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Financial and Material Resource Management

Course description

Availability of adequate financial resources may be a pre-requisite to make many other activities

possible, but it is not sufficient. How financial resources are managed and accounted for is

equally important. It should be noted here that financial resources do not only refer to money but

also materials that are money-worth. In health care institutions, auditors and finance officers will

be interested in both the management of funds and materials like drugs, and equipment. Indeed

these materials consume a share of the budget that is often as significant as their impact on the

quality of health care services rendered.

The scarcity of financial and material resources is an established fact. The need of managing

them honestly, efficiently and effectively is an obvious truism. It is, also, an objective that is as

often unmet as it is reiterated and stressed. Health managers must be competent in the reading,

assessing and interpreting of financial statements. They must have skills and competency in

budgeting. They must be able to plan, procure, control and use material resources effectively and

efficiently. Yet, few of them ever received any formal training in these fields and therefore

frequently make mistakes of great consequences. Good management of funds and material

resources, clear, unambiguous and regular accountability of their use, are essential if their flow

or usefulness is to be maintained.

CHAPTER ONE

BASIC ACCOUNTING TERMINOLOGY, CONCEPTS AND PRINCIPLES

These concepts constitute the very basis of accounting. All the concepts have been developed

over the years from experience and thus they are universally accepted rules. Following are the

various accounting concepts that have been discussed in the following sections:

1. Business entity concept

2. Money measurement concept

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3. Going concern concept

4. Accounting period concept

5. Accounting cost concept

6. Duality aspect concept

7. Realization concept

8. Accrual concept

9. Matching concept

1. BUSINESS ENTITY CONCEPT

This concept assumes that, for accounting purposes, the business enterprise and its owners are

two separate independent entities. Thus, the business and personal transactions of its owner are

separate. For example, when the owner invests money in the business, it is recorded as liability

of the business to the owner. Similarly, when the owner takes away from the business cash/goods

for his/her personal use, it is not treated as business expense. Thus, the accounting records are

made in the books of accounts from the point of view of the business unit and not the person

owning the business. This concept is the very basis of accounting

Significance

The following points highlight the significance of business entity concept:

This concept helps in ascertaining the profit of the business as only the business expenses

and revenues are recorded and all the private and personal expenses are ignored.

This concept restrains accountants from recording of owner’s private/ personal

transactions.

It also facilitates the recording and reporting of business transactions from the business

point of view.

It is the very basis of accounting concepts, conventions and principles

2. MONEY MEASUREMENT CONCEPT

This concept assumes that all business transactions must be in terms of money that is in the

currency of a country. In our country such transactions are in terms of rupees.

Thus, as per the money measurement concept, transactions which can be expressed in terms of

money are recorded in the books of accounts For example, sale of goods worth Rs.200000,

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purchase of raw material Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money,

and so they are recorded in the books of accounts. But the transactions which cannot be

expressed in monetary terms are not recorded in the books of accounts. For example, sincerity,

loyalty, honesty of employees are not recorded in books of accounts because these cannot be

measured in terms of money although they do affect the profits and losses of the business

concern.

Significance

The following points highlight the significance of money measurement concept:

This concept guides accountants what to record and what not to record.

It helps in recording business transactions uniformly.

If all the business transactions are expressed in monetary terms, it will be easy to

understand the accounts prepared by the business enterprise.

It facilitates comparison of business performance of two different periods of the same

firm or of the two different firms for the same period.

3. GOING CONCERN CONCEPT

This concept states that a business firm will continue to carry on its activities for an indefinite

period of time. Simply stated, it means that every business entity has continuity of life. Thus, it

will not be dissolved in the near future. This is an important assumption of accounting, as it

provides a basis for showing the value of assets in the balance sheet; For example, a company

purchases a plant and machinery of Rs.100000 and its life span is 10 years. According to this

concept every year some amount will be shown as expenses and the balance amount as an asset.

Thus, if an amount is spent on an item which will be used in business for many years, it will not

be proper to charge the amount from the revenues of the year in which the item is acquired.

Only a part of the value is shown as expense in the year of purchase and the remaining balance is

shown as an asset.

Significance

The following points highlight the significance of going concern concept;

This concept facilitates preparation of financial statements.

On the basis of this concept, depreciation is charged on the fixed asset.

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It is of great help to the investors, because, it assures them that they will continue to get

income on their investments.

In the absence of this concept, the cost of a fixed asset will be treated as an expense in the

year of its purchase.

A business is judged for its capacity to earn profits in future.

4. ACCOUNTING PERIOD CONCEPT

All the transactions are recorded in the books of accounts on the assumption that profits on these

transactions are to be ascertained for a specified period. This is known as accounting period

concept. Thus, this concept requires that a balance sheet and profit and loss account should be

prepared at regular intervals. This is necessary for different purposes like, calculation of profit,

ascertaining financial position, tax computation etc.

Further, this concept assumes that, indefinite life of business is divided into parts. These parts are

known as Accounting Period. It may be of one year, six months, three months, one month, etc.

But usually one year is taken as one accounting period which may be a calendar year or a

financial year.

Year that begins from 1st of January and ends on 31st of December, is known as

Calendar Year.

The year that begins from 1st of April and ends on 31st of March of the following year, is

known as financial year.

As per accounting period concept, all the transactions are recorded in the books of accounts for a

specified period of time. Hence, goods purchased and sold during the period, rent, salaries etc.

paid for the period are accounted for and against that period only.

Significance

It helps in predicting the future prospects of the business.

It helps in calculating tax on business income calculated for a particular time period.

It also helps banks, financial institutions, creditors, etc to assess and analyze the

performance of business for a particular period.

It also helps the business firms to distribute their income at regular intervals as dividends.

5. ACCOUNTING COST CONCEPT

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Accounting cost concept states that all assets are recorded in the books of accounts at their

purchase price, which includes cost of acquisition, transportation and installation and not at its

market price. It means that fixed assets like building, plant and machinery, furniture, etc are

recorded in the books of accounts at a price paid for them. For example, a machine was

purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1,000

were spent on transporting the machine to the factory site. In addition, Rs.2000 were spent on its

installation. The total amount at which the machine will be recorded in the books of accounts

would be the sum of all these items i.e. Rs.503000. This cost is also known as historical cost.

Suppose the market price of the same is now Rs 90000 it will not be shown at this value. Further,

it may be clarified that cost means original or acquisition cost only for new assets and for the

used ones, cost means original cost less depreciation. The cost concept is also known as

historical cost concept. The effect of cost concept is that if the business entity does not pay

anything for acquiring an asset this item would not appear in the books of accounts. Thus,

goodwill appears in the accounts only if the entity has purchased this intangible asset for a price.

Significance

This concept requires asset to be shown at the price it has been acquired, which can be

verified from the supporting documents.

It helps in calculating depreciation on fixed assets.

The effect of cost concept is that if the business entity does not pay anything for an asset,

this item will not be shown in the books of accounts.

6. DUAL ASPECT CONCEPT

Dual aspect is the foundation or basic principle of accounting. It provides the very basis of

recording business transactions in the books of accounts. This concept assumes that every

transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.

Therefore, the transaction should be recorded at two places. It means, both the aspects of the

transaction must be recorded in the books of accounts.

For example, goods purchased for cash has two aspects which are

(i) Giving of cash

(ii) (ii) Receiving of goods. These two aspects are to be recorded.

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Thus, the duality concept is commonly expressed in terms of fundamental accounting equation :

Assets = Liabilities + Capital

The above accounting equation states that the assets of a business are always equal to the claims

of owner/owners and the outsiders. This claim is also termed as capital or owners equity and that

of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in identifying

the two aspects of a transaction which helps in applying the rules of recording the transactions in

books of accounts. The implication of dual aspect concept is that every transaction has an equal

impact on assets and liabilities in such a way that total assets are always equal to total liabilities.

Let us analyze some more business transactions in terms of their dual aspect :

1.Capital brought in by the owner of the business

The two aspects in this transaction are :

(i) Receipt of cash

(ii) Increase in Capital (owners’ equity)

2. Purchase of machinery by cheque The two aspects in the transaction are (i) Reduction in

Bank Balance (ii) Owning of Machinery

3. Goods sold for cash The two aspects are (i) Receipt of cash

(ii) Delivery of goods to the customer

4. Rent paid in cash to the landlord

The two aspects are:

(i) Payment of cash

(ii) Rent (Expenses incurred).

Once the two aspects of a transaction are known, it becomes easy to apply the rules of

accounting and maintain the records in the books of accounts properly. The interpretation of the

Dual aspect concept is that every transaction has an equal effect on assets and liabilities in such a

way that total assets are always equal to total liabilities of the business.

Significance

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This concept helps accountant in detecting error.

It encourages the accountant to post each entry in opposite sides of two affected accounts.

UNDERSTANDING BASIC FINANCIAL STATEMENTS

Elements of the financial Statements

Elements of the financial statements include Assets, Liabilities, Equity, Income &Expenses. The first

three elements relate to the statement of financial position whereas the latter two relate to the income

statement.

The first three elements relate to the statement of financial position while the latter two relate to income

statements.

Assets

Asset is a resource controlled by the entity as a result of past events and from which future economic

benefits are expected to flow to the entity (IASB Framework).

Explanation

In simple words, asset is something which a business owns or controls to benefit from its use in some

way. It may be something which directly generates revenue for the entity (e.g. a machine, inventory) or it

may be something which supports the primary operations of the organization (e.g. office building).

Classification

Assets may be classified into Current and Non-Current. The distinction is made on the basis of time

period in which the economic benefits from the asset will flow to the entity.

Current Assets are ones that an entity expects to use within one-year time from the

reporting date.

Non Current Assets are those whose benefits are expected to last more than one year

from the reporting date.

Types and Examples

Following are the most common types of Assets and their Classification along with the economic benefits

derived from those assets.

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Asset

Classification

Economic Benefit

Machine

Non-current

Used for the production of goods for sale to

customer.

