Prudential Norms

Click this link for the Prudential Norms:

http://caalley.com/rbi10/74MCIR010710_F.pdf

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.

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

SA Summary

Please download the SA Summary from:

http://www.4shared.com/document/WXXFQi_e/Microsoft_Word_-_SA_Summary.html?

Clause 49 Compliance (Corporate Governance)

Clause 49 of the Listing Agreement to the Indian stock exchange comes into effect from 31 December 2005. It has been formulated for the improvement of corporate governance in all listed companies.

In corporate hierarchy two types of managements are envisaged: i) companies managed by Board of Directors; and ii) those by a Managing Director, whole-time director or manager subject to the control and guidance of the Board of Directors.

• As per Clause 49, for a company with an Executive Chairman, at least 50 per cent of the board should comprise independent directors. In the case of a company with a non-executive Chairman, at least one-third of the board should be independent directors.

• It would be necessary for chief executives and chief financial officers to establish and maintain internal controls and implement remediation and risk mitigation towards deficiencies in internal controls, among others.

• Clause VI (ii) of Clause 49 requires all companies to submit a quarterly compliance report to stock exchange in the prescribed form. The clause also requires that there be a separate section on corporate governance in the annual report with a detailed compliance report.

• A company is also required to obtain a certificate either from auditors or practising company secretaries regarding compliance of conditions as stipulated, and annex the same to the director's report.

• The clause mandates composition of an audit committee; one of the directors is required to be "financially literate".

• It is mandatory for all listed companies to comply with the clause by 31 December 2005.

Corporate Governance may be defined as “A set of systems, processes and principles which ensure that a company is governed in the best interest of all stakeholders.” It ensures Commitment to values and ethical conduct of business; Transparency in business transactions; Statutory and legal compliance; adequate disclosures and Effective decision-making to achieve corporate objectives.In other words, Corporate Governance is about promoting corporate fairness, transparency and accountability. Good Corporate Governance is simply Good Business.

Clause 49 of the SEBI guidelines on Corporate Governance as amended on 29 October 2004 has made major changes in the definition of independent directors, strengthening the responsibilities of audit committees, improving quality of financial disclosures, including those relating to related party transactions and proceeds from public/ rights/ preferential issues, requiring Boards to adopt formal code of conduct, requiring CEO/CFO certification of financial statements and for improving disclosures to shareholders. Certain non-mandatory clauses like whistle blower policy and restriction of the term of independent directors have also been included.

The term ‘Clause 49’ refers to clause number 49 of the Listing Agreement between a company and the stock exchanges on which it is listed (the Listing Agreement is identical for all Indian stock exchanges, including the NSE and BSE). This clause is a recent addition to the Listing Agreement and was inserted as late as 2000 consequent to the recommendations of the Kumarmangalam Birla Committee on Corporate Governance constituted by the Securities Exchange Board of India (SEBI) in 1999.

Audit of Mutual Funds: Mutual Funds Constituents

AMC: A company that invests its clients' pooled fund into securities that match its declared financial objectives. These companies earn income by charging service fees to their clients.

Sponsor: The sponsor initiates the idea to set up a mutual fund. It could be a registered company, scheduled bank or financial institution. The sponsor appoints the trustees, AMC and custodian. Once the AMC is formed, the sponsor is just a stakeholder.

Trust/board of trustees: Trustees hold a fiduciary responsibility towards unit holders by protecting their interests. Sometimes, as with Canara Bank, the trustee and the sponsor are the same.

Clause 49 vs. SOX

A) Internal control:-

Clause 49(revised) :-

CEO/CFO accept responsibility for establishing and maintaining internal controls and that they have evaluated the effectiveness of the internal control systems of the company and they have disclosed to the auditors and the Audit committee, deficiencies in the design or operation of internal controls, if any, of which they are aware and the steps they have taken or propose to take to rectify these deficiencies. The role of audit committee is to review this internal control report.

Sec. 302 of Sarbanes-Oxley:-

The principle executive officer or officers and the principle financial officer or officers or persons performing similar functions have the responsibility of designing, establishing and maintaining the internal controls. Here in the Sarbanes Oxley Act the public company accounting oversight board will review the same and not the audit committee.

a. In Clause 49 the audit committee will review the internal control mechanism whereas as per the Sarbanes Oxley Act the public company accounting oversight board will review the same.

b. In Clause 49 Internal Control is only specified but no elaborative details are given about it whereas in Sec. 404 of the Sarbanes Oxley act the details regarding the same are specified.

B) Audit Committee composition:-

Section 301 of Sarbanes-Oxley:-

The committee (or equivalent body) established by the board of directors of the issuer for the purpose of overseeing the accounting and financial reporting processes of the issuer. If there is no such committee then entire board of director is considered to be the member of the audit committee. Each member of the company's audit committee must be a director and must otherwise be independent.

Clause 49 (revised) :-

1. The audit committee shall have minimum three directors as members.

2. Two-thirds of the members of audit committee shall be independent directors.

3. All members of audit committee shall be financially literate and at least one

member shall have accounting or related financial management expertise.

In Sarbanes Oxley act the number of directors constituting the audit committee is not specified. Also the frequency, the time gap between the meetings of audit committee is not specified. This points are clear in the Clause 49.

