on from 27 April, 1961 for 5 days and a Bill was then referred to a st Select Committee on 1 May, 1961. The report of the Select Committee was presented to the Lok Sabha in August 1961 and introduced as an Act which received th the assent of the President on 13 September, 1961. The 1961 Act pioneered the levy of super tax on undistributed profits of closely held companies. Double taxation provisions continued as in the 1922 Act such as taxing the same income in the hands of the firm as well as the partners. Substantial procedural changes from its predecessor Acts starting from the filing of returns upto collection of taxes were introduced. To c o r r e c t t h e w r o n g s i n t h e i n i t i a l v e r s i o n , amendments were made every year to the 1961 Act, leaving it with more complexities than solutions. Due to these complexities and inequities in the Act, this Act has become a vexed one with large scale litigation. The Act as it stands now can hardly be understood without the help of law dictionaries, though the purported objective of the Act was to simplify. The notional allowances and disallowances, deductions and exemptions as incentives for various purposes such as bringing in foreign exchange into India, setting up undertakings in specified locations etc were important provisions in the Act and also the subject matter of vexed litigation. They were instrumental in making the Act a “give-and-take-policy”. The Act as the law gave the benefits, the administration as the executive took away. Now that the limits of this game have been reached, a new law namely the Direct Tax Code is being contemplated. Even before it has become law, it has undergone changes. The D i r e c t Ta x C o d e w a s initially proposed in the year 2009 to be modified as the Direct Tax Code, 2010. What is new in the Direct Tax Code 2010 •
The numbering system — no more alphanumeric but purely numeric starting from 1 to 319.
Definitions — Section 314 alone consisting of 297 definitions.
Two-in-one Act — It replaces the Income Tax Act and the Wealth Tax Act
Bare Act — keeping to the bare minimum - No explanations or provisos.
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AUDITOR • January 2012
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Combining law with arithmetic and algebra — Computations are in the form of formulae using all the arithmetic operators addition, subtraction, Multiplication and Division. An allowance is to be computed on the basis of a formula for example A + B / (C*D) with A, B, C and D denoting different things.
Use of tables Most schedules are in the form of tables with at least three columns in each table.
Newer terminologies without disturbing the underlying concepts so that the populace has to learn new words.
The stated objective of this Code is to simplify the language and structure of the Direct Tax Laws, resulting in lesser need for amendments, lesser tax avoidance, better and easier compliance with reduced difficulties in deciphering the language by an average tax payer and consequently lesser litigation. What appears from the printed Code is something different. •
Even a simple reading of the Direct Tax Code for example relating to reopening of assessments conveys to the reader that no assessment would
ever stand completed until the time for reopening is over. •
It would be much easier to reopen an assessment under the Direct Tax Code than even under the I n c o m e Ta x A c t , 1 9 6 1 l e a d i n g t o g r e a t e r uncertainties, multiplicity of proceedings and more litigations.
All areas relating to charge of income tax which have been subject matters of litigation have been resolved by the Code in favour of revenue by making such sums chargeable to tax irrespective of the correctness or otherwise of the same.
All artificial disallowances continue even under the Code. It is crystal clear that the there is nothing new in the Direct Tax Code, except for the outer costume and the accessories, all of which have gone to make the tax law lot less prettier than it used to be (!).
To be fair, it cannot be said that the Code would not benefit anyone. The tax practitioners would be the highly benefited, as the Direct Tax Code, in its present form can only increase the confusion that already prevails under the 1961 Act.
Income Tax Timeline in India 1860
Introduced for the first time for a period of five years to cover the 1857 mutiny expenses. It was abolished in 1873.
The tax system was revived as a result of the Great Famine of 1876.
Introduced as Act II of 1886. It laid down the basic scheme of income tax that continues till the present day.
Introduced as Act VII of 1918. It had features like aggregation of income from various sources for the determination of the rate, classification of income under six heads and application of the Act to all income that accrued or arose or was received in India from whatever source in British India.
On the recommendations of the All-India Income Tax Committee, the father of the present act was introduced. The central government was vested with the power to administer the tax.
The Act came into force from 1 April 1962, it extended to the whole of India.