Office

Building

Non-current

Provides space to employees for administering

company affairs.

Vehicle

Non-current

Used in the transportation of company products

and also for commuting.

Inventory

Current

Cash is generated from the sale of inventory.

Cash

Current

Cash!

Receivables

Current

Will eventually result in inflow of cash.

A financial asset is an intangible asset whose value is derived from a contractual claim, such

as bank deposits, bonds, and stocks. Financial assets are usually more liquid than other tangible

assets, such as commodities or real estate, and may be traded on financial markets.

Types of financial assets

According to the International Financial Reporting Standards (IFRS), a financial asset can be:

(i) Cash or cash equivalent,

(ii) Equity instruments of another entity,

(iii) Contractual right to receive cash or another financial asset from another entity or to

exchange financial assets or financial liabilities with another entity under conditions that are

potentially favorable to the entity,

(iv) Contract that will or may be settled in the entity's own equity instruments and is either a

non-derivative for which the entity is or may be obliged to receive a variable number of the

entity's own equity instruments, or a derivative that will or may be settled other than by exchange

of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity

instruments.

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According to 'Linus Tweufilwa Haitembu' Financial assets are intangible assets that represent the

monetary value of that specific asset. Financial assets are more liquid assets than tangible assets.

Treatment of financial assets under IFRS

Under IFRS, financial assets are classified into four broad categories which determine the way in

which they are measured and reported:

Financial assets "held for trading" — i.e., which were acquired or incurred principally

for the purpose of selling, or are part of a portfolio with evidence of short-term profit-taking, or

are derivatives — are measured at fair value through profit or loss.

Financial assets with fixed or with determinable payments and fixed maturity which

the company has to be willing and able to hold till maturity are classified as "held-to-

maturity" investments. Held-to-maturity investments are either measured at fair value through

profit or loss by designation, or determined to be financial assets available for sale by

designation.

Financial assets with fixed or determinable payments which are not listed in an

active market are considered to be "loans and receivables". Loans and receivables are also

either measured at fair value through profit or loss by designation or determined to be financial

assets available for sale by designation.

All other financial assets are categorized as financial assets "available for sale" and

are measured at fair value through profit or loss by designation.

For financial assets to be measured at fair value through profit or loss by designation, designation

is only possible at the amount the asset was initially recognized at. Moreover, designation is not

possible for equity instruments which are not traded in an active market and the fair value of

which cannot be reliably determined. Further (alternative) requirements for designation are e.g.

at least a clear diminution of a "mismatch" with other financial assets or liabilities,[7] an internal

valuation and reporting and steering at fair value,[8] or a combined contract with an embedded

derivative which is not immaterial and which may be separated.[9] Regarding financial assets

available for sale by designation, designation is only possible at the amount the asset was

initially recognized at as well. However, there are no further restrictions or requirements.

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ACCOUNTING CONCEPT AND PRINCIPLES

Accounting Concepts and Principles are a set of broad conventions that have been devised to

provide a basic framework for financial reporting. As financial reporting involves significant

professional judgments by accountants, these concepts and principles ensure that the users of

financial information are not mislead by the adoption of accounting policies and practices that go

against the spirit of the accountancy profession. Accountants must therefore actively consider

whether the accounting treatments adopted are consistent with the accounting concepts and

principles.

In order to ensure application of the accounting concepts and principles, major accounting

standard-setting bodies have incorporated them into their reporting frameworks such as the IASB

Framework.

Following is a list of the major accounting concepts and principles:

a) Relevance

b) Reliability

c) Matching Concept

d) Timeliness

e) Neutrality

f) Faithful Representation

g) Prudence

h) Completeness

i) Single Economic Entity Concept

j) Money Measurement Concept

k) Comparability/Consistency

l) Understandability

m) Materiality

n) Going Concern

o) Accruals

p) Business Entity

q) Substance over Form

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r) Realization Concept

s) Duality Concept

In case where application of one accounting concept or principle leads to a conflict with another

accounting concept or principle, accountants must consider what is best for the users of the

financial information. An example of such a case would be the trade-off between relevance and

reliability. Information is more relevant if it is disclosed timely. However, it may take more time

to gather reliable information. Whether reliability of information may be compromised to ensure

relevance of information is a matter of judgment that ought to be considered in the interest of the

users of the financial information.

ACCOUNTING FOR CASH AND CASH TRANSACTIONS

Cash Transactions

Cash transactions are ones that are settled immediately in cash, and Cash transactions also

include transactions made through cheques. Cash transactions are usually classified into cash

receipts and cash payments.

1) Cash Receipts

Cash receipts are accounted for by debiting cash / bank ledger to recognize the increase in the

asset.

Following are common types of cash receipt transactions along with relevant accounting entries:

Cash Sale:

Debit Cash

Credit Sales

Cash receipt from receivable:

Debit Cash

Credit Receivable

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Capital contribution from shareholders:

Debit Bank

Credit Share Capital

Receipt of loan from a bank:

Debit Bank

Credit Loan

2) Cash Payments

Cash payments are accounted for by crediting the cash / bank ledger to account for the decrease in the

asset.

Following are common types of cash payment transactions along with relevant accounting entries:

Cash payment to a payable:

Debit Payable

Credit Cash

Purchase of inventory for cash:

Debit Purchases

Credit Cash

Purchase of a machine for cash:

Debit Machinery – Asset

Credit Cash

Cash Drawings by owner:

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Debit Drawing

Credit Cash

Repayment of loan installment:

Debit Loan

Credit Cash

Companies that use cash basis accounting record revenues when cash is received and record

expenses when they are paid. Cash basis accounting is simple and may be sufficient for some

small businesses.

Businesses must choose one or the other of two possible approaches to financial accounting and

reporting:

Cash basis accounting is the practice of recording revenues when cash is received and recording

expenses when the expense is paid.

Accrual accounting is the practice of recording revenues when they are earned and recording

expenses when they are owed.

On first hearing the distinction between cash accounting and accrual accounting, the difference

may sound minor. When the natures of the two accounting systems are better understood

however, it is clear that the choice of accounting system has a profound influence on the way the

company bills its customers, collects payments, pays its bills, and meets reporting obligations to

regulatory agencies and governments. The vast majority of businesses choose accrual

accounting. It is almost impossible for a public company (a company that sells shares of stock to

the public) to meet its reporting requirements using cash accounting alone.

Cash transactions eligible for recording in a cash basis system include actual physical transfer of

coins and banknotes, of course, but also forms of transmission that will turn into cash very

quickly, including written checks, credit cards, bank debit cards, and bank wire transfers. In a

cash basis system, however, the receipt of a promissory note, the creation of an account

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receivable, or the sending of a customer invoice are not, by themselves, transactions eligible for

recording.

Major differences between cash and accrual accounting

The difference between cash and accrual accounting stems from the fact that most business

transactions involve two events and, moreover, these events can occur at different times. The

seller delivers goods or services (one event) and the buyer pays for the goods and services

(another event). These events may occur more or less simultaneously or there may be a time

lapse between them. Either event may precede the other.

The seller may deliver goods, for instance, then invoice the customer and wait 30 days or more

for payment. Or the seller may receive payment "up front," and then deliver later (e.g., when the

buyer leases floor space, the payment is typically made before the occupancy period).

Under cash basis accounting, the seller's paid expenses for delivering goods or services

are recorded only when they actually occur. Similarly, the seller records cash received from the

customer only when that occurs, even if time passes between the events, and even if they occur

in different accounting periods.

The generally accepted accounting principles (GAAP) in most countries,

however, incorporate the matching concept, the idea that reported incoming revenues should be

matched (reported in the same accounting period) with the costs that bring them. Otherwise,

reported margins and profits are misleading.

In contrast to cash basis accounting, the alternative—accrual accounting with adouble

entry system—achieves matching by using two pairs of transactions for a single sale. For

the seller, closing the sale and delivering goods or services brings two bookkeeping entries

(a debit to one account and a credit to another), while receiving the customer's cash payment

brings another two entries (again, a debit to one account and a credit to another). Similarly,

the buyer records two transactions when the payment is owed, and another two when cash is

paid. Under accrual accounting, the reported income for both buyer and seller is based on each

party's first pair of transactions—i.e. entries showing the money earned (for the seller) and the

money owed (for the buyer).

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CASH BASIS ACCOUNTING EXAMPLES

Cash accounting works hand-in-glove with single-entry accounting, while accrual accounting

works well only with double entry accounting. As a result, examples that Illustrated the

differences between cash accounting and accrual accounting are very similar to illustrations

showing the differences between single entry and double entry systems.

Cash accounting with a single entry approach is very similar to the check register that individuals

use to keep track of checks, deposits, and balances for a single checking account: The amount of

each cash inflow or outflow is recorded along with the transaction name or description. Tables 1

and 2, below, are examples showing how the cash basis single entry record might look for one

day's transactions for a very small business (e.g., a small retail shop operating as a sole

proprietorship).

Date Transaction Amount

1 June XX Starting balance for day $4,520.00

1 June XX Electricity bill for month ($149.80)

1 June XX Postage stamps purchased ($43.00)

1 June XX Inventory purchased ($624.15)

1 June XX Daily product sales $1,040.25

1 June XX Sales tax paid ($83.22)

1 June XX Dailyservice revenues $592.25

1 June XX Bank interest received $180.83

1 June XX Customer refund paid ($42.95)

1 June XX Ending balance for day $5,390.21

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Table 1. The simplest form of cash basis accounting in a single

entry system, showing one day's transactions for a small business. Cash

funds received are positive numbers and cash funds paid out are negative

(in parentheses).

