INDIA Trade ( Audit Requirements and Practices)

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Investor considerations

Companies incorporated under the Companies Act 1956 must keep proper books and records, sufficient to give a true and fair view of the company's affairs and to explain its transactions. Shareholders of such companies must appoint auditors at the annual general meeting. In practice, a firm of accountant whose partners would each qualify for appointment is usually appointed.

Auditors must report to a company's shareholders on the accounts examined by them; their report must cover various matters and include whether in their opinion the accounts give a true and fair view of the state of affairs of the company and of its results.

For all companies whose annual turnover exceeds a specified amount, a statutory audit under the Companies Act is required, along with a tax audit for certain matters prescribed under the Income Tax Act.

The government may direct that a cost audit be carried out for a company required to maintain detailed cost accounting records.

STATUTORY REQUIREMENTS

Books and records

Every company is required to keep proper books of account with respect to the following.

1. All sums of money received and expanded by the company as well as the matters with respect to which the receipts and expenditures took place.

2. All sales and purchases of goods made by the company.

3. The assets and liabilities of the company.

A company that belongs to a class of companies engaged in production, processing, manufacturing, or mining activities also must maintain such details of utilization of material, labor and other items of cost as may be prescribed by the central government for that class.

There is no provision in the Companies Act as to the form in which the books of account are to be maintained, but it is

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incumbent on a company to maintain such books on an accrual basis. Such books and vouchers as are relevant to any entry in the books of account must be maintained for a period of at least eight years after the end of any financial year.

The books of account must be kept at the company's registered office. In the case of a company with a branch office, the books of account relating to the branch transactions may be kept at the branch office. If the board of directors decides to keep the books at a place other than the registered office, it must inform the Registrar of Companies within seven days of its decision and given the address of the place where the books are located.

The books of account and other books and papers are open to inspection by any director the Registrar of Companies or authorized government officials during business hours. Except in the case of a winding-up of a company, the shareholders have no right to inspect the books of account.

In addition to the books of account mentioned above, a company is required to keep various registers, e.g., an investment (securities) register, a register of shareholders, a separate register of directors and their share holdings, and minute books of shareholders' and directors' meetings. The shareholders have the right of access to most of these registers, which must be kept at the registered office of the company.

Audited financial statements

AT every annual general meting of a company, the board of directors must lay before the shareholders financial statements consisting of a balance sheet and a profit and loss account (income statement). These financial statements must be accompanies by the auditor's report and the report of the company's board of directors. The auditor is required to report on a long list of matters prescribed either in the Companies Act or in the orders issued under the Act and on any deviation from the mandatory accounting standards issued by the Institute of Charted Accountants of India (ICAI).

The period covered by the income statement should not end on a date that is more than six months before the date of the annual general meeting unless the date of the general meeting is extended by the Registrar of Companies. However, in the case of the first annual general meeting, the gap between the two dates may be none months. The financial year may be less or more than a year, but it should not exceed 15 months. With special permission of the Registrar, however, this period may be extended to 18 months.

The audited financial statements, together with a report by the board of directors, must be sent to shareholders and trustees for debenture holders at least 21 days before the date of the annual general meeting. Quoted companies can no longer send an abridged set of accounts to the shareholders and trustees for debentures holders, according to a circular dated September 23, 1994 issued by the Securities and Exchange Board of Indian. This circular was issued to the stock exchanges to modify all listing agreements. Quoted companies are also required by their listing agreement to furnish the stock exchange with unaudited financial results and required details on a half-yearly basis within two months of the expiration of the period and also to advertise such details in at least one national-language and one English daily newspaper. Publication of the unaudited results for the second half-year is not obligatory if the company informs the stock exchange that it will publish audited results within three months of the closure of the accounting year. If the total of the two half years' unaudited results with respect to any items in the prescribed form varies by 20 percent or more when compared with the audited accounts for the full year, a listed company must explain the reasons to the stock exchange.