C) Independent Director:-

As per Sarbanes-Oxley:-

In order to be considered independent the one who does not

1. Accept any consulting, advisory or other compensatory fee from the issuer.

2. Be an affiliated person of the issuer or any subsidiary there of.

As per Clause 49 (revised) :-

For the purpose of the sub-clause (ii), the expression ‘independent director’ shall mean a non-executive director of the company who:

a. apart from receiving director’s remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associates which may affect independence of the director;

b. is not related to promoters or persons occupying management positions at the board level or at one level below the board;

c. has not been an executive of the company in the immediately preceding three

financial years;

d. is not a partner or an executive or was not partner or an executive during the

preceding three years, of any of the following:

i) the statutory audit firm or the internal audit firm that is associated with the company, and

ii) the legal firm(s) and consulting firm(s) that have a material association with the company.

e. is not a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the director; and

f. is not a substantial shareholder of the company i.e. owning two percent or more of the block of voting shares.

As per the clause 49 the definition of the independent director is wider in scope than the one in Sarbanes Oxley Act.

Shareholders / Investors complaints:-

Sec. 301 of Sarbanes-Oxley:-

As per this section, each audit committee shall establish procedures for

1. The receipt, retention and treatment of complaints received by the issuer regarding accounting, internal accounting controls or auditing matters and

2. the confidential, anonymous submission by employee of the issuer of concerns regarding questionable accounting or auditing matters.

Clause 49 (revised) :-

Shareholders section in the disclosures of clause 49 states that:

A board committee under the chairmanship of a non-executive director shall specifically look into the redressal of shareholder and investors complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc. This Committee

shall be designated as ‘Shareholders/Investors Grievance Committee’.

Sarbanes Oxley act mainly considers the accounts related queries whereas Clause 49 covers the topic in the broad sense.

E) Penal Provisions:-

Clause 49 (revised) :-

For violation of the listing agreement, Section 23E of Securities Contract Regulation Act, 1956 provides for a pecuniary penalty of upto Rs.25 crores-on the company.

Sec. 302 of Sarbanes-Oxley:-

For violation of Sarbanes-Oxley Act, Section 906 provides for fines and imprisonment of up to $ 1 million and 10 years for knowing violations of Section 906, and up to $5 million and 20 years for willful violations

F) Code of Conduct/Ethics:-

Section 406 of Sarbanes-Oxley:-

The act directs the companies to disclose if they have adopted code of conduct, if not, reasons thereof. Code of ethics for senior financial officers: Issuers shall adopt a code of ethics for senior financial officers, applicable to its principal financial officer and comptroller or principal accounting officer, or persons performing similar functions.

Clause 49(Revised):-

1.The Board shall lay down a code of conduct for all Board members and senior management of the company. The code of conduct shall be posted on the website of the company.

2. All Board members and senior management personnel shall affirm compliance with the code on an annual basis. The Annual Report of the company shall contain a declaration to this effect signed by the CEO.

3. For this purpose, the term "senior management" shall mean personnel of the company who are members of its core management team excluding Board of Directors. Normally, this would comprise all members of management one level below the executive directors, including all functional heads.

As per the above paragraph, in the Indian context, it will be obligatory for the board of the company to lay down a code of conduct for the board members and the senior management of the company. As per Sarbanes-Oxley restricts the code of conduct to be applicable to only 'principal financial officer and comptroller or principal accounting officer, or persons performing similar functions.

G) Public Company Accounting Oversight Board:-

As per the Sarbanes Oxley act, a Public Company Accounting Oversight Board has been set up to oversee the audit of listed companies in order to protect investors’ and public interest in matters relating to the preparation of audited financial statements.

There is no such provision in the Clause 49. In India the ICAI is legally empowered to carry out most of the regulatory, oversight and disciplinary functions outlined in the SOX Act (barring prosecution and levying of penalties). But the public perception is that the ICAI mechanisms are slow and the institute is not interested in adequately disciplining the members. In India the functions of PCAOB are carried out by various regulatory agencies viz. SEBI, RBI, ICAI, ICSI, ICWAI etc. If there were to be an Indian version of the PCAOB, then such powers would need to be withdrawn from the existing regulatory agencies and concentrated in the proposed public oversight board.

Peer Review

The peer review mechanism was established by the Council of the ICAI with the issuance of the Statement on Peer Review in March, 2002. Peer review will help in reassuring the stakeholders and the society at large that the profession is conscious of its responsibilities and strives at its best to ensure that the highest standards are observed by all the practising members rendering audit and attestation services to the society. It is to be noted that peer review report has nothing to do with the disciplinary or other regulatory mechanism. Under peer review one chartered accountant will examine the other chartered accountant to judge the quality of attestation work performed by them. The former is known as Reviewer and the latter is known as practice unit/ audit firm.

The main objective of peer review is to ensure that in carrying out their professional attestation service assignments, the members of the Institute:

(i) comply with the technical standards laid down by the ICAI;

(ii) have in place proper systems, including documentation systems, for maintaining the quality of the attestation services they perform.

The peer review is administered by Peer Review Board (PRB) constituted by ICAI. The Reviewer shall submit his report to PRB and necessary follow up action may be taken by PRB on such report.