Valuation is not merely the determination of values of the assets as appearing in the balance sheet but it also the critical examination of these values on the basis of normally accepted accounting principles. Auditor is not the valuer, but he is definitely connected intimately with valuation.
For the purpose of valuation assets are classified as follows
- Fixed Assets: Eg- Land, Building, Plant
- Floating or Current or Circulating Assets: Eg- Debtors, Stock
- Wasting Assets: Eg- Mines, Oil wells
- Intangible Assets: Eg- Goodwill, Patent, Copyright
- Fictitious Assets: Eg- Preliminary exp., Discount on shares.
Table of Contents
Valuation of Fixed Assets
A fixed asset may be defined as an asset which is held with the intension that it will be used for the production or long term purpose & not for sale in the normal course of business. Accordingly
- They are carried over from year to year
- b. They are relatively higher value
- In inflationary market condition, their book value is lower than their replacement value.
Fixed Assets may be classified as
- Assets which are not subject to depreciation. Eg. Land- land having infinite life & it’s value always appreciate. Since land never depreciated.
- Assets which are subject to depreciation. Eg. Building, Plant & machinery.
- Assets which are subject to depletion. Eg. Mines, Oil wells.
- Assets which are subject to amortized. Eg. Goodwill.
- Non-depreciable assets are valued: at cost price, including purchase price, broker’s commission, registration fees, legal fees & other expenses on its conditioning.
- Depreciable assets are valued: at cost of purchase or construction, which includes all incidental payments.
- Any fluctuations in the price are to be ignored because the assets are not meant for resale & their usefulness to the business is not influenced by their market price.
Valuation of Current/Floating Assets
Floating assets are those current assets, which are purchased or created in normal course of business. They are held temporarily for the purpose of ultimately converting them into cash.
Mainly these assets are two types:
typesi. Stock in trade & ii. Debtors & receivables
- Debtors & bill receivables will be valued at their realizable value. l Whereas stock valued differently-
- Raw material & work in progress should be normally valued at cost.
- Finished goods are valued at cost or NRV whichever is lower. (NRV= Net Realizable Value)
Audit of Current Assets
- Auditor’s responsibility as to the valuation of assets does not end with merely securing a certificate of valuation from expert, including officials of the client.
- He has a duty to take all reasonable steps & exercise due care to ensure that the value of assets is shown in certificates does indeed represent a true & fair.
- He is required to ascertain the valuation has been done in conformity with legal & professional standards
- Principles & practice governing the valuation of assets have been consistently followed.
Inventories (Stock in Trade)
Inventories constitute the single most important item affecting the results of operation of an enterprises & its financial condition. Object of verification of inventories is:
- To ascertain that proper care has been taken in determining the physical quantities & their conditions.
- To ensure that any lien or pledging of the goods is disclosed in the financial statements.
- To assure that the quantities have been fairly & consistently priced in accordance with accepted accounting principles.
Some Important Points as to Inventory Verification:
A large part of inventory verification is done by client staff members. Auditor should take the following precautions to ensure that inventory verification is free of errors & frauds.
- Auditor should examine the system of internal control to ascertain the effectiveness of work. Proper segregation of responsibilities for custody & accounting of stock in trade.
- He should secure a copy of client’s physical inventory verification instruction in advance & see whether these contain adequate safeguards against possible errors & frauds.
- He should satisfy himself that proper & adequate records have been maintained by client, & proper cutoff arrangements made. Any movement of goods are properly added or deducted as required.
- He should ensure that the methods regarding counting, weighing & measuring of inventories are duly adhered to.
- He should test check the physical existence of at least 5% of the items to ascertain whether records do correctly represent the stock in hand.
- He should check the original verification sheet to ascertain whether all items are covered. Any difference between the physical count & inventory record should be investigated & suitable adjustments made in records.
- He should see that inventory lying with third parties, are included in inventory sheets. It should also ensure that these are not counted twice.
- He should work out the ratio between gross profit & sales & compare with previous year. Any material difference between two should be properly investigated.
- Auditor should see that inventory is valued “at lower of cost or NRV”. Cost should be further defined as average, FIFO, etc.
Valuation of Inventory
- Inventory should be valued in accordance with Accounting Standard 2.
- Management determines the basis on which the inventories are valued. The normal basis is Cost or Net Realizable Value, whichever is lower.
- Cost is to be arrived at by taking the aggregate of costs of conversion & other cost incurred in bringing inventory to the present location & condition.
- The net realizable value is the estimated selling price in the ordinary course of business, less cost incurred in order to make the sale.
Long term Work in Progress
- Auditor should ascertain by reference to appropriate evidence regarding to the inventory of Work-in-progress (WIP) at the end of the accounting year. Particularly in a situation where no cost system is in operation or where a cost system is in operation but is not considered reliable.
- The auditor should review the procedure of stocktaking & also allocation of material & wages to jobs has been done properly should be verified.
- Where physical verification is not conducted by the management, the statement submitted by the management should be reviewed with other internal records maintained.
