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Friday, October 8, 2010

Due Diligence vs. Audit

Due diligence goes far beyond the financial analysis. It differs from an audit in that the latter is concerned with the truth and fairness of historical financial statements only. The scope of a due diligence review is generally wider – it includes a review of historical figures as one of its elements and also involves analysing the sustainability of business, competition, business plan, future prospects, corporate & management structure, technology, synergy of target business to company’s business apart from researching regulatory compliances , legal issues and other financial data

Methodology of Indirect Tax Audit

The indirect tax audit would involve the following steps:

  • Evaluation of internal controls as to the proper quantification and discharge of the indirect taxes;
  • Collection of information about the company and the industry with particular information on amount of imports, percentage of customs, amount of removals, quantum of CENVAT, proportion of credit, etc.;
  • Design the audit programme depending on the evaluation of internal controls. This would include the records to be verified, areas to be verified and the specific aspects to be checked;
  • The staff conducting the audit should be properly trained and should be conversant of the applicable laws and procedures. The audit should be consultative in nature without compromising the independence which is required to give opinion;
  • The report on indirect tax audit should also provide specific comments on the statutory information, material matters reported by way of an executive summary and the assertion or qualification.

Accounting Treatment for MAT Credit

  • The Council of Institute of Chartered Accountants of India has issued a ‘Guidance Note on Accounting for Credit Available In Respect of Minimum Alternative Tax (MAT) under the Income Tax Act, 1961’.

Accounting Treatment:

The Guidance Note on Accounting for MAT credit suggests the following:

MAT credit is not a Deferred Tax Asset – As per AS – 22 on Accounting for Taxes on Income issued by ICAI, deferred tax liability or deferred tax asset arises on account of timing differences (i.e. the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods). Further, MAT credit does not give rise to any timing difference. It is simply a current tax. Hence, MAT is not a deferred tax asset.

MAT credit is an Asset – An asset is a resource that is controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise. Now, the following questions arise as to whether MAT credit:

  • is a resource that is controlled by the enterprise as a result of past events – Yes, it is a resource controlled by the enterprise as a result of payment of MAT in past.
  • give rise to future economic benefits that are expected to flow to the enterprise – Yes, it give rise to future economic benefits. The future benefit is in the form of adjustment that can be made while discharging the normal tax liability.
Recognition of MAT credit in Financial Statements – Since MAT credit is an asset, it can be recognised in the financial statements if the following conditions are fulfilled:
  • It is probable that the future economic benefits will flow to the enterprise; and
  • Its value can be measured reliably.
The probability (i.e. more likely than not) is assessed on the basis of concept of prudence and on the basis of evidence available while preparing the financial statements. Thus, MAT credit should be recognised as an asset in the financial statements only to the extent of convincing evidence available that the company will be paying tax as per normal provisions during the period for which MAT credit can be carried forward

EDP Audit: Important Questions

  • What are the different audit approaches in an IT environment?
  • “The method of collecting audit evidence and evaluating the same, changes drastically under the EDP auditing.” Discuss the correctness of the said statement. [Nov. 1997, C.A. (Final)]
  • The overall objective of audit does not change in an EDP audit. Comment.
  • For what reasons audit trail is either lost or sketchy in a computerised environment. What audit techniques can be adopted by the auditor in such circumstances? [Nov. 1995, Nov. 2000 C.A. (Final)]
  • What are the different kinds of Internal Controls that should be considered by the auditor to determine the nature, timing and extent of his audit procedures?
  • Outline the special points that are required to be considered in establishing and evaluating a system of internal controls for computer applications processed at a service bureau. [May 1999, C.A. (Final)]
  • Draw up a check list for evaluation of output controls on accounts maintained under EDP system. [Nov. 1998, C.A. (Final)] (Hint: (i) whether the user department receives the print outs intact; (ii) whether the print outs accurate, timely, comprehensive; (iii) whether these are serially numbered; (iv) whether the source of print out can be traced; (v) how the action is taken on exception report)
  • “Where the financial accounting system has not been computerised, the auditor need not verify computerised management system.” Comment. [May 2000, C.A. (Final)] (Hint: Discuss in light of inter-relationship of other business functions with accounting function. If financial system is not computerised, it does not mean that the information generated in other sections have no impact on the manually maintained accounting records)
  • Write short notes on: Utility Routine [Nov. 2000]These are generalised programs that perform necessary but routine jobs in a computer installation. They are controlled by parameters to indicate the particular characteristics of the data or the requirements. There can be three types of utility routines:

Data set utilities are used to manipulate files of stored data. For example, merging a file, copying a file, printing a selected portion of data, or sorting of data.

System utilities are used to simplify the task of knowing where data are stored in a computer file. For example, adding data to a file, naming a set of data, labeling magnetic tapes, or reporting of errors that take place during processing.

Independent utilities perform housekeeping functions such as preparing back up copy, analysing magnetic disk for defective tracks, etc.

  • Describe the role of CAATs in an EDP environment.

Monday, October 4, 2010

Professional Skepticism and Professional Judgement

Professional Skepticism: An attitude that includes:
  1. a questioning mind,
  2. being alert to conditions which may indicate possible misstatement due to error or fraud, and
  3. a critical assessment of audit evidence.
Professional Judgment: The application of relevant training, knowledge and experience, within the context provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.

Management vs. Those Charged with Governance

SA 260

‘Those charged with governance’ means the person(s) with responsibility for overseeing the strategic direction of the entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting and disclosure process. In some cases, those charged with governance are responsible for approving the financial statements (in other cases management has this responsibility).

AAS 27

‘Those charged with governance’ means the person(s) responsible for the supervision, control and direction of an entity who are accountable for ensuring that the entity achieves its objectives, with regard to reliability of financial reporting, effectiveness and efficiency of operations, compliance with applicable laws, and reporting to interested parties. Those charged with governance include management only when it performs such functions.

The new definition concentrates on oversight and eliminates references to ‘control’ and ‘ensuring that the entity achieves its objectives’

SA 260

‘Management’ means the person(s) who have executive responsibility for the conduct of the entity’s operations. In some entities, management includes some or all of those charged with governance, e.g., executive directors, or owner-managers. Management is responsible for preparing the financial statements, overseen by those charged with governance, and in some cases management is also responsible for approving the financial statements (in other cases those charged with governance have this responsibility