In addition to accounts showing its position as a separate entity, a company that has subsidiaries must submit for each subsidiary the financial statements, the board's report and the auditor's report, all of which must be prepared in accordance with the requirements of the Act. A statement must be attached that shows the extent of the holding company's interest in each subsidiary at the end of the subsidiary's financial year and the profits and losses not dealt with in the holding company's accounts. The time lag between the balance sheet dates of the holding company and of the subsidiaries should not exceed six months. When the financial years of the subsidiary and its holding company do not coincide, the following information must be shown for each subsidiary.

1. Whether during the interval there has been any change in the holding company's interest in the subsidiary and, if so, the extent thereof.

2. Details of any material change occurring during the same period in fixed assets, investments, and loans given or taken by the subsidiary. All listed companies whose financial year ends in March 1996 or thereafter will be required to, as per the amended listing agreements, give a cash flow statement along with the balance sheet and profit and loss account. Such a statement is to be prepared in accordance with the requirements prescribed by the Securities Exchange Board of India and duly certified by the statuette auditors.

There is no need to prepare group accounts.

After the accounts have been laid before the company at the annual general meeting, three copies of these accounts, together with all the documents that are required to be attached thereto-e.g., auditor's report, Board's report-must be filed with the Registrar of Companies within 30 days from the date of the annual general meeting. Under the tax laws a uniform accounting year, April 1 to March 31, is to be followed. However, the Companies Act does not stipulate any such uniform accounting year. As a result, companies having financial statements closing on a date other than March 31 are required to get their accounts audited for the year ended March 31 for tax purposes as well.

Appointment of auditors

The Companies Act requires that only chartered accountants within the meaning of the Chartered Accountants Act 1949 can qualify for appointment as auditors. The first auditor of a company is usually appointed by the directors. Subsequently, except for appointments to fill casual vacancies, auditors are normally appointed by the shareholders at each annual general meeting by an ordinary resolution to hold office until the next general meeting by an ordinary resolution to hold office until the next annual general meeting. In the case of companies in which not less than 51 percent of the paid-up share capital is held by the central or state government or by government-owned companies/corporations or a combination thereof, the auditor is appointed or reappointed by the central government on the advice of the Comptroller and Auditor general of India. However, in the case of a company in which not less than 25 percent of the subscribed share capital is held singly or jointly by the government a prescribed financial institution, a government company, a nationalized bank, or an insurance company, the appointment or reappointment of an auditor at each annual general meeting must be made by a special resolution that must be passed by not less than 75 percent of the total votes.

Casual vacancies arising other than by the resignation of an auditor are filled by the board. A vacancy in the office of auditor arising from resignation may be filled only be filled only by the shareholders in a general meeting. The shareholders at an annual general meeting may pass a resolution appointing as auditor a person other than the retiring auditor. The intention of proposing such a resolution must be notified by a shareholder to the company at least 14 clear days before the date of the meeting. The company, in turn, must give notice of the resolution to its shareholders within seven days before the date of meeting. This procedures is designated to avoid the removal of an auditor without providing a reasonable opportunity for all the shareholders to attend the meeting and vote on the matter

Except for the first auditor, no auditor may be removed before the expiration of the period of appointment without the previous approval of the government.

In practice, a firm of accountant whose partners all qualify for appointment is usually appointed as auditors. No officer or employee of the company and no corporate body can be appointed auditor of the company, no person who is a partner or in the employment of an officer or employee of the company can be appointed auditor of any company. The tern "officer" is defined by the Companies Act to include the directors, the secretary and management personnel of the company. The Companies Act sets a limit on the number of company audits that may be undertaken by an auditor; the ceiling is 20 companies per partner of an audit firm, of which companies with paid-up shares capital above Rs 2.5 million should not number more than ten.

The auditor has the right of access at all times to the accounting and other records of the company, as well as the right to require from the officers of the company such information and explanation as the auditor deems necessary for the audit.