Date Transaction Revenues Expenses Balance

1 June

XX

Starting balance for day $4,520.00

1 June

XX

Electricity bill for month ($149.80) $4,370.20

1 June

XX

Postage stamp purchase ($43.00) $4,327.20

1 June

XX

Inventory purchased ($624.15) $3,703.5

1 June

XX

Daily product sales $1,040.25 $4,743.30

1 June

XX

Sales tax paid ($83.22) $4,660.08

1 June

XX

Dailyservice revenues $592.25 $5,252.33

1 June

XX

Bank interest received $180.83 $5,433.16

1 June

XX

Customer refund paid ($42.95) $5,390.21

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1 June

XX

Ending balance for day $5,390.21

Table 2. Cash basis transactions with a single entry system, using a running

balance and separate columns for incoming cash revenues and outgoing

cash expenses. Funds received are positive numbers, funds paid out are

negative.

Additional columns can be added, of course, to show different categories of revenues or

expenses. The only structure required in the records is to include enough different revenue and

expense categories to meet tax reporting requirements.

WHEN CASH BASIS ACCOUNTING MAY BE SUFFICIENT

Cash accounting can be adequate for a some small businesses. The cash basis approach may, in

fact, be preferred over an accrual system for small companies where all or most of these

conditions apply:

The company uses a single entry system approach for bookkeeping and

accounting, not a double entry system.

The company has relatively few financial transactions per day.

The company does not sell on its own credit, meaning it does not deliver goods or

services and then invoice customers for payment later. Customers must pay at the time of

the sale either in cash, or by written check or bank transfer, or with a 3rd-party

credit/debit card.

The company has very few employees.

The company owns few expensive business-supporting physical assets (e.g., it may own

some product inventory, office supplies, and cash in a bank account, but it does not own

buildings, substantial amounts of office furniture, large computer systems, production

machinery, vehicles, etc.).

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The company is privately held or operates as a sole proprietorship or partnership (i.e., the

company does not need to publish the income statement, balance sheet, or other financial

statements that are required of publicly owned companies).

Under such conditions, a cash basis system may be adequate to meet the company's legal

reporting obligations. The cash basis system may be adequate for

Supporting the company's income tax reporting (for which the primary data are incoming

revenues and outgoing expenses, in several categories, if necessary).

Proving that the company collected and paid government sales taxes for goods or services

sold.

Proving that the company complied with minimum wage payment and employee income

tax withholding requirements.

Proving that the company pays its own income tax.

Forecasting future budgetary needs and sales revenues.

Providing real-time visibility and control of incoming and outgoing funds, to help prevent

spending over budget or overdrawing the company checking account.

ADVANTAGES AND DISADVANTAGES OF CASH BASIS ACCOUNTING

The advantages and disadvantages of cash basis accounting (with a single entry accounting

system) are best described by comparison with the primary alternate approach, accrual

accounting with a double entry system.

Cash basis accounting advantages

Cash basis accounting has the great advantage of simplicity over accrual accounting.

The cash basis approach (and single entry bookkeeping) are readily understood by people with little

or no financial or accounting background.

For many small companies, the cash basis approach can be implemented without the involvement of a

trained bookkeeper or accountant.

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The cash basis approach does not require complex accounting software. It should be clear from the

examples above, for instance, that a cash basis single entry system can be created and maintained

easily in a written notebook or a very simple spreadsheet.

CASH BASIS ACCOUNTING DISADVANTAGES

Cash basis accounting provides insufficient records and i sufficient control for public companies

and other organizations that are required to file audited financial statements such as the income

statement or balance sheet. Nor can it by itselfgive owners and management crucial information

for evaluating the company's financial position. Some of the important differences between the

two approaches illustrate disadvantages of the cash basis approach:

Lack of error checking

An accrual accounting system and double entry bookkeeping provide several forms of error

checking that are absent in cash accounting with a single entry system. In the accrual system,

every financial transaction results in both a debit (DR) entry in one account and an equal,

offsetting credit (CR) entry in another account. For any time period, the sum of all debits must

equal the sum of all credits. That is:

Total DR = Total CR

Moreover, an accrual double entry system works so that the balance sheet equation always holds:

Assets = Liabilities + Equities

These equations together are known as the accounting equation. Any departure from these

equalities in an accrual double entry system is a signal that a transaction entry error has been

made somewhere.

This kind of error checking is not built into a cash basis single entry system. If the cash

basis bookkeeper mistakenly enters, say, a revenue inflow as $10,000 when the correct value is

$1,000, the error may not be detected until the company receives a bank statement with an

unexpected low balance for a bank account (or an overdrawn account). In an accrual double

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entry system, however, the $1,000 cash deposit entry (a debit to an asset account, "cash on

hand") will be accompanied by another entry recognizing the source, e.g., a credit to a liability

account (e.g., "bank loan") or a credit to another asset account ("accounts receivable"). If the

second entry were not made, the sums of credits and debits in the system would differ,

immediately revealing the error.

Focus on revenues and expenses only

A double entry system keeps in view the company's entire chart of accounts. That is, all

transactions in a double entry system result in entries in two different accounts, which may be

the so-called income statement accounts (revenue accounts and expense accounts) or the so-

called balance sheet accounts (asset accounts, liability accounts, and equities accounts).

When the company receives cash through a bank loan, for as mentioned, the double entry system

records a debit for an asset account, e.g., "cash on hand" (for an asset account, a debit is an

increase), as well as a credit to a liability account, e.g., "bank loans" (with a liability account, an

increase is a credit).

With a single-entry system, the company may record cash received from a bank loan as incoming

cash, but there is no easy way to record the corresponding increase in liability (bank loan to be

repaid). Single entry systems do not easily track the value of assets, liabilities or equities.

Single entry systems, moreover, work hand-in-glove with cash basis accounting, where inflows

and outflows are recorded only when cash actually flows. Single entry systems cannot easily

support the alternative approach, accrual accounting as used by the vast majority of businesses

worldwide. When the delivery of goods and services comes at a different time from cash

payment for those goods and services, for instance, accrual accounting provides the mechanisms

for implementing the matching concept, the practice of recognizing revenues and the costs that

brought them in the same accounting period.

If the vendor delivery and the customer payment fall in different time periods, however, the

single entry system has no way of matching the two events and thus presents a misleading

picture of earnings for either period.

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As a result, it is extremely difficult to build a single entry system that conforms to the GAAP

requirements in most countries (Generally accepted accounting principles). This lack may not

concern sole proprietorships, partnerships, or very small privately held corporations—whose

accounting systems must support only the company's needs to comply with tax and employment

reporting requirements. It is nearly impossible to build a single entry system, however,

that supports by itself the reporting needs of public corporations, or other companies that must

report statements of income financial position (balance sheet), retained earnings, or cash flow

(changes in financial position).

ACCOUNTING CONTROL

DEFINITION OF 'ACCOUNTING CONTROL'

Methods and procedures that are implemented by a firm to help ensure the validity and accuracy

of its own financial statements. The accounting controls do not ensure compliance with laws and

regulations, but rather are designed to help a company comply.

BREAKING DOWN 'Accounting Control'

An example of an accounting control would be limiting management's involvement in the

preparation of financial statements. Sometimes it is helpful for management to be involved, since

they generally know the company better than anyone. But final say on numbers should be in the

hands of an accountant, because management may have incentive to distort numbers to inflate

the company's performance.

COST ACCOUNTING

DEFINITION OF 'COST ACCOUNTING'

Cost accounting is a type of accounting process that aims to capture a company's costs of

production by assessing the input costs of each step of production as well as fixed costs such

as depreciation of capital equipment. Cost accounting will first measure and record these costs

individually, then compare input results to output or actual results to aid company management

in measuring financial performance.

CLASSIFYING AND VALUING ASSETS

22

The task of identifying assets that need to be protected is a less glamorous aspect of information security. But

unlas we know these assets, their locations and value, how are we going to decide the amount of time, effort or money

that we should spend on securing the assets? by Avinash Kadam

In this series on Information Security Management System, we have so far discussed Security policy writing and

Security organization structure. Security policy is essential, since it shows the management's commitment to the

subject of information security, and establishes an outline giving clear direction in this matter. Security organization

creates an administrative infrastructure defining roles and responsibilities of various participants who are entrusted

with the responsibility of implementing and monitoring various aspects of information security.

The task of identifying assets that need to be protected is a less glamorous aspect of information security. But

unless we know these assets, their locations and value, how are we going to decide the amount of time, effort or money

that we should spend on securing the assets?

The major steps required for asset classification and controls are:

A. Identification of the assets

B. Accountability of assets

C. Preparing a schema for information classification

D. Implementing the classification schema

A. Identification of assets

What are the critical assets? Suppose your corporate office was gutted in a major fire. Coping with this level of disaster

will depend on what critical information you previously backed up at a remote location. Another nightmarish scene is

that a hacker entered your network and copied your entire customer database. What impact will this have on your

business?

Identifying the critical assets is essential for many reasons. You will come to know what is critical and essential

for the business. You will be able to take appropriate decisions regarding the level of security that should be provided

to protect the assets. You will also be able to decide about the level of redundancy that is necessary by keeping an extra

copy of the data or an extra server that you should procure and keep as a hot standby.

Next question that we need to ponder upon is: What exactly is an information asset? Is it the hardware, the

software, the programs or the database?

23

We can broadly classify assets in the following categories:

1. Information assets

Every piece of information about your organization falls in this category. This information has been collected,

classified, organized and stored in various forms.

Databases: Information about your customers, personnel, production, sales, marketing, finances. This information

is critical for your business. It's confidentiality, integrity and availability is of utmost importance.

Data files: Transactional data giving up-to-date information about each event.

Operational and support procedures: These have been developed over the years and provide detailed instructions

on how to perform various activities.

Archived information: Old information that may be required to be maintained by law.

Continuity plans, fallback arrangements: These would be developed to overcome any disaster and maintain the

continuity of business. Absence of these will lead to ad-hoc decisions in a crisis.

2. Software assets

These can be divided into two categories:

a) Application software: Application software implements business rules of the organization. Creation of

application software is a time consuming task. Integrity of application software is very important. Any flaw in the

application software could impact the business adversely.

b) System software: An organization would invest in various packaged software programs like operating systems,

DBMS, development tools and utilities, software packages, office productivity suites etc.

