Auditing and Assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

How would an auditor verify and deal with the following?
a. Foreign traveling expenses of a directors in connection with a trip for exports and import of machinery for a new project.
b. Interest paid for plant machinery purchased on deferred credit.
c. Receipt of compensation from the insurance company in respect of a motor accident claim.
d. Loose tools manufactured in a factory for internal use.

a. The expense, in the instant case is on composite purpose of exports and of a new project. Verification:
 Examine the Board’s minutes for the sanction of the foreign trip of the director, the amount of expense allowed and the purpose of the trip.
 Verify the sanction of foreign exchange the bank regulating foreign exchange.
 Peruse the report, if any, submitted the director on return.
 Examine correspondence with foreign parties in connection with the trip.
 Examine statement if expenses submitted the director after return
 See that the expenses are in accordance with the Board’s sanction.
 Verify supporting vouchers (e.g. counterfoil of plane ticket, hotel bills etc.
 If the director is entitled to a daily allowance, in lieu of or in addition to the cost of stay, verify that the daily allowance has been paid in accordance with the rules.

How to deal:
Since the travel cost is of a composite nature, the same should be apportioned on same reasonable basis, say, in proportion to time spent abroad for the above two purposes, the part attributable to export should be charged to revenue and the part attributable to Export should be charged to revenue and the part attributable to import of machinery for a new project may be capitalized and debited to the machinery if the same is imported in the relevant financial year. Alternatively, such expenses on foreign trip for import of machinery may be accounted to an account called expenditure during construction of the project and capitalized at the time of completion of the project.

b. Answer Verification:

 Examine the deferred credit agreement and ascertain the rate of interest payable, and the periodicity of payment.
 Check the calculation of interest
 Verify the acknowledgement of the machinery supplier for the payment made.
 In case the amount is paid outside the country, the permission of the Reserve Bank regulating foreign exchange should be verified.
 In case the amount of interest paid is not separately stated in the agreement but is paid in lump sum, installment of the deferred credit payment determine the amount of interest included in each installment separately and see that the same has been debited to interest account.

How to deal:
Interest being a period cost for finance/ credit, it should be debited to revenue account of the respective year for which the same is paid, computed on the principle sum outstanding. It should be seen that the interest or any part of it is not capitalized even though the interest might have been paid in the installment payment under the deferred credit arrangement. it is assumed that plants machinery purchased on deferred credit is ready for use immediately after purchase.

c. Receipt of a sum from the insurance company in respect of a mother accident claim:

Further enquiries to be made are the following:

 Whether the motor car involved in the accident was covered the insurance policy taken the client and the extent of the coverage of the risks;
 Computation of the claim in terms of the policy and scrutiny of the claim lodged with the insurer together with the survey report, if any, as also correspondence exchanged with the insurer;
 Examination of the basis on which the claim was finally settled and the communication from the insurer of the amount at which the claim was settled;

 Whether the amount has actually been received and deposited in the bank.
 Whether any further amount is expected to be received.

Treatment in Accounts:
The amount received as claim for the accident loss should be credited to motor vehicles account, if the case is of a total loss. The difference, between the written down value of the motor car and the amount of the claim, should be appropriately adjusted in the accounts. If the written down value is higher, the difference being loss should be debited to the profit and loss account. In the converse the capital gain i.e. the excess, if any, over the original cost of the vehicle should be credited to profit and loss account. Appropriate entry should be made in the Motor Vehicles Register also.

If the claim was for a partial loss, the amount of the claim should be credited to a separate account and amount required to carry out the necessary repairs should be debited to that account. The difference, if any, should be credited or debited to the profit and loss account.

Any debit or credit to the profit and loss account in either of the cases mentioned above should be separately shown, as it is an unusual item.

d. Answer
For verification of loose tools manufactured for own use, it would be useful to acquaint oneself with the management policy in this regard to ascertain the circumstances in which tools are made the factory itself and in which they are bought from outside. Departures from the principle should be enquired into it should be seen that the departure was specially authorized a competent person.

The steps necessary for verification of loose tools manufactured for internal use are given hereunder: –

 Ascertain the name of the official who is vested with the power to order such manufacture.
 Examining the orders for manufacture with reference to stores requisitions and observing the time limits specified for the completion of the jobs. Undue delays in execution of the jobs should be brought to the notice of the management.
 Examining the production records to find out the quantities and types of tools manufactured and to ensure that these are backed production order of the appropriate authority and the stores requisition.
 Enquiring whether the factory has the predetermined material schedule and labor hours for these productions.
 Examination of the costing records, if any, that are maintained and comparison of the same with the pre-determined materials schedule and labor hours. In the absence of aforesaid records, examination of the cost build-up with reference to available information.
 Reviewing whether the costs incurred are significantly higher than the prices at which the same could be obtained from external sources.

 Considering the accounting entries for transfer of loose tools from the production account to the loose tools account, it should, however, be ensured that, except appropriate burned of overhead, the pricing should not include any profit element.
 If scrapped damaged and/or obsolete machines, tools, etc., are being melted to have the requisite raw material for the production of these loose tools, it should be seen that costing of the tools is based on the valuation placed the company on such scarp materials, etc.
 For year-end valuation, these tools in stores should be valued at cost or market price, whichever is lower; and those which have been issued to the operating departments and still have unexpired life, can be valued on the basis of a consistent policy of revaluation or can as well be charged off to production, if the management’s policy is such.

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