- Auditor should follow the under mentioned procedure to test the reliability of costing records,
- Ascertain that the cost sheets are duly attested by the works engineer & works manager.
- Test the correctness of the cost as disclosed by the cost records with reference to records maintained & original evidence in respect of all expenditure included in cost sheet.
- Compare the unit cost or job cost as shown by the cost sheet with the standard cost or estimates.
- Compare cost sheet in detail with the previous year’s records. If they vary materially, the causes thereof should be investigated.
- To ascertain that the WIP is valued either at cost or net realizable value whichever is lower. The auditor should also see that the mode of valuation.
- Certificate from the management should be obtained regarding quantity & value of WIP.
Following procedure should be adopted for verification of debtors:
- Obtain a list of debtor balance & agree the total with a control account. Tests should be performed on individual debtors account with nil balances.
- Scrutinize the control account for unusual items & test a selection of balances.
- Agree a selection of receipts after the year-end.
- Bad debts:
The auditor has to satisfy himself that adequate provision has been made for all doubtful & bad debts. He mus
- Obtain a detailed age analysis of debtors & test the analysis.
- Obtain an analysis of the provision for doubtful debts.
- Scrutinize analysis & identify those debts which appear doubtful. –
- Discuss with management their reasons, if any of those debts which are not included in the provision for bad debts.
- Perform further testing where any dispute exists.
- Reach the final conclusion regarding the adequacy of bad debts provision.
- Cutoff Procedures:
Auditor will need to perform tests to ensure that
- The last invoices issued during the year & which have been included in debtors that the goods have been dispatched & the goods are not included in stock.
- All goods dispatched prior to the year end have been removed from the stock record & included in debtors.
- Goods sold after the year end is not included in year end debtors.
- Debtors Confirmation:
The auditor should:
- Obtain the client’s permission.
- Decide the sample required &select the sample including nil balances.
- Control the posting of letters
- Enclose a stamped addressed envelope & ensure that replies are received by the auditor himself.
- Send reminders if replies are not received
- Investigate thoroughly any balances which are not agreed by the customers. Full explanations should be obtained
- Where no reply is received the auditor should perform additional testing.
The auditor is required to satisfy himself as regards the powers of the enterprises under audit to make investments, by examining the documents such as the “Memorandum of Association” in case of company. Investments may be classified as
- Marketable securities
- Long term investments
Marketable securities are readily saleable, but long term investments which are held with no likely intention to sell, are not so.
All investments should be held in the name of the client. If they are held in the name of his nominee, the letter confirming the arrangement should be examined. Investments should be verified by reference to the schedule of investment. The schedule of investment should give particular as the date of purchase, name of security, cost, market price, date of receipt or accrual of interest or dividend & these should be tallied with the investment register.
The object of verification of investments is to ascertain that
- There is a valid evidence of their ownership & custody.
- They are properly classified in financial statement as current & long term.
- There is adequate disclosure of any pledging, hypothecation.
- They are valued on a basis in accordance with legal & professional standards.
Here, Current Investment – shown at cost or NRV, whichever is lower.
Long Term Investment – shown at cost. Except if there is permanent decline in investment.
The auditor should take following step for verification of balances of loan
- Year end scrutiny to ascertain bad & doubtful debts & checking individual balances in the ledger with the list of loans & advances.
- Inspection of loan agreements & the acknowledgements of parties in respect of receipt.
- Examination of the sanction of loans by the board directors, the purpose of the loans & compliance with the provisions.
- Ensuring the loan made by the company are intra-vires of power of the company.
- Examination of all the documents relating to the loan & satisfying that the borrower is competent to receive the loan. The auditor should enquire whether the lending company has satisfied itself about the loans compliance by the borrower.
- In case of secured loans, inspecting the securities, collateral & other documents of title & determining the security is adequate & title is clear.
Advances include the amounts recoverable either in cash or in kind for value to be received.
- The auditor should obtain the list of advances & compare them with balances in the ledger.
- He should ascertain that advances were made under proper authority & were being recovered regularly by agreed instalments. Where there is an agreement, the same should be inspected.
- Auditor should ensure that adequate provision has been made in respect of irrecoverable balances.
- Auditor should compare the entries in cash book with those in the passbook.
- A bank reconciliation statement prepared by the client should be checked.
- Auditor should also obtain the certificate from bank confirming the balance at the yearend as shown in passbook.
- If bank account is overdrawn, auditor should obtain from bank particulars of assets on which the charge has been created to secure the overdraft.
Cash balance on Hand
- The auditor should verify the cash in hand at the close of the business on the last day of the financial year. If it is not possible then cash in hand should be checked on someday close to year-end.
- All cash should be assembled at one place & counted at same time to avoid frauds.
- In case of outstation branches, certificate should be obtained from the branch manager. It should be ascertained that cash balance is not large in relation to the client’s normal requirements.
- A statement should be prepared in duplicate showing the denomination & number of currency notes, & values of coins & small change, which have been counted. One copy of the statement should be retained by the auditor’s staff & other copy should be given to the cashier.