Most of the software under this category would be available off the shelf, unless the software is obsolete or non-

standard.

3. Physical assets

These are the visible and tangible equipment and could comprise of:

a) Computer equipment: Mainframe computers, servers, desktops and notebook computers.

b) Communication equipment: Modems, routers, EPABXs and fax machines.

c) Storage media: Magnetic tapes, disks, CDs and DATs.

d) Technical equipment: Power supplies, air conditioners.

24

e) Furniture and fixtures

4. Services

a) Computing services that the organization has outsourced.

b) Communication services like voice communication, data communication, value added services, wide area network

etc.

c) Environmental conditioning services like heating, lighting, air conditioning and power.

B. Accountability of assets

The next step is to establish accountability of assets. This is not difficult for the tangible assets like physical assets.

Usually the organization will have a fixed assets register maintained for the purpose of calculating depreciation.

A more difficult task is establishing ownership for the information assets. There will be a number of users for

these assets. But the prime responsibility for accuracy will lie with the asset owner. Any addition or modification to the

information asset will only be done with the consent of the asset owner. For example, any changes to customer

information will be done with the knowledge and consent of the marketing head. Information technology staff will

probably make the changes, physically. But ownership clearly lies with the business head who has the prime

responsibility for the content in the customer database.

Using these criteria, we have to identify the actual owners of each of the information assets. This is also an

important step for one more reason. Only an owner of the asset will be able to decide the business value of the asset.

Unless the correct business value of the asset is known, we cannot identify the security requirement of the asset.

The next step is identifying owners of the application software. Application software implements the business

rules. As such the business process owner should be the owner of application software. But the responsibility of

maintaining application software to accurately reflect business rules will be vested with the application developers. As

such, the accountability for application software should be with the application development manager.

System software ownership could be with the appropriate persons within the IT team. The owner of these assets

will be responsible for maintaining all the system software including protecting the organization against software

piracy.

Assets valuation

What is the value of an asset? Like beauty, which is in the eyes of the beholder, an asset's value is best known to the

asset owner. It may not be merely the written down value. A more realistic measure is the replacement value. How

25

much is it going to cost if the asset has to be acquired today? Accurate valuation of an information asset is a tricky

task. Due care must be taken. A seemingly small item may be immensely difficult to replace today.

True value of the asset will lead us to identify realistic measures needed for protection of the asset.

C. Preparing a schema for classification

The next task is to create classification levels. The criteria for the classification of assets could be:

1. Confidentiality: Can the information be freely distributed? Or do we need to restrict it to certain identified

individuals?

2. Value: What is the asset value? Is it a high value item, costly to replace or a low value item?

3. Time: Is the information time sensitive? Will its confidentiality status change after some time?

4. Access rights: Who will have access to the asset?

5. Destruction: How long the information will be stored? How can it be destroyed, if necessary?

Each asset needs to be evaluated against the above criteria and classified for easy identification. Let us look at

each category for classification.

Confidentiality could be defined in terms of:

a) Confidential: Where the access is restricted to a specific list of people. These could be company plans, secret

manufacturing processes, formulas, etc.

b) Company only: Where the access is restricted to internal employees only. These could be customer databases,

manufacturing procedures, etc.

c) Shared: Where the resources are shared within groups or with people outside of the organization. This could be

operational information and contact information like the internal telephone book to be shared with business partners

and agents.

d) Unclassified: Where the resources are publicly accessible. For example, the company sales brochure and other

publicity material.

Classification based on value could be high, medium or low value. A detailed explanation should be prepared

giving the reasoning for this classification. A critical component costing a few rupees may be a very high value item as

it is not easily available and could stop the production of a high cost item.

Access rights need to be defined for individuals as well as groups. Who is cleared to access confidential

information in the organization? And who decides the access rights? Logically, it will be the asset owner who will

26

decide these access rights.

Destruction should be a scheduled and controlled activity. The information that is no longer needed by the

company but which could still be useful to competitors, should be destroyed as per a pre-decided schedule and

method—depending on the confidentiality classification. For information recorded on hard disk, mere deletion of files

does not obliterate information. A more stringent procedure like multiple overwriting may be needed.

Classification schema should lead to an implementable structure. It should be simple to understand and identify.

D. Implementation of the classification schema

The real test of classification schema is when it is implemented. Information is a fluid resource. It keeps changing its

form. The implementation should lead to a uniform way of identifying the information so that a uniform protection

could be provided.

Let us take an example. A company's business plan is a confidential document. Let us trace its journey in the

corporate world.

The plan will be discussed behind closed doors, known to only a few senior members. In the next step the final

plan will be prepared and stored on the MD's computer or that of his secretary. A soft copy of this plan would be sent

by email to all executives who need to refer to it. The hard disk of every computer where the plan is stored will also

have a backup copy on floppy or other media. Each member will no doubt print it and keep a hard copy folder for

reference. An extra copy will also be prepared using the copying machine. If the email is not available, the plan would

be sent by fax, post or courier.

So the 'confidential' plan is now distributed across the organization, available on the hard disks of computers

belonging to each secretary and each senior executive. You get the general idea. If this can happen to confidential

information, imagine how easy it is to get hold of other types of information. The information explosion has given rise

to proliferation of information in every nook and corner of the organization.

A practical implementation of classification schema thus becomes very important. The classification label should

not give an easy way of identification, which could be misused. It should provide the right amount of protection.

In the example given above, each and every asset where the confidential information is residing or transiting

through will have to be given the same classification level as that of the information itself.

It may be desirable to altogether avoid transmission of confidential documents in soft copy format, for example as

27

an attachment to email. Only a restricted number of hard copies should be circulated. If it is necessary to carry the soft

copies, everyone should be instructed to encrypt information for transmission and storage, and to memorize their

passwords and keep them secret.

Asset classification is thus the key to various security controls that need to be implemented for asset protection.

FIXED ASSETS, DEFINITION, CLASSIFICATION AND VALUATION: THE REGISTER OF

FIXED ASSETS

Fixed Assets

Definition and Explanation

Fixed assets, also known as Property, Plant and Equipment, are tangible assets held by an entity

for the production or supply of goods and services, for rentals to others, or for administrative

purposes.

These assets are expected to be used for more than one accounting period. Fixed assets are

generally not considered to be a liquid form of assets unlike current assets. Examples of common

types of fixed assets include buildings, land, furniture and fixtures, machines and vehicles.

The term 'Fixed Asset' is generally used to describe tangible fixed assets. This means that they

have a physical substance unlike intangible assets which have no physical existence such as

copyright and trademarks.

Fixed assets are not held for resale but for the production, supply, rental or administrative

purposes. Assets that held for resale must be accounted for as inventory rather than fixed asset.

So for example, if a company is in the business of selling cars, it must not account for cars held

for resale as fixed assets but instead as inventory assets. However, any vehicles other than those

28

held for the purpose of resale may be classified as fixed assets such as delivery trucks and

employee cars.

Fixed assets are normally expected to be used for more than one accounting period which is why

they are part of Non Current Assets of the entity. Economic benefits from fixed assets are

therefore derived in the long term.

In order for fixed assets to be recognized in the financial statements of an entity, the basic criteria

for the recognition of assets laid down in the IASB Framework must be met:

The inflow of economic benefits to entity is probable.

The cost/value can be measured reliably.

CHAPTER TWO

FINANCIAL STATEMENTS

Financial Statements represent a formal record of the financial activities of an entity. These are

written reports that quantify the financial strength, performance and liquidity of a company.

Financial Statements reflect the financial effects of business transactions and events on the

entity.

The four main types of financial statements are:

Statement of Financial Position

Statement of Financial Position, also known as the Balance Sheet, presents the financial position

of an entity at a given date. It is comprised of the following three elements:

1. Assets: Something a business owns or controls (e.g. cash, inventory, plant and

machinery, etc)

2. Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)

3. Equity: What the business owes to its owners. This represents the amount of capital that

remains in the business after its assets are used to pay off its outstanding liabilities.

Equity therefore represents the difference between the assets and liabilities.

Income Statement

29

Income Statement, also known as the Profit and Loss Statement, reports the company's financial

performance in terms of net profit or loss over a specified period. Income Statement is composed

of the following two elements:

1. Income: What the business has earned over a period (e.g. sales revenue, dividend

income, etc)

2. Expense: The cost incurred by the business over a period (e.g. salaries and

wages, depreciation, rental charges, etc)

Net profit or loss is arrived by deducting expenses from income.

Cash Flow Statement

Cash Flow Statement, presents the movement in cash and bank balances over a period. The

movement in cash flows is classified into the following segments:

1. Operating Activities: Represents the cash flow from primary activities of a business.

2. Investing Activities: Represents cash flow from the purchase and sale of assets other

than inventories (e.g. purchase of a factory plant)

3. Financing Activities: Represents cash flow generated or spent on raising and repaying

share capital and debt together with the payments of interest and dividends.

Statement of Changes in Equity

Statement of Changes in Equity, also known as the Statement of Retained Earnings, details the

movement in owners' equity over a period. The movement in owners' equity is derived from the

following components:

Net Profit or loss during the period as reported in the income statement

Share capital issued or repaid during the period

Dividend payments

Gains or losses recognized directly in equity (e.g. revaluation surpluses)

Effects of a change in accounting policy or correction of accounting error

30

The Link between Financial Statements: The following diagram summarizes the link between

financial statements.

31

INCOME STATEMENTS, BALANCE SHEETS, CASH FLOWS

INCOME STATEMENTS

32

An income statement or profit and loss account (also referred to as a profit and loss statement

(P&L), statement of profit or loss, revenue statement, statement of financial

performance, earnings statement, operating statement, or statement of operations) is one of

the financial statements of a company and shows the company’s revenues and expenses during a

particular period.

It indicates how the revenues (money received from the sale of products and services before

expenses are taken out, also known as the “top line”) are transformed into the net income (the

result after all revenues and expenses have been accounted for, also known as “net profit” or the

“bottom line”).