Establishment of the Tax Reform Committee under the chairmanship of Dr. Raja J. Chelliah. It was followed by restructuring the income tax with parameters like lower taxes, fewer slabs, higher execptions, etc.
The Kelkar Task Force, which was followed by outsourcing of PAN/TAN, exemption of dividend income, compensated by levy of the dividend distributed tax to be paid by the company.
Direct Tax Code Bill Introduced.
Taxing Innovations When the previous FM, Mr P. Chidambaram introduced FBT and BCTT, all of us frowned and were critical of the move. History has examples of some weird taxes, innovated by leaders of the countries. Some of them were: Bachelor Tax: Mussolini believed that Italy could become a superpower if it multiplied its 40-million-odd population a couple of times over. So on December 20, 1820, Missouri imposed a bachelor tax on unmarried men between 21 and 50. Julius Ceaser had also tried in 18 B.C. The English imposed it in 1895. And The Russians under Peter the Great used it in 1702. So, Mussolini was not the pioneer! Soul Tax: In 1718, Peter the Great of Russia, introduced a soul tax on all males - excepting the clergy and the nobles, to finance his military reforms. Salt Tax: Napoleon Bonaparte reintroduced salt tax to fund his invasion of Italy and interestingly the tax survived till 1949. From the ancient times, in India, salt tax existed, in fact, ever since the time of the Mauryas. Taxes on salt have been prevalent even during the time of Chandragupta Maurya. The Arthashastra which describes the different duties of the people says that a special officer called lavananadhyaksa was appointed to collect salt tax. Britishers only increased it greatly. However, this one act by the Britishers paved the way for their exit from the country, as the wide protests against this tax led by Gandhiji got unprecedented media coverage around the world and showed Britain in poor light. – P.S. Prabhakar
AUDITOR • January 2012
Audit Process: Sample Selection
CA S Aditya Kumar
Background: Audit is a Science of examining the records and forming an opinion. A Statutory Auditor would be required to form an opinion on the Financial Statements, whereas Internal Auditors are required to report on efficiency and efficacy of the Internal Control System. However, for any type of attest functions, an Auditor is required to look into the records under a microscope. Considering the size of the Operations of the Client and the complexity of business involved, is an auditor expected to verify 100% of the records? No, not required. An Auditor is not expected to verify 100% of the records, a portion of the records are expected to be verified and the results are extrapolated to the population. The procedure to obtain or to decide on the less than 100% of the Population is called as Sample Selection. Taste the Population! In simple words, the Sample should be a representative of the Population. To a large extent the Qualities of Sample should reflect that of the Total Population. Therefore, it is imperative to understand what is the Population we are auditing. For Example: Say, You are verifying Sales. The Sales Population has to contain all the Types of Customers, Whether it is Domestic or Export, Sales to Related or Unrelated Party, Discounts given or not, etc., The Sample should be selected from each of the types of category. This is discussed in greater details elsewhere in this document. Select the right thing: When are we so choosy about what we wear and what laptop we use, we need to be choosier, about the numbers we select to verify. There is no Science or Art behind our choice of Clothes or Laptops, we listen to our heart, and if time is paucity we listen to the Sales Guy! One can't afford this in an Audit. We need to listen to the Art of picking up Sample. Sample Selection is a Science; since the Auditor has to ensure that the sample selected covers every segment of the Population and as mentioned earlier should reflect the Population. When it comes to choice between Samples, well it's an Art. An Art perfected only by experience during professional engagements. What's the Secret Formula to Choose the Right Sample? Well, let's wind up from the World of Auditing for a while, and move to the World of Statistics. That's where the sample selection techniques are discussed.