Tax audit

Every company with a total sales turnover or gross receipts over Rs 4 million must have its accounts audited in accordance with the Income Tax Act. This audit is in addition to the statutory audit under the Companies Act and mainly involves verification and confirmation of certain facts, figures and information that are generally required by the Tax authorities in the course of assessment proceedings and that broadly relate to the following.

1. Books of account examined.

2. Methods of accounting employed and their consistency.

3. Methods of valuation and quantitative reconciliation of inventories.

4. Amounts of expenditure incurred under various headings that are not allowable in full or that result indirect benefits to directors or their relatives or officers.

5. Borrowings and repayments of certain types of loans.

6. Prior-period adjustments.

7. Deductions of tax at source and deposit thereof with appropriate authorities.

These particulars must be certified as true and correct based on the auditor's opinion land information and explanation received.

The tax audit requirements also apply to other types of business entities whose total sales turnover or gross receipts in business exceed Rs 4 million and to entities carrying on a profession whose gross receipts in the profession exceed Rs 1 million in any year.

Cost audit

Companies are required to maintain cost accounting records, and they may be directed by the government to have a cost audit. Unlike the financial audit and tax audit, which are carried out from year to year, a cost audit is carried out only upon specific order of the government. The cost auditor submits a report to the Company Law Boards of the central government and sends a copy to the company.

Accounting profession

The bodies of accountants whose members are engaged in public practice in India and that are recognized by the government are the Institute of Charted Accountants of India and the Institute of Cost and Works Accountants of India. The memberships of the two bodies in 1995 were over 70,000 and 15,000 respectively. The financial audit and the tax audit of a company are conducted by members of the former body; the cost audit is performed by members of the latter body.

The Institute of Charted Accountants of India has recognized the training and examinations of the Institute of Chartered Accountants in England and Wales, the Institute of Charted Accountants of Scotland, and the Institute of Chartered Accountants in Ireland as being equivalent to the training and examination prescribed for its members. As a result, members of these three institutes are also eligible to become members of the Indian Institute, subject to their fulfilling certain conditions, and may consequently engage in practice in India.

The need for independence in mental attitude in an auditor is recognized. However, it is not considered improper for auditors to have a financial interest in a company on which they report. If, however, the auditor has a substantial interest in the company's finances, the Charted Accountatnts Act 1949 requires that this be disclosed. The phrase "substantial interest" has been defined by the Act as a holding of shares carrying not less htan 20 percent of the voting power beneficially either by the member or jointly with relatives. Members of the Institute are alsorequired to adhere to a code of professional ethics, failing which they are deemed guilty of professional miscounduct and are subject to disciplinary action.

Accounting and auditing practice in India is derived largely from practice in the United Kingdom. However, with the introduction of the Manufacturing and Other Companies (Auditors' Report) Order 1988 (see the sample Auditor's Report below), various other enactments in the Companies Act and other legislation connected with such things as employee remuneration, auditing practice in India is gradually becoming more independent. And the demands made by the government, the public and other agencies on the auditors are far greater than before. For the guidance of its members, the Indian Institute from time to time published briefs on various matters relating to auditing and accounting practices.

Auditing standards

The Institute of Chartered Accountants of India (ICAI) is a member of the International Federation of Accountants (IFAC), and the Auditing Practices Committee (APC) of the Indian Institute is committed to giving due consideration to the auditing guidelines issued by the International Auditing Practices Committee of IFAC and integrating them to the extent possible with the Indian Auditing Standards being issued by APC, in the light of conditions and practices prevailing in India. The following statements on Standard Auditing Practices (SAP) have been issued by APC.

SAP 1 - Basic Principles Governing an Audit.

SAP 2 _ Objectives and Scope of the Audit of Financial Statements.

SAP 3 - Documentation.

SAP 4 - Fraud and Error.

SAP 5 - Audit Evidence.