It displays the revenues recognized for a specific period, and the cost and expenses charged

against these revenues, including write-offs (e.g., depreciation and amortization of

various assets) and taxes. The purpose of the income statement is to

show managers and investors whether the company made or lost money during the period being

reported.

One important thing to remember about an income statement is that it represents a period of time

like the cash flow statement. This contrasts with the balance sheet, which represents a single

moment in time.

Usefulness and limitations of income statement

Income statements should help investors and creditors determine the past financial performance of the

enterprise, predict future performance, and assess the capability of generating future cash flows through

report of the income and expenses.

However, information of an income statement has several limitations:

Items that might be relevant but cannot be reliably measured are not reported (e.g., brand

recognition and loyalty).

Some numbers depend on accounting methods used (e.g., using FIFO or LIFO

accounting to measure inventory level).

Some numbers depend on judgments and estimates (e.g., depreciation expense depends

on estimated useful life and salvage value)

33

INCOME STATEMENT GREENHARBOR LLC -

For the year ended DECEMBER 31 2010

€ €

Debit Credit

Revenues

GROSS REVENUES (including INTEREST income) 296,397

--------

Expenses:

ADVERTISING 6,300

BANK & CREDIT CARD FEES 144

BOOKKEEPING 2,350

SUBCONTRACTORS 88,000

ENTERTAINMENT 5,550

INSURANCE 750

LEGAL & PROFESSIONAL SERVICES 1,575

LICENSES 632

PRINTING, POSTAGE & STATIONERY 320

RENT 13,000

MATERIALS 74,400

TELEPHONE 1,000

UTILITIES 1,491

--------

TOTAL EXPENSES (195,513)

--------

NET INCOME 100,885

Guidelines for statements of comprehensive income and income statements of business entities

are formulated by the International Accounting Standards Board and numerous country-specific

organizations, for example the FASB in the U.S..

34

Names and usage of different accounts in the income statement depend on the type of

organization, industry practices and the requirements of different jurisdictions.

If applicable to the business, summary values for the following items should be included in

the income statement:

Operating section

Revenue - Cash inflows or other enhancements of assets of an entity during a period from delivering

or producing goods, rendering services, or other activities that constitute the entity's ongoing major

operations. It is usually presented as sales minus sales discounts, returns, and allowances. Every time

a business sells a product or performs a service, it obtains revenue. This often is referred to as gross

revenue or sales revenue.[5]

Expenses - Cash outflows or other using-up of assets or incurrence of liabilities during a period from

delivering or producing goods, rendering services, or carrying out other activities that constitute the

entity's ongoing major operations.

Cost of Goods Sold (COGS) / Cost of Sales - represents the direct costs attributable to goods

produced and sold by a business (manufacturing or merchandizing). It includes material

costs, direct labour, and overhead costs (as in absorption costing), and excludes operating costs

(period costs) such as selling, administrative, advertising or R&D, etc.

Selling, General and Administrative expenses (SG&A or SGA) - consist of the combined

payroll costs. SGA is usually understood as a major portion of non-production related costs, in

contrast to production costs such as direct labour.

Selling expenses - represent expenses needed to sell products (e.g., salaries of sales people,

commissions and travel expenses, advertising, freight, shipping, depreciation of sales store

buildings and equipment, etc.).

General and Administrative (G&A) expenses - represent expenses to manage the business

(salaries of officers / executives, legal and professional fees, utilities, insurance,

depreciation of office building and equipment, office rents, office supplies, etc.).

Depreciation / Amortization - the charge with respect to fixed assets / intangible assets that

have been capitalised on the balance sheet for a specific (accounting) period. It is a systematic

and rational allocation of cost rather than the recognition of market value decrement.

Research & Development (R&D) expenses - represent expenses included in research and

development.

35

Expenses recognised in the income statement should be analysed either by nature (raw

materials, transport costs, staffing costs, depreciation, employee benefit etc.) or byfunction (cost

of sales, selling, administrative, etc.). (IAS 1.99) If an entity categorises by function, then

additional information on the nature of expenses, at least, – depreciation, amortisation and

employee benefits expense – must be disclosed. (IAS 1.104) The major exclusive of costs of

goods sold, are classified as operating expenses. These represent the resources expended, except

for inventory purchases, in generating the revenue for the period. Expenses often are divided into

two broad sub classicifications selling expenses and administrative expenses.[5]

NON-OPERATING SECTION

Other revenues or gains - revenues and gains from other than primary business activities

(e.g., rent, income from patents, goodwill). It also includes unusual gains that are either unusual or

infrequent, but not both (e.g., gain from sale of securities or gain from disposal of fixed assets)

Other expenses or losses - expenses or losses not related to primary business operations,

(e.g., foreign exchange loss).

Finance costs - costs of borrowing from various creditors (e.g., interest expenses, bank charges).

Income tax expense - sum of the amount of tax payable to tax authorities in the current reporting

period (current tax liabilities/ tax payable) and the amount of deferred taxliabilities (or assets).

Irregular items

They are reported separately because this way users can better predict future cash flows -

irregular items most likely will not recur. These are reported net of taxes.

Discontinued operations is the most common type of irregular items. Shifting business location(s),

stopping production temporarily, or changes due to technological improvement do not qualify as

discontinued operations. Discontinued operations must be shown separately.

Cumulative effect of changes in accounting policies (principles) is the difference between the

book value of the affected assets (or liabilities) under the old policy (principle) and what the

book value would have been if the new principle had been applied in the prior periods. For

example, valuation of inventories using LIFO instead of weighted average method. The changes

36

should be applied retrospectively and shown as adjustments to the beginning balance of affected

components in Equity. All comparative financial statements should be restated. (IAS 8)

However, changes in estimates (e.g., estimated useful life of a fixed asset) only

requires prospective changes. (IAS 8)

No items may be presented in the income statement as extraordinary items under IFRS

regulations, but are permissible under US GAAP. (IAS 1.87) Extraordinary items are both

unusual (abnormal) and infrequent, for example, unexpected natural disaster, expropriation,

prohibitions under new regulations. [Note: natural disaster might not qualify depending on

location (e.g., frost damage would not qualify in Canada but would in the tropics).]

Additional items may be needed to fairly present the entity's results of operations. (IAS 1.85)

Disclosures

Certain items must be disclosed separately in the notes (or the statement of comprehensive

income), if material, including: (IAS 1.98)

Write-downs of inventories to net realisable value or of property, plant and equipment to recoverable

amount, as well as reversals of such write-downs

Restructurings of the activities of an entity and reversals of any provisions for the costs of

restructuring

Disposals of items of property, plant and equipment

Disposals of investments

Discontinued operations

Litigation settlements

Other reversals of provisions

Earnings per share

Because of its importance, Earnings per share (EPS) are required to be disclosed on the face

of the income statement. A company which reports any of the irregular items must also report

EPS for these items either in the statement or in the notes.

37

There are two forms of EPS reported:

Basic: in this case “weighted average of shares outstanding” includes only actual stocks outstanding.

Diluted: in this case “weighted average of shares outstanding” is calculated as if all stock options,

warrants, convertible bonds, and other securities that could be transformed into

shares are transformed. This increases the number of shares and so EPS decreases. Diluted EPS is

considered to be a more reliable way to measure EPS.

Sample income statement

The following income statement is a very brief example prepared in accordance with IFRS. It

does not show all possible kinds of accounts, but it shows the most usual ones. Please note the

difference between IFRS and US GAAP when interpreting the following sample income

statements.

Fitness Equipment Limited

INCOME STATEMENTS

(in millions)

Year Ended March 31, 2009 2008 2007

----------------------------------------------------------------------------------

Revenue $ 14,580.2 $ 11,900.4 $ 8,290.3

Cost of sales (6,740.2) (5,650.1) (4,524.2)

------------- ------------ ------------

Gross profit 7,840.0 6,250.3 3,766.1

------------- ------------ ------------

SGA expenses (3,624.6) (3,296.3) (3,034.0)

------------- ------------ ------------

Operating profit $ 4,215.4 $ 2,954.0 $ 732.1

------------- ------------ ------------

Gains from disposal of fixed assets 46.3 - -

Interest expense (119.7) (124.1) (142.8)

------------- ------------ ------------

Profit before tax 4,142.0 2,829.9 589.3

38

------------- ------------ ------------

Income tax expense (1,656.8) (1,132.0) (235.7)

------------- ------------ ------------

Profit (or loss) for the year $ 2,485.2 $ 1,697.9 $ 353.6

DEXTERITY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions)

Year Ended December 31, 2009 2008 2007

----------------------------------------------------------------------------------------------

Revenue $ 36,525.9 $ 29,827.6 $ 21,186.8

Cost of sales (18,545.8) (15,858.8) (11,745.5)

----------- ----------- ------------

Gross profit 17,980.1 13,968.8 9,441.3

----------- ----------- ------------

Operating expenses:

Selling, general and administrative expenses (4,142.1) (3,732.3) (3,498.6)

Depreciation (602.4) (584.5) (562.3)

Amortization (209.9) (141.9) (111.8)

Impairment loss (17,997.1) — —

----------- ----------- ------------

Total operating expenses (22,951.5) (4,458.7) (4,172.7)

----------- ----------- ------------

Operating profit (or loss) $ (4,971.4) $ 9,510.1 $ 5,268.6

----------- ----------- ------------

Interest income 25.3 11.7 12.0

Interest expense (718.9) (742.9) (799.1)

----------- ----------- ------------

Profit (or loss) from continuing operations

before tax, share of profit (or loss) from

associates and non-controlling interest $ (5,665.0) $ 8,778.9 $ 4,481.5

----------- ----------- ------------

39

Income tax expense (1,678.6) (3,510.5) (1,789.9)

Profit (or loss) from associates, net of tax (20.8) 0.1 (37.3)

Profit (or loss) from non-controlling interest,

net of tax (5.1) (4.7) (3.3)

----------- ----------- ------------

Profit (or loss) from continuing operations $ (7,369.5) $ 5,263.8 $ 2,651.0

----------- ----------- ------------

Profit (or loss) from discontinued operations,

net of tax (1,090.3) (802.4) 164.6

----------- ----------- ------------

Profit (or loss) for the year $ (8,459.8) $ 4,461.4 $ 2,815.6

Bottom line[edit]

“Bottom line” is the net income that is calculated after subtracting the expenses from revenue.