2. Limitations of the Resource or the Availability of Information, 3. Availability of Statistical Data. Assess the Population: Let's be clear. The first step in Auditing is to assess the Situation. Remember SA 315, it is important to understand the Client's Business, Industry and Economy, Applicability of Laws, Management Structure and How Committed they are. Based on these parameters, a fair estimate of the Quality of the Book Keeping is made. Is the Management aggressive in choosing Accounting Policies? Are there are special or industry specific laws that govern the business of the Client? To what extent the economic condition and industrial relationships influence the decision making purpose? An experience auditor will be able to make a mental picture of the State of the Affairs. Once, we have a fair idea of the Quality of the Book Keeping, the next step is break up the entire population into segments. Population should be segregated based on the nature of Product or Service rendered. The preliminary analysis is essential to understand the trend of the Activity. Segregation of Data: The Population should be first analyzed based on their contents. For Example: In case of Sales, the segregation could be done as given in Table 1. After the Preliminary analysis like rendered above, the segregation of the data should be further analyzed based on:
Both SA 550 and Researchers M. Hanson and P. Hauser, in their Article “Principles of Sample Design,” describe the pre-requisites of Population which impact Sample Selection, as follows:
2. Number of times a variable has repeated
1. Quality of Resource,
3. Above or Below the Average
1. Percentage of the sub-component to the Total Segment
AUDITOR • January 2012
TABLE 1: Pre-dominant Feature
Customer wise Contribution to Revenue
% of Contribution by Customers
Based on Monetary Value
Highest, Lowest, Above and Below Average from Mean
Based on Type of Product or Service
Analysis on Season or Period
Export Sales and Domestic Sales
Based on a Customer or Value
Supply to a Single customer
Based on the Period
Based on Period or Season
Variety of Products
Based on Products
Period wise Analysis.
Pre-dominantly related parties and also non-related parties
Sales to related parties and to non-related parties
A Combination of any of the above methods.
4. Having Unusual Trends 5. Seasonal or Cyclical Changes. The Analysis may be done, as given in Table 1: Golden Rule: Any Audit Procedure can be classified into 2 components: a. Testing the Control b. Testing the Details Of all the Statistical and Mathematical Models one may use, at the end of the day it is the Auditor's professional judgment on the quality of accounts and initial due-diligence will influence the extent of verification that is planned. Let's take some examples and discuss how the sample selection is influenced, in other words, these are the incidents where Sample Size would Increase. It is better not to decrease the sample size; since the variety of population should not be disturbed. Auditor's Assessment on Controls: Client Specific: Operational Controls is Weak and higher level of verification is required. Ex: Internal Controls as per Internal Audit Report or Discussion with Client indicates weak, Weak Delegation of Authority, Frequent changes in Policy without adequate explanation. Lower Rate of Tolerable Error - Ex: Multiple Regulations and Complexity of Accounts where errors may cost the Company's business and Audit Risk is high, especially in case of Listed Companies and PSU. Previous Audit Experience with Client and in Industry where Sample results has proved to be contrary to the Result of the Population. During the course of Audit; there are indications of higher rate of Errors in Accounting; then Sample size should be revised at higher end.
Auditor Specific: Auditor based on his experience and professional judgment is skeptical about the Accounting practice. Cherry Picking: Now that we know how the layout or view of the Population is, it's time to pick the cherries, which would undergo the magnifying lens. Yes, the samples are now selected. Within each subsegment, there are lots of data lying to be chosen. How do we choose the right ones? Is choosing the right one an Art or Science? Should we throw dice and chose the number? Here is where the Science of Statistics applies. Let's see what Statistics have to say as to how to select a sample: Random Number: This technique uses Random Number Table to choose among the uniform data, having homogenous characteristics. Systematic Selection: In this technique, sample size is arrived at first determining the Quantity of Sample Size. Say there are 1000 Invoices. Sample Size required is 100. Therefore, every 10th Invoice may be selected after 100th Invoice. Monetary Unit Selection: a. S a m p l e s o f a l l a m o u n t s b e l o w o r a b o v e a particular amount may be chosen. For Example: All invoices worth Rs.10,000/- or more is chosen. b. Use of Pareto Analysis: ABC Analysis of the Data is done, and the segment, which yields the majority percentage, will be selected as sample. c. Sample which are higher or below the Average Amount. Haphazard Selection: Samples are selected using blindfold theory i.e., how would chose something if you were blindfolded. It is purely based on guess and is not scientific in nature.
Practical Application: Method
When to use?
Characteristics of the variables are homogenous.
When there is no major difference in the spread of the Population.
Monetary Unit Selection
When Opinion is sought on the Quality of the ledger Account.
Non-significant items, but still need to be verified.
If there are indications of errors in a particular area or cluster.
Where Sample is required from a combination of variables.
