Auditing and Assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

Give your opinions with reason on the following cases:

a) A sum of Rs.10,00,000 is received from an Insurance company in respect of a claim for loss of goods in transit costing Rs.8,00,000. The amount is credited to the Purchases Account.
b) An auditor of a limited company did not verify the investment and he inserted a note in the balance sheet “Investment not verified”. The shareholders approved and adopted the accounts at the annual general meeting. Subsequently, it transpired that investments were misappropriated and the company suffered a loss.
c) BMG Ltd. is a manufacturing company produces durable consumer goods with an annual turnover of Rs. 100 crores. The company receives orders from its commission agents all over the country, but goods are dispatched directly to the customers. The documents including transport bills are sent through the bank for collection. At the end of the 6th year, it is found that documents covering the dispatch of goods worth Rs. 10 crores were still lying with the banks not cleared the customers even though the normal collection period of 15 days from the date of dispatch has expired. Should revenue be recognized in the above case?
a) Answer
All items of income and expense which are recognized in a period should be included in the determination of net profit or loss for the period. The claim for loss of goods in transit is arising out of ordinary activities of the enterprise as a part of its normal course of business. However, the cost of goods lost in transit is only Rs.8,00,000 while the insurance money received is Rs.10,00,000. Purchases Account need not be credited since it would distort the purchases done during the year and as also the gross profit. Therefore, entire amount of Rs.10 lacs needs to be taken to profit and loss account under an appropriate head. This is an income arising from an ordinary activity of the enterprise but having regard to amount involved and exceptional nature, a separate disclosure is to be made in the profit and loss account. Such disclosure would enable the users to understand the performance of an enterprise for the period.

b) Answer
In case of audit of a limited company, an auditor has to comply with the statutory duties as prescribed under Companies Act. Verification of investments is an important function of an auditor since, it is an important asset shown in the balance sheet. The auditor cannot be expected to give a report on the truth and fairness of the financial statements of the company without verifying its investment. If he specifically mentions in his audit report, the fact that, he did not verify the investments, he would not be relieved from his statutory duties. Such statutory duties can never be curbed, though they may be extended.

c) Answer
According to set standards on Revenue, revenue from the sale of goods shall be recognized when
 the seller of goods has transferred to the buyer the significant risks and rewards of ownership of the goods;

 the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
 the amount of revenue can be measured reliably.
 It is probable that the economic benefits associated with the transaction will flow to the entity; and
 The costs incurred or to be incurred in respect of the transaction can be measured reliably.

Since the transport bills were sent through the bank for collection, it may be said that the seller entity has retained effective control over the ownership of goods. Further since the documents were not cleared the customer even after the expiry of the normal period of collection, there is an uncertainty in the realization of sale proceeds. Apparently, the amount also appears to be quite material being 10% of total turnover. Hence, revenue should not be recognized in this case.

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