Since this forms the last line of the income statement, it is informally called “bottom line.” It is

important to investors as it represents the profit for the year attributable to the shareholders.

After revision to IAS 1 in 2003, the Standard is now using profit or loss for the year rather

than net profit or loss or net income as the descriptive term for the bottom line of the income

statement.

Requirements of IFRS[edit]

On 6 September 2007, the International Accounting Standards Board issued a revised IAS 1:

Presentation of Financial Statements, which is effective for annual periods beginning on or after

1 January 2009.

A business entity adopting IFRS must include:

a statement of comprehensive income or

two separate statements comprising:

1. an income statement displaying components of profit or loss and

40

2. a statement of comprehensive income that begins with profit or loss (bottom line of the

income statement) and displays the items of other comprehensive income for the

reporting period. (IAS1.81)

All non-owner changes in equity (i.e., comprehensive income ) shall be presented in either in

the statement of comprehensive income (or in a separate income statement and a statement of

comprehensive income). Components of comprehensive income may not be presented in

the statement of changes in equity.

Comprehensive income for a period includes profit or loss (net income) for that period

and other comprehensive income recognised in that period.

All items of income and expense recognised in a period must be included in profit or loss

unless a Standard or an Interpretation requires otherwise. (IAS 1.88) Some IFRSs require or

permit that some components to be excluded from profit or loss and instead to be included in

other comprehensive income. (IAS 1.89)

Items and disclosures

The statement of comprehensive income should include:[4] (IAS 1.82)

1. Revenue

2. Finance costs (including interest expenses)

3. Share of the profit or loss of associates and joint ventures accounted for using the equity method

4. Tax expense

5. A single amount comprising the total of (1) the post-tax profit or loss of discontinued

operations and (2) the post-tax gain or loss recognised on the disposal of the assets or disposal

group(s) constituting the discontinued operation

6. Profit or loss

7. Each component of other comprehensive income classified by nature

8. Share of the other comprehensive income of associates and joint ventures accounted for using the

equity method

9. Total comprehensive income

41

The following items must also be disclosed in the statement of comprehensive income as

allocations for the period: (IAS 1.83)

Profit or loss for the period attributable to non-controlling interests and owners of the parent

Total comprehensive income attributable to non-controlling interests and owners of the parent

No items may be presented in the statement of comprehensive income (or in the income

statement, if separately presented) or in the notes as extraordinary items

B. CASH FLOW

Cash flow is the movement of money into or out of a business, project, or financial product. It is

usually measured during a specified, limited period of time. Measurement of cash flow can be

used for calculating other parameters that give information on a company's value and situation.

to determine a project's rate of return or value. The time of cash flows into and out of projects are

used as inputs in financial models such as internal rate of return and net present value.

to determine problems with a business's liquidity. Being profitable does not necessarily mean

being liquid. A company can fail because of a shortage of cash even while profitable.

as an alternative measure of a business's profits when it is believed that accrual

accounting concepts do not represent economic realities. For instance, a company may be

notionally profitable but generating little operational cash (as may be the case for a company that

barters its products rather than selling for cash). In such a case, the company may be deriving

additional operating cash by issuing shares or raising additional debt finance.

cash flow can be used to evaluate the 'quality' of income generated by accrual accounting. When

net income is composed of large non-cash items it is considered low quality.

to evaluate the risks within a financial product, e.g., matching cash requirements, evaluating

default risk, re-investment requirements, etc.

Cash flow notion is based loosely on cash flow statement accounting standards. the term is

flexible and can refer to time intervals spanning over past-future. It can refer to the total of all

flows involved or a subset of those flows. Subset terms include net cash flow, operating cash

flow and free cash flow.

Symptoms of cash flow problems. There are many reasons a business can suffer cash flow

problems – some are down to mismanagement and poor decisions, and in some cases factors

42

outside of your control. Any of the following symptoms can indicate that a business is

experiencing cash flow problems:

Up to overdraft limit – no headroom / returned payments

Stretch to pay salaries each month

Trade creditor arrears

Taxation arrears

Rent arrears

No working capital ‘buffer’ – surviving day to day

Negative working capital on balance sheet – over geared / losses?

Lack of funds for remedial action (redundancies / premises relocation)

Lack of profitability – insufficient to support owner / manager’s lifestyle

Unable to pay for professional advice

Business' financials

The (total) net cash flow of a company over a period (typically a quarter, half year, or a full year)

is equal to the change in cash balance over this period: positive if the cash balance increases

(more cash becomes available), negative if the cash balance decreases. The total net cash flow

for a project is the sum of cash flows that are classified in three areas

1. Operational cash flows: Cash received or expended as a result of the company's internal business

activities.

so how to calculate operating cash flow of a project?

OCF=incremental

earnings+depreciation=( earning before interest and tax-tax)+depreciation=earning

before interest and tax*

( 1-tax rate)+ depreciation= ( revenue - cost of good sold- operating expense- depreciation)* (1-

tax rate)+depreciation= ( Revenue - cost of good sold- operating expense)* (1-tax rate)+

depreciation* tax.

By the way,

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depreciation*tax which locates at the end of the formula is called depreciation shield through

which we can see that there is a negative relation between depreciation and cash flow.

1. changing in net working capital. It is the cost or revenue related to the company's short-term asset

like inventory.

2. capital spending. This is the cost or gain related to the company's fix asset such as the cash used

to buy a new equipment or the cash which is gained from selling an old equipment.

The sum of the three component above will be the cash flow for a project.

And the cash flow for a company also include three parts:

1. operating cash flow: It refers to the cash received or loss because of the internal activities of a

company such as the cash received from sales revenue or the cash paid to the workers.

2. investment cash flow: It refers to the cash flow which related to the company's fix asset such as

equipment building and so on such as the cash used to buy a new equipment or a building

3. financing cash flow: cash flow from a company's financing activities like issuing stock or paying

dividends.

The sum of the three components above will be the total cash flow of a company.

Examples[edit]

Description Amount ($) totals ($)

Cash flow from operations

+70

Sales (paid in cash) +30

Incoming loan +50

Loan repayment -5

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Taxes -5

Cash flow from investments

-10

Purchased capital -10

Total

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The net cash flow only provides a limited amount of information. Compare, for instance, the

cash flows over three years of two companies:

Company A Company B

Year 1 Year 2 year 3 Year 1 Year 2 year 3

Cash flow from operations +20M +21M +22M +10M +11M +12M

Cash flow from financing +5M +5M +5M +5M +5M +5M

Cash flow from investment -15M -15M -15M 0M 0M 0M

Net cash flow +10M +11M +12M +15M +16M +17M

Company B has a higher yearly cash flow. However, Company A is actually earning more cash

by its core activities and has already spent 45M in long term investments, of which the revenues

will only show up after three years.

C.BALANCE SHEET

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In financial accounting, a balance sheet or statement of financial position is a summary of the

financial balances of a sole proprietorship, a business partnership, a corporation or other business

organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a

specific date, such as the end of its financial year. A balance sheet is often described as a

"snapshot of a company's financial condition". Of the three basic financial statements, the

balance sheet is the only statement which applies to a single point in time of a business' calendar

year.

A standard company balance sheet has three parts: assets, liabilities, and ownership equity. The

main categories of assets are usually listed first, and typically in order of liquidity. Assets are

followed by the liabilities. The difference between the assets and the liabilities is known as

equity or the net assets or the net worth or capital of the company and according to

the accounting equation, net worth must equal assets minus liabilities.

Another way to look at the balance sheet equation is that total assets equals liabilities plus

owner's equity. Looking at the equation in this way shows how assets were financed: either by

borrowing money (liability) or by using the owner's money (owner's or shareholders' equity).

Balance sheets are usually presented with assets in one section and liabilities and net worth in the

other section with the two sections "balancing".

A business operating entirely in cash can measure its profits by withdrawing the entire bank

balance at the end of the period, plus any cash in hand. However, many businesses are not paid

immediately; they build up inventories of goods and they acquire buildings and equipment. In

other words: businesses have assets and so they cannot, even if they want to, immediately turn

these into cash at the end of each period. Often, these businesses owe money to suppliers and to

tax authorities, and the proprietors do not withdraw all their original capital and profits at the end

of each period. In other words businesses also have liabilities.

INTERPRETATION OF ACCOUNTS

A statement clarifying how accounting standards should be applied. Accounting interpretations

are issued by accounting standards groups, such as the Financial Accounting Standards Board

(FASB), American Institute of CPAs (AICPA) or International Accounting Standards Board

(IASB). Interpretations are generally not requirements, but rather outline best practices and give

46

further explanation. By contrast, accountants are required to follow the accounting standards that

are in place.

How can you do The Interpretation of Accounts (or ‘Ratios’)?

The Interpretation of Accounts (or ‘Ratios’)

a) Where you are asked to calculate 5/6 specific ratios;

b) Where you can use your own choice of ratios to answer a particular question;

c) Where you are asked a theory question which relates to the interpretation of accounts.

If we start with the easiest part, the theory questions generally asked in part (C) are covered in

my ‘Accounting Theory’ notes. Just go back to the webpage you got these notes on and click on

‘Accounting Theory’.

If you scroll down on that page you’ll find the ratios section.

Part (A) is also pretty straightforward in that there’s not much room for confusion. You simply

need to know all the relevant ratios (go back to my webpage and click on ‘Ratios Sheet’ to get

the list) and then practice using them until you can do each one without needing to look it up.