SAP 6 - Study and Evaluation of the Accounting System and Related Internal Audit Control in Connection with an Audit.

SAP 7 - Relying upon the Work of an Internal Auditor.

SAP 8 - Audit Planning.

SAP 9 - Using the Work of an Expert.

SAP 10 - Using the Work of Another Auditor.

SAP 11 - Representations by Management.

These standards are all mandatory and are in addition to the following statements on auditing already issued by the Institute, which are also mandatory.

Statements on Auditing Practices.

Statements of Qualifications in Auditor's Report.

Statement on the Responsibilities of Joint Auditors.

Statement on Payment to Auditors for Other Services.

Statement on Manufacturing and Other Companies (Auditor's Report) Order 1988.

Besides the above, the following guidance notes have also been issued by ICAI. These are recommendations rather than rules.

Auditing of Accounts of Liquidators.

Maintenance of Unduly Heavy Cash Balances by Companies.

Auditor's Ditties.

Independence of Auditors.

Surprise Checks.

Coordination Between the Internal Auditors and Statuary Auditors.

Audit Reports and Certificates for Special Purposes.

Audit of Accounts of Noncorporate Entities.

Reports in Company Prospectus.

Control on the Quality of Audit Work.

Revision / Rectification of Financial Statements.

Audit Engagement Letters.

Audit of Inventories, Investments, Debtors, Loans and Advances, Liabilities, Cash and Bank Balances, Fixed Assets.

Audit of Banks.

Audit of Miscellaneous Expenditure Shown in Balance Sheet.

Audit of Accounts of Members of Stock Exchange.

Tax Audit Under the Income Tax Act.

Unqualified Auditor's Report.

A typical unqualified auditors' report on the accounts of manufacturing, service, trading, and / or finance company laid before the company at the annual general meeting is set out below. However, the applicability of individual clauses is based on the activities of the company in question.

AUDITORS' REPORT

TO THE MEMBERS OF XYZ LIMITED

We report that we have audited the balance sheet of XYZ Limited as at 31 March 1996 signed by us under reference to this report, and the relative profit and loss account for the year ended on that date, which are in agreement with the books of account.

In our opinion and to the best of our information and according to the explanations given to us, the balance sheet and the profit and loss account together with the notes thereon given, in the prescribed manner, the information required by the Companies Act 1956 and also give, respectively, a true and fair view of the state of the Company's affairs as at 31 March 1996 and its profit for the year ended on that date.

We have obtained all the information and explanations which to the best of our knowledge and belief were necessary for our audit. In our opinion, proper books of account have been kept as required by law so far as appears from our examination of those books.

As required by the Manufacturing and Other Companies (Auditors' Report) Order dated 7 September 2988 and issued by the Central Government and on the basis of such checks as we considered appropriate and according to the information and explanations given to us, we further report that

i.a. The Company has maintained proper records to show full particulars including quantitative details and situation of its fixed assets;

i.b. The fixed assets of the Company have been physically verified during the year by the management and no material discrepancies between the book records and the physical inventory have been noticed.

ii. The fixed assets of the Company have not been revalued during the year.

Iii The stocks of finished goods, stores, spares parts, and raw materials of the Company at all its locations have been physically verified by the management during / at the end of the year.

iv. In our opinion, the procedures of physical verification of stocks followed by the management are reasonable and adequate in relation to the size of the Company and nature of its business.

v. The discrepancies between the physical stocks and the book stocks, which were not material, have been properly dealt with in the books of account.

vi. In our opinion, the valuation of stocks of finished goods, stores, spare parts, and raw materials has been fair and proper in accordance with the normally accepted accounting principles and is on the same basis as in the earlier years.

vii. The Company has not taken any loans secured or unsecured from companies, firms or other parties listed in the register maintained under Section 301 of the Companies Act 1956 and / or companies under the same management as defined under sub-section (1B) of Section 370 of the Companies Act, 1956.