AUDITOR â€˘ January 2012
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Block Selection: Selecting a group of data say, if there are 1000 invoices, one choses Invoice No. 500 to Invoice No. 600. Drawback in this method is the spread is narrowed and the best of samples may not be available and they necessary are not representative of sample. Multi-Stage Sample: Involves sampling at various levels. In the first levels Sample Data are short-listed and then from the short list the final sample is selected. After Selecting Sample: Normal Audit Procedures like Vouching, Physical Verification, and Analytical Procedures are to be carried out with the samples. In case of Statutory Audits, it plays a pivotal role in forming an opinion on the quality of the ledger accounts or the facts that are being reported. Therefore, it is very important that the audit procedures are to be performed on the Samples with great care. In case of Internal Audits, where normally, auditor use â€œWomb to Tombâ€? approach, i.e., where the verification is done from the Point of Origination to the Point of Culmination, the samples will reflect the prevailing system in an organization and also reflect the operational gaps. Results of Verification: Let's remember, the outcome of the verification i.e., we could conclude that there is delay in accounting or accounting is incomplete or documentation is inadequate, etc., is only for the sample tested. However, since the sample reflects the population, one needs to extrapolate the results at the Population level. In simple words, we conclude that the Population has passed or failed the test of verification based on the samples we select. Hence, the selection of right sample is very important. Noticing Red Flags: As mentioned earlier, an opinion is formed based on the sample selected. As an Auditor, we at times, have to question our own judgment. What if the Sample itself was wrong? What if the abnormal results were one off the case and there is no indication or the results are not corroborated with other tests? Yes, there is always a possibility that sample can go wrong. There is always a possibility that the results may portray a picture better or worse than the entire population that is the Risk that an auditor has to take with the process. This risk is called Sample Risk.
could lead to Auditor performing additional functions, which may not be required at all. Either the Auditor Overestimates or Underestimates the effectiveness of the Controls. This could happen after the Sample Selection. To a step back; what if the method of Sampling was right and Audit Procedures were inappropriate? Example: Relying more on Internal Evidence than the External Evidence. Not enquiring into long outstanding dues represented in the Reconciliation Statements. It is called as Non-Sampling Risk. This could lead to incorrect audit conclusions of the Sample and which is extrapolated to the Population. How much can go wrong? There will be a degree of mis-match with the Population. The degree of mismatch is identified through the Probability Theory. This could be used if the Sample Selection was based on some statistical data. What ever may be the theory of probability, an auditor should always approach the work with professional skepticism. Things can go wrong, but one has to ensure it does not go wrong beyond expectations. How much margin of error can the auditor tolerate or are acceptable to him? This margin of error is called Tolerable Mis-Statement (in c a s e o f M o n e t a r y Va l u e s ) To l e ra b l e R a t e o f Dev iation (while evaluating internal control procedures). In simple words, Errors / Total Sample gives a % of mis-statements. Translate this into Population i.e., Population x % of Errors (x Probability) will give how wrong is the Population. This has to be compared with the Materiality levels set up the Auditor. If it crosses the levels, the Red Flag has to be raised. C o n c l u d i n g t h e Ve r i f i c a t i o n : I f t h e r e s u l t s extrapolated to the Population and the Auditor concludes that the deviations are more than the tolerable range (i.e., Materiality), the sample size may have to be revised to obtain greater amount of comfort on the accounting; beside doing other audit procedures to corroborate the audit evidence already obtained. Bibliography: 1. SA 530 (Revised) : Audit Sampling 2. Tumbling Dice and Birthdays Understanding the Central Limit Theorem Michelle Paret (Product Marketing Manager) and Eston Martz (Senior Creative Services Specialist), Minitab Inc.,
Can Auditor go wrong? An Auditor would either conclude that the Controls are working effectively and in fact they may not be working effectively. This could lead to inappropriate audit opinion.