While the list might look huge, a quick look at the past exam papers will show you that really

there’s actually a group of the same ten or so ratios that come up year in-year out. On the day of

the exam you need to work out each ratio correctly and make sure to add the correct units (i.e If

the answer is a percent make sure to have a % sign, if it’s in money make sure to have a € sign,

etc). So the big area for losing or gaining marks is part (B).

In part (B) we are asked to answer a question (see the normal ones below) and to use whatever

ratios we want in order to back-up our view. There are three pretty standard questions that are

asked… - Would we buy shares in this company (or would we be happy if we currently owned

shares in it)? - Would the debenture holders (people who lend money to the company) be happy?

- If you were a bank manager, would you lend money to the company? The good news is that the

answers to each of these questions are remarkably similar so we definitely don’t need to learn

three totally different things. In fact the answers we will give for the ‘Debenture’ and the ‘Bank’

questions are basically the same (because they are both people who have lent money to the firm

and are keen to have their interest and original loan amount repaid). To be ready for whichever

option comes up therefore we need to be very comfortable working out and explaining 5 or 6 of

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the most important ratios (and we’ll use these same ones to answer whichever question appears

in part (B)).

The most important areas to cover (and the ratios we will use) in our answer are… - Profitability

(Return on Capital Employed) - Liquidity (Current Ratio & Acid Test Ratio) - Gearing (Gearing

Ratio & Interest Cover) - Dividend Policy (Earnings Per Share v Dividend Per Share) - Industry /

Sector - Share Price or Security (Depending on what the question we’ve been asked is) The

crucial thing in Part (B) is to be happy that you can calculate and explain each of the above areas

in relation to what you have been specifically asked. If this sounds a bit wooly don’t panic, we’ll

work through an example shortly. First of all, a few technical points… - Normally we are marked

on six points, so don’t go writing one big essay answer or making loads of tiny points. Our

answer should look like six 4/5 line little paragraphs. - Remember the three normal options for

what can be asked above? Keep it in mind that depending on which one we’re asked, we need to

tailor our answer slightly to suit it. For example shareholders (or people considering buying

shares) will be most interested in things like the profitability of the company, the amount of

dividends being paid, and the general stability of the business. People who lend money to the

company on the other hand (debenture holders and banks) are most interested in knowing

whether the business has many other debts and whether or not they will be repaid on time

INTERPRETING FINANCIAL STATEMENTS

Financial statements provide important financial information for people who do not have access to the

internal accounts. For example, current and potential shareholders can see how much profit a company

has made, the value of its assets, and the level of its cash reserves. Although these figures are useful they

do not mean a great deal by themselves. If the user is to make any real sense of the figures in the financial

statements, they need to be properly analysed using accounting ratios and then compared with either the

previous year’s ratios, or measured against averages for the industry.

PROFITABILITY RATIOS

One of the most important measures of a company’s success is its profitability. However,

individual figures shown in the income statement/profit and loss account for gross profit and net

profit mean very little by themselves. When these profit figures are expressed as a percentage of

sales, they are more useful. This percentage can then be compared with those of previous years,

or with the percentages of other similar companies. Changes in the gross profit percentage ratio

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can be caused by a number of factors. For example, a decrease may indicate greater competition

in the market and therefore lower selling prices and a lower gross profit or, alternatively, an

increase in the cost of purchases. An increase in the gross profit percentage may indicate that the

company is in a position to exploit the market and charge higher prices for its products or that it

is able to source its purchases at a lower cost. The relationship between the gross and the net

profit percentage gives an indication of how well a company is managing its business expenses.

If the net profit percentage has decreased over time while the gross profit percentage has

remained the same, this might indicate a lack of internal control over expenses.

The return on capital employed (ROCE) ratio is another important profitability ratio. It

measures how efficiently and effectively management has deployed the resources available to it,

irrespective of how those resources have been financed. Various formulae can be found in

textbooks for calculating ROCE. The most common uses operating profit (defined as profit

before interest and taxation) and the closing values for capital employed (although using

averages for the year is more accurate). This ratio is useful when comparing the performance of

two or more companies, or when reviewing a company’s performance over a number of years.

LIQUIDITY RATIOS Liquidity refers to the amount of cash a company can generate quickly

to settle.

COSTS AND COSTING: COST IDENTIFICATION AND ANALYSIS: THEORY AND

PRACTICE

1.Cost

In production, research, retail, and accounting, a cost is the value of money that has been used up

to produce something, and hence is not available for use anymore. In business, the be one(?) of

acquisition, in which case the amount of money expended to acquire it is counted as cost. In this

case, money is the input that is gone in order to acquire the thing. This acquisition cost may be

the sum of the cost of production as incurred by the original producer, and further costs of

transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the

price also includes a mark-up for profit over the cost of production.

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More generalized in the field of economics, cost is a metric that is totaling up as a result of a

process or as a differential for the result of a decision.[1] Hence cost is the metric used in the

standard modeling paradigm applied to economic processes.

Costs (pl.) are often further described based on their timing or their applicability.

Types of accounting costs

In accounting, costs are the monetary value of expenditures for supplies, services, labor,

products, equipment and other items purchased for use by a business or other accounting entity.

It is the amount denoted on invoices as the price and recorded in bookkeeping records as

an expense or asset cost basis.

Opportunity cost, also referred to as economic cost is the value of the best alternative that was

not chosen in order to pursue the current endeavor—i.e., what could have been accomplished

with the resources expended in the undertaking. It represents opportunities forgone.

In theoretical economics, cost used without qualification often means opportunity cost

Comparing private, external, and social costs

When a transaction takes place, it typically involves both private costs and external costs.

Private costs are the costs that the buyer of a good or service pays the seller. This can also be

described as the costs internal to the firm's production function.

External costs (also called externalities), in contrast, are the costs that people other than the

buyer are forced to pay as a result of the transaction. The bearers of such costs can be either

particular individuals or society at large. Note that external costs are often both non-monetary

and problematic to quantify for comparison with monetary values. They include things like

pollution, things that society will likely have to pay for in some way or at some time in the

future, but that are not included in transaction prices.

Social costs are the sum of private costs and external costs.

For example, the manufacturing cost of a car (i.e., the costs of buying inputs, land tax rates for

the car plant, overhead costs of running the plant and labor costs) reflects theprivate cost for the

manufacturer (in some ways, normal profit can also be seen as a cost of production; see, e.g.,

Ison and Wall, 2007, p. 181). The polluted waters or polluted air also created as part of the

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process of producing the car is an external cost borne by those who are affected by the pollution

or who value unpolluted air or water. Because the manufacturer does not pay for this external

cost (the cost of emitting undesirable waste into the commons), and does not include this cost in

the price of the car (a Kaldor-Hicks compensation), they are said to be external to the market

pricing mechanism. The air pollution from driving the car is also an externality produced by the

car user in the process of using his good. The driver does not compensate for the environmental

damage caused by using the car.

Cost estimation

When developing a business plan for a new or existing company, product, or project, planners

typically make cost estimates in order to assess whether revenues/benefits will cover costs

(see cost-benefit analysis). This is done in both business and government. Costs are often

underestimated, resulting in cost overrun during execution.

Cost-plus pricing, is where the price equals cost plus a percentage of overhead or profit margin.

Manufacturing Costs vs. Non-manufacturing Costs

Manufacturing Costs are those costs that are directly involved in manufacturing of products.

Examples of manufacturing costs include raw materials costs and charges related to workers.

Manufacturing cost is divided into three broad categories:

1. Direct materials cost.

2. Direct labor cost.

3. Manufacturing overhead cost.

Non-manufacturing Costs are those costs that are not directly incurred in manufacturing

a product. Examples of such costs are salary of sales personnel and advertising expenses.

Generally non-manufacturing costs are further classified into two categories:

1. Selling and distribution Costs.

2. Administrative Costs.

Other costs

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A defensive cost is an environmental expenditure to eliminate or prevent environmental damage.

Defensive costs form part of the genuine progress indicator (GPI) calculations.

Labour on=costs would include travel time, holiday pay, training costs, working clothes, social

insurance, taxes on employment &c.

Path cost is a term in networking to define the worthiness of a path, see Routing.

ACTIVITY-BASED COSTING

Activity-based costing (ABC) is a costing methodology that identifies activities in an

organization and assigns the cost of each activity with resources to all products and services

according to the actual consumption by each. This model assigns more indirect costs (overhead)

into direct costs compared to conventional costing.

CIMA (Chartered Institute of Management Accountants) defines ABC as an approach to the

costing and monitoring of activities which involves tracing resource consumption and costing

final outputs. Resources are assigned to activities, and activities to cost objects based on

consumption estimates. The latter utilize cost drivers to attach activity costs to outputs.

Objectives

With ABC, a company can soundly estimate the cost elements of entire products, activities and

services. That may help inform a company's decision to either:

Identify and eliminate those products and services that are unprofitable and lower the

prices of those that are overpriced (product and service portfolio aim)

Or identify and eliminate production or service processes that are ineffective and allocate

processing concepts that lead to the very same product at a better yield (process re-engineering

aim).

In a business organization, the ABC methodology assigns an organization's

resource costs through activities to the products and services provided to its customers. ABC is

generally used as a tool for understanding product and customer cost and profitability based on

the production or performing processes. As such, ABC has predominantly been used to support

52

strategic decisions such as pricing, outsourcing, identification and measurement of process

improvement initiatives.

Prevalence

Following initial enthusiasm, ABC lost ground in the 1990s, to alternative metrics, such as

Kaplan's balanced scorecard and economic value added. An independent 2008 report concluded

that manually driven ABC was an inefficient use of resources: it was expensive and difficult to

implement for small gains, and a poor value, and that alternative methods should be

used.[2] Other reports show the broad band covered with the ABC methodology.[3]

However, application of an activity based recording may be applied as an addition to activity

based accounting, not as a replacement of any costing model, but to transform concurrent

process accounting into a more authentic approach.

Historical development

Traditionally, cost accountants had arbitrarily added a broad percentage of analysis into the

indirect cost.[4] In addition, activities include actions that are performed both by people and

machine.