viii. The Company has not granted any loans secured or unsecured to companies, firms or other parties listed in the register maintained under Section 301 of the Companies Act 1956 and / or companies under the same management as defined under sub-section(1B) of Section 370 of the Companies Act 1956.

ix. Interest free loans or advances in the nature of loans have been given to the employees only, who are repaying the principal amounts as stipulated.

x. In our opinion, there is an adequate internal control procedure commensurate with the size of the Company and the nature of its business for purchase of stores, raw materials including components, plant and machinery, equipment and similar assets, and for the sale of goods.

xi. In our opinion, purchase of goods and materials and sale of goods, materials and services, made in pursuance of contract or arrangements entered in the register maintained under Section 301 of the Companies Act 1956 and aggregating during the year to Rs 50,000 or more in value in respect of each party, have been made at prices which are reasonable having regard to the prevailing market prices for such goods, materials or services or the prices at which the transactions for similar goods or services have been made with other parties.

xii. The Company has a system of determining unserviceable or damaged stores, raw materials and finished goods on the basis of technical evaluation and on the aforesaid basis, in our opinion, adequate provision for the loss has been made in the accounts.

xiii. In the cases of public deposits received by the Company, the directives issued by the Reserve Bank of India and the provision of Section 58A of the Companies Act 1956 and the rules framed thereunder, where applicalbe, have been complied with.

xiv. In our opinion, reasonable records have been maintained by the Company for the sale and disposal of production scrap. The Company has no by-product.

xv. In our opinion, the Company's present internal audit system is commensurate with its size and nature of business.

xvi. The Central Government has not prescribed the maintenance of cost records by the Company under Section 209 (1) (d) of the Companies Act 1956 for any of its products.

xvii. The Company has generally been regular during the year in depositing provident fund dues with the appropriate authorities. As informed to us, the Company is at present not covered under the Employees' State Insurance Act 1948.

xviii. At the last day of the year there were no amounts outstanding in respect of all undisputed income tax, wealth tax sales tax, customs duty, and duty which were due for more than six months from the date e they became payable.

xix. During the course of our examination of the books of account carried out in accordance with the generally accepted auditing practices, we have not come across any personal expenses which have been charged to Profit and Loss Account, nor have we been informed of such case by the management.

xx. The Company is not a sick industrial company within the meaning of Clause (o) of Section 3(1) of the Sick Industrial Companies (Special Provisions) Act 1985.

xxi. In respect of services rendered :

i) In our opinion, the company has a reasonable system of recording receipts, issues and consumption of materials and stores and allocating materials and stores consumed to the relative jobs commensurate with the size and nature of its business.
ii) In out opinion, the company has a reasonable system of allocating man hours utilized to the relative jobs, commensurate with its size and nature of its business.
iii) In our opinion, there is reasonable system of authorization at proper levels with necessary controls on the issue of stores and allocation of stores and labor to various job and the related system of internal control of the company is commensurate with the size of the company and the nature of its business.

xxii. In respect of trading activities there are no damaged goods in the possession of the Company as on 31 March 1996.

Unqualified tax audit report

A typical unqualified tax audit report is set out below.

Form No. 3CA
Audit Report under Section 44AB of the Income Tax Act, 1961

We have to report that the statutory audit of XYZ Limited (Permanent Account No. XXX) was conducted by us in pursuance of the provisions of the Companies Act 1956 and we annex hereto a copy of our audit report dated June 1996 along with a copy of the audited profit and loss account for the year ended on 31 March 1996 and a copy of the audited balance sheet as at 31 March 1996, along with the documents declared by the relevant Act to be part of, or annexed to, the profit and loss account and balance sheet.

A further report as required under the provision to Section 44AB is furnished in Form 3CD annexed hereto.

In our opinion and to the best of our information and according to explanations given to us, the particulars given in Form No. 3CD are true and correct.

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