3. Audit Sampling Requires Auditor Judgment The Agency Examiner December 1994
Or, the Auditor may conclude that the Controls are not working properly, on the other extreme. This
4. How to Use Statistical Sample by Jim Kaplan AuditNet 2003 (The AuditNet Monograph Series
AUDITOR â€˘ January 2012
Recent Judicial Decisions Reported Statute: Income Tax Act – Section 2(22)(e) – Deemed dividend Title : Pradip Kumar Malhotra vs CIT Citation: 338 ITR 538
P.M. Veeramani, FCA Decision in favour of : Assessee Bench: Kolkatta HC
Assessee permitted his immovable property to be mortgaged to bank for enabling company to take loan. Company giving interest free deposit to the shareholder to be returned. For retaining the benefit of loan availed from the bank if advance was given to assessee, it was not to give gratuitous advance to its shareholder but to protect the business interest of the company. The advance could not be treated as deemed dividend. Statute: Income Tax Act – Section2 (47), 37 – Reduction of capital; obsolete items Title : Bennet Coleman and Co Ltd vs Addl CIT Citation: 12 ITR Trib 97 SB
Decision in favour of : Revenue/Assessee Bench: ITAT Mumbai
Value of shares held reduced as a result of reduction of share capital of the company. No transfer is involved in reduction of value and no consideration flowing from the company consequent to reduction of capital. No loss to the share holder on account of reduction in share capital and hence notional loss on such transaction not allowable. Held against the assessee. There is nothing wrong in the method of accounting of the assessee in valuing obsolete and non moving stock at Re.1 resulting in loss during the relevant period. The loss being genuine and incidental to the business was allowable. Statute: Income Tax Act 1961 – Section 11,12 – Nature of contribution Title : ACIT vs Balaji Educational and Charitable Public Trust Citation: 48 SOT 281
Decision in favour of : Assessee Bench: ITAT Chennai
There is no difference between voluntary contribution and involuntary contribution, only distinction is that voluntary contributions are to be treated as income under section 12 and corpus donations are to be treated as capital receipt under section 11. Whether voluntary or involuntary, only course of action available before law is to see whether such contribution have been treated by assessee as income and also applied for charitable purposes. Statute: Income Tax Act 1961 – Section 15 – Tips is salary
Decision in favour of : Assessee
Title : CIT vs ITC Limited
Bench: Delhi HC
Citation: 338 ITR 598 Tips collected and paid by assessee hotelier to his employees is an additional income in the hands of employees and therefore, tips constitute salary within the meaning of section 15 read with section 17(3); Assessee employer was correctly treated as an assessee in default for non-deduction of TDS on account of banquet and restaurant tips collected and paid by it to its employees. Statute: Income Tax Act – Section 36(1)(iii) – Borrowed capital for investment in subsidiary Title : CIT vs Tulip Star Hotels Ltd. Citation: 338 ITR 482
Decision in favour of : Assessee Bench: Delhi HC
For the effective control of new business acquired by the assessee under its management it had invested in a wholly owned subsidiary company. The expenditure on interest on borrowed capital was incurred for business purposes and was thus allowable. Statute: Income Tax Act – Section 41(1) – Waiver of Cash credit loan
Decision in favour of: Revenue
Title : Rollatiners Ltd vs CIT
Bench: Delhi HC
Citation: 339 ITR 54 When the cash credit loan was received in the course of carrying on business even if it was treated as loan at the time of receipt which was of capital nature, on the waiver had become assessee’s own money which was taken to the profit and loss account. This benefit was in revenue field as the money had been borrowed for day to day affairs and hence taxable under section 41(1).
AUDITOR • January 2012
Statute: Income Tax Act – Section 54 – Registration not mandatory Title : Sureshchandra Agarwal vs ITO Citation: 48 SOT 210
Decision in favour of : Assessee Bench: ITAT Mumbai
Assessee sold a building and invested in a new flat within the period prescribed and claimed exemption under section 54. AO denied the deduction on ground that registration of property was done after stipulated period and in view of amendment in Section 53A of Transfer of Property Act, where requirement of registration of transfer is brought into the statue. Held, in view of fact that both buyer and seller had performed their obligations, mere non-registration of transfer deed would not change the date of transfer. Statute: Income Tax Act – Section 90 – PE in India; Sec.254 : Scope of Misc Pet. Title : Reuters Limited Construction House vs JCIT Citation: 48 SOT 246
Decision in favour of : Revenue Bench: ITAT Mumbai
Even though agents act independently in the ordinary course of business, if they devote their activities wholly or mostly wholly on behalf of the foreign enterprise, they would be considered as PE of the foreign enterprise irrespective of whether they conclude contracts binding on the principal or not; Scope of a miscellaneous petition is only to rectify an apparent mistake in order of Tribunal and not meant to consider the plea that view expressed by Tribunal was erroneous. Statute: Income Tax Act – Section 143(2) – Notice not mandatory Title : Ashok Chaddha vs ITO Citation: 338 ITR 399
Decision in favour of : Revenue Bench: Delhi HC
Section 153A provides for the procedure for assessment in search cases. Sub-section 1 starts with non obstante clause stating that it is ‘not withstanding anything contained in sections 147. 148 and 149’. The words ‘so far as may be’ in clause 153A(1)(a) cannot be interpreted to mean that the issue of a notice under section 143(2) is mandatory in the case of assessment under 153A. Decision of Supreme Court in the case of Hotel Bluemoon distinguished. Statute: Income Tax Act – Section 192 – Responsibility of employer for TDS Title : Madhya Gujarat Vij Co Ltd vs ITO Citation: 133 ITD 89
Decision in favour of : Revenue Bench: ITAT Ahmedabad
AO after examining annual return of salaries treated assessee to be in default since TDS on salary was not made on average rate every month. Assessee pleaded that that it had made good deficiency in deduction by deducting balance at the end of financial year as required under section 192(3). Intention of section 192(3) is not that employer can casually take deduction of tax from payment of salary in different months and resort to lump sum deduction at the end of the year to make good deficiency. Employer to find out immediately at the time of subsequent payment to employee whether there was deficiency of deduction of tax in preceding month and make good deficiency or other wise show his bonafide. Assessee liable for interest for non deduction. Statute: Income Tax Act – Section 234 B – Retropsective amendment to law Title : Emami Ltd vs CIT Citation: 337 ITR 4 70
Decision in favour of : Assessee Bench: Kolkatta HC
Liability arising due to subsequent amendment of law with retrospective effect does not fasten the assessee with the liability to pay advance tax. Interest not to be levied for non-payment of advance tax. Statute: Income Tax Act – Section 271(1)(c ) – CA firm liable for penalty Title : ACIT vs Khanna & Annadhanam Citation: 62 DTR Trib 250
Decision in favour of : Revenue Bench: ITAT Delhi
Assessee being a firm of Chartered Accountants, it cannot be accepted that it was entertaining a bonafide doubt regarding nature of compensation received by it on discontinuation of professional partnership with another accounting firm which was patently a revenue receipt and therefore, assessee is liable for penalty, more so, when said receipt was credit to directly to partners accounts and not reflected in profit and loss account.
AUDITOR • January 2012
MESSAGES FOR “AUDITOR” I feel it my proud privilege to address the readers of newsletter ‘AUDITOR’ of the Society of Auditors, which is being re-launched. The expectations of the society from the audit function as well as the auditors are growing with the passage of time. Auditors need to have adequate knowledge and skills/techniques to meet the ever growing expectations of the various stake holders like the clients/regulators/ government/ investors and the society from them. The Society of Auditors has been contributing quite actively in its own way in the development of profession. I would consider it worthy to mention here that the views expressed and submitted by all the auditors of this Society have been given due importance during the formative years of this Society. At the helm of our profession in The Institute of Chartered Accountants of India (ICAI), let me inform you that we are going ahead with a variety of MoUs, MRAs, etc., with national and international professional bodies of repute, and taking joint initiatives with renowned international accountancy bodies. We are working in association with and for various government offices and officials in the interest of our profession in particular and for the nation at large. We are constantly enhancing the infrastructural facilities for our profession by launching ICAI Connect to revive the membership of profession, providing websites exclusively for CA firms, organising seminars, conferences, workshops, training programmes, etc., not only to empower and update the professionals, but also to help our society advance with time. We are endeavouring towards a green and paperless organisation through our IT-initiatives in the interest of our ecological balance. I sincerely believe that good work begets good work and will be happier if our responsible work percolates into other fractions of society. I hope that the said newsletter proves to be a useful and handy referencer for all the professionals while discharging their duties and assignments. I also hope that the readers would continue to share and discuss their concerns through this newsletter, while making the optimum utilisation of this professional space and opportunity. I compliment the Society of Auditors for bringing out this newsletter ‘AUDITOR’. Best wishes CA. G. Ramaswamy President, ICAI AUDITOR • January 2012
MESSAGES FOR “AUDITOR” Dear President, It is a matter of delight to know that the Society of Auditors has decided to revive its monthly Journal “ Auditor”. In fact, the journal was an excellent medium for the Society to reach out to the Members with knowledge and information quite relevant and useful to their day to day functioning. On many matters of current importance, interesting and analytical articles appeared making a meaningful contribution to the endeavour of the members to be enriched. Both CA. P.S. Prabhakar and CA. N.S. Srinivasan had done very well as editors of the magazine in the past and had ensured that articles on technical topics as well as macro level matters were published. I am glad that CA. Prabhakar will shoulder the responsibility to bring out the magazine periodically henceforth. I am sure that he will get adequate support from the members in contributing to the contents from time to time. I take this opportunity to congratulate you as the President of the Society for reviving this noble measure and wish CA. Prabhakar all the very best in this initiative. With personal regards, – T.N. Manoharan, Past President of ICAI
It is refreshing and heartening to note that the “Society of Auditors” is reviving the issue of the News Letter “The Auditor”. Dissemination of knowledge and spreading of information about the economy in a timely manner go a long way to keep the professional fraternity on the alert. The Society of Auditors initiative in relaunching the News Letter is a welcome move and would be applauded by the members. Though there could be assorted means of gathering professional information, one authentic source would ensure continuity and consistency in the chain of information passed on to professionals. Looking from this point of view, this would prove to be a connecting medium among members who could share knowledge and experience on this platform. My best wishes for a successful re-launch to keep members well informed in the professional field. – CA. R. Bupathy, Past President of ICAI
I congratulate “The Society of Auditors” on their initiative to revive “Auditor”. An official organization like “ICAI” cannot afford to give its independent views. It has its own limitations. Therefore, a journal like “Auditor” will have the duty to educate the members and also the public at large on various matters of interest, not only in the Accounting profession but also the nation as a whole. Having known the writing skills of Sri Prabhakar, I am sure, the “Auditor” will be a resounding success. It is also the duty of all of us to join this venture by extending intellectual and financial support. In course of time, we should develop this as a useful instrument in the hands of our Members. I wish the journal “Auditor” and its editorial team a very great success. – G. Narayanaswamy, Past President, SOA 14
AUDITOR • January 2012
The Society of Auditors â€“ New Team Office-bearers for the year 2011-12 CA CA CA CA CA CA
P Anand R Sivakumar S Ramakrishnan B K Moorthy P S Prabhakar V Swaminathan
Committee Members CA S K Phyaji Basha Saheb CA N S Srinivasan CA K Ramadurai CA M Srinivasan CA S A Bhat CA S Mohan CA Rozario CA Malcom Joseph CA G Subramania Sarma CA B Rajagopalan CA C R Sundararajan CA Mahesh Krishnan CA B Ramanakumar CA R Viswanathan CA Anush Shankar CA V G Aravindanayagi CA S Somasundaram CA G Muralidharan Special Invitees Mr G Narayanaswamy Mr G V Raman Mr K Ananthachari Mr P S Kumar Mr M Naganathan Mr D Audisesha Reddy Mr S Pattabiraman Mr V Pichaikutty Mr R Sundararaman Mr S Sankaran Mr M Bheema Bhat Mr R Balakrishnan Technical Directors Mr S Rajaratnam Mr George Cherian Office Administration Mr S Balasubramanian
President Vice President Vice President Secretary Joint Secretary Treasurer Training Program for Staff & Students CA R Sivakumar CA V G Aravindanayagi CA S Mohan CA Anush Shankar Technical Committee CA K Ramadurai, Chairman CA C R Sundararajan CA N S Srinivasan CA R G Rajan CA Chinnaswamy Ganesan CA B Rajagopalan Programme Committee CA Mahesh Krishnan, Chairman CA M Srinivasan CA S Somasundaram Publication & Web Content Committee CA P S Prabhakar, Chairman CA B Ramanakumar CA Subramania Sarma CA Mahesh Krishnan Membership Records Committee CA S A Bhat, Chairman CA R Viswanathan Membership Development Committee CA S Ramakrishnan CA V Swaminathan CA K Ramadurai CA A Rozario CA G Murali