However, as the percentages of indirect or overhead costs rose, this technique became

increasingly inaccurate, because indirect costs were not caused equally by all products. For

example, one product might take more time in one expensive machine than another product—but

since the amount of direct labor and materials might be the same, additional cost for use of the

machine is not being recognized when the same broad 'on-cost' percentage is added to all

products. Consequently, when multiple products share common costs, there is a danger of one

product subsidizing another.

ABC is based on George Staubus' Activity Costing and Input-Output Accounting.[5] The

concepts of ABC were developed in the manufacturing sector of the United States during the

1970s and 1980s. During this time, the Consortium for Advanced Management-International,

now known simply as CAM-I, provided a formative role for studying and formalizing the

principles that have become more formally known as Activity-Based Costing.[6]

Robin Cooper and Robert S. Kaplan, proponents of the Balanced Scorecard, brought notice to

these concepts in a number of articles published in Harvard Business Reviewbeginning in 1988.

53

Cooper and Kaplan described ABC as an approach to solve the problems of traditional cost

management systems. These traditional costing systems are often unable to determine accurately

the actual costs of production and of the costs of related services. Consequently managers were

making decisions based on inaccurate data especially where there are multiple products.

Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and

effect relationships to objectively assign costs. Once costs of the activities have been identified,

the cost of each activity is attributed to each product to the extent that the product uses the

activity. In this way ABC often identifies areas of high overhead costs per unit and so directs

attention to finding ways to reduce the costs or to charge more for costly products.

Activity-based costing was first clearly defined in 1987 by Robert S. Kaplan and W. Bruns as a

chapter in their book Accounting and Management: A Field Study Perspective.[7]They initially

focused on manufacturing industry where increasing technology and productivity improvements

have reduced the relative proportion of the direct costs of labor and materials, but have increased

relative proportion of indirect costs. For example, increased automation has reduced labor, which

is a direct cost, but has increased depreciation, which is an indirect cost.

Like manufacturing industries, financial institutions have diverse products and customers, which

can cause cross-product, cross-customer subsidies. Since personnel expenses represent the

largest single component of non-interest expense in financial institutions, these costs must also

be attributed more accurately to products and customers. Activity based costing, even though

originally developed for manufacturing, may even be a more useful tool for doing this.[8][9]

Activity-based costing was later explained in 1999 by Peter F. Drucker in the book Management

Challenges of the 21st Century.[10] He states that traditional cost accounting focuses on what it

costs to do something, for example, to cut a screw thread; activity-based costing also records the

cost of not doing, such as the cost of waiting for a needed part. Activity-based costing records

the costs that traditional cost accounting does not do.

The overhead costs assigned to each activity comprise an activity cost pool.

Alternatives

Lean accounting methods have been developed in recent years to provide relevant and thorough

accounting, control, and measurement systems without the complex and costly methods of

54

manually driven ABC. However lean accounting is a snapshot concept for capturing just partial

derivatives or differentials of selected cost functions. Lean accounting takes an opposite

direction from ABC by working to eliminate peculiar cost allocations rather than apply complex

methods of resource allocation.

Lean accounting is primarily used within lean manufacturing. The approach has proven useful in

many service industry areas including healthcare, construction, financial services, governments,

and other industries.

Application of Theory of constraints (TOC) is analysed in a study[11] showing interesting aspects

of productive coexistence of TOC and ABC application. Identifying cost drivers in ABC is

described as somewhat equivalent to identifying bottlenecks in TOC. However the more

thorough insight into cost composition for the inspected processes justifies the study result: ABC

may deliver a better structured analysis in respect to complex processes, and this is no surprise

regarding the necessarily spent effort for detailed ABC reporting.

Methodology

Methodology of ABC focuses on cost allocation in operational management. ABC helps to

segregate

Fixed cost

Variable cost

Overhead cost

The split of cost helps to identify cost drivers, if achieved. Direct labour and materials are

relatively easy to trace directly to products, but it is more difficult to directly allocate indirect

costs to products. Where products use common resources differently, some sort of weighting is

needed in the cost allocation process. The cost driver is a factor that creates or drives the cost of

the activity. For example, the cost of the activity of bank tellers can be ascribed to each product

by measuring how long each product's transactions (cost driver) takes at the counter and then by

measuring the number of each type of transaction. For the activity of running machinery, the

driver is likely to be machine operating hours. That is, machine operating hours drive labor,

maintenance, and power cost during the running machinery activity.

Application

55

ABC has proven its applicability beyond academic discussion. ABC is applicable throughout

company financing, costing and accounting:

ABC is a modeling process applicable for full scope as well as for partial views.

ABC helps to identify inefficient products, departments and activities.

ABC helps to allocate more resources on profitable products, departments and activities.

ABC helps to control the costs at any per-product-level level and on a departmental level.

ABC helps to find unnecessary costs that may be eliminated.

ABC helps fixing the price of a product or service with any desired analytical resolution.

A report summarizes reasons for implementing ABC as mere unspecific and mainly for case

study purposes (in alphabetical order):

Better Management

Budgeting, performance measurement

Calculating costs more accurately

Ensuring product /customer profitability

Evaluating and justifying investments in new technologies

Improving product quality via better product and process design

Increasing competitiveness or coping with more competition

Management

Managing costs

Providing behavioral incentives by creating cost consciousness among employees

Responding to an increase in overheads

Responding to increased pressure from regulators

Supporting other management innovations such as TQM and JIT systems

Beyond such selective application of the concept, ABC may be extended to accounting, hence

proliferating a full scope of cost generation in departments or along product manufacturing. Such

56

extension, however requires a degree of automatic data capture that prevents from cost increase

in administering costs.

According to Velmurugan, Activity based costing must be implemented in the following

ways:

1) Identify and assess ABC needs - Determine viability of ABC method within an

organization.

2) Training requirements - Basic training for all employees and workshop sessions for

senior managers.

3) Define the project scope - Evaluate mission and objectives for the project.

4) Identify activities and drivers - Determine what drives what activity.

5) Create a cost and operational flow diagram – How resources and activities are related to

products and services.

6) Collect data – Collecting data where the diagram shows operational relationship.

7) Build a software model, validate and reconcile.

8) Interpret results and prepare management reports.

9) Integrate data collection and reporting.

Integrating EVA and Process Based Costing

Recently, Mocciaro Li Destri, Picone & Minà (2012) proposed a performance and cost

measurement system that integrates the Economic Value Added (EVA) criteria with Process

Based Costing (PBC).

Authors note that activity-based costing system is introspective and focuses on a level of analysis

which is too low. On the other hand, they undescore the importance to consider the cost of

capital in order to bring strategy back into performance measures.

Limitations

Applicability of ABC is bound to cost of required data capture. That drives the prevalence to

slow processes in services and administrations, where staff time consumed per task defines a

dominant portion of cost. Hence the reported application for production tasks do not appear as a

favorized scenario.

Tracing Costs

57

Even in ABC, some overhead costs are difficult to assign to products and customers, such as the

chief executive's salary. These costs are termed 'business sustaining' and are not assigned to

products and customers because there is no meaningful method. This lump of unallocated

overhead costs must nevertheless be met by contributions from each of the products, but it is not

as large as the overhead costs before ABC is employed.

Although some may argue that costs untraceable to activities should be "arbitrarily allocated" to

products, it is important to realize that the only purpose of ABC is to provide information to

management. Therefore, there is no reason to assign any cost in an arbitrary manner.

Transition to automated Activity-based costing accounting

The prerequisite for lesser cost in performing ABC is automating the data capture with an

accounting extension that leads to the desired ABC model. Known approaches for event based

accounting simply show the method for automation. Any transition of a current process from one

stage to the next may be detected as a relevant event. Paired events easily form the respective

activity.

The state of the art approach with authentication and authorization

in IETF standard RADIUS gives an easy solution for accounting all work position based

activities. That simply defines the extension of the Authentication and Authorization (AA)

concept to a more advanced AA and Accounting (AAA) concept. Respective approaches for

AAA get defined and staffed in the context of mobile services, when using smart phones as

e.a. intelligent agents or smart agents for automated capture of accounting data .

Public sector usage

When ABC is reportedly used in the public administration sector, the reported studies do not

provide evidence about the success of methodology beyond justification of budget ingpractise

and existing service management and strategies.

BUDGETS AND BUDGETING

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Budgets

Introduction

A budget is a financial plan for the future concerning the revenues and costs of a business. However, a

budget is about much more than just financial numbers.

In the broadest sense, a budget is an allocation of money for some purpose. The word once used

to mean "pouch" or "purse"; a budget therefore is "what's in the pouch." Budgeting as an activity

ranges in extent from managing household finances on up to the preparation of the Budget of the

United States, undertaken yearly by Congress; that document is nearly 1,400 pages in length.

This article will focus principally on "formal budgeting" as practiced in corporations, sometimes

called the "budget process.

Budgetary control is the process by which financial control is exercised within an

organisation.

Budgets for income/revenue and expenditure are prepared in advance and then compared with

actual performance to establish any variances.

Managers are responsible for controllable costs within their budgets and are required to take

remedial action if the adverse variances arise and they are considered excessive.

There are many management uses for budgets. For example, budgets are used to:

o Control income and expenditure (the traditional use)

o Establish priorities and set targets in numerical terms

o Provide direction and co-ordination, so that business objectives can be turned into practical reality

o Assign responsibilities to budget holders (managers) and allocate resources

o Communicate targets from management to employees

o Motivate staff

o Improve efficiency

o Monitor performance

Whilst there are many uses of budgets, there are a set of guiding principles for good budgetary

control in a business.

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In an effective budget system:

Managerial responsibilities are clearly defined – in particular the responsibility to adhere to their

budgets

Individual budgets lay down a plan of action

Performance is monitored against the budget

Corrective action is taken if results differ significantly from the budget

Departures from budgets are permitted only after approval from senior management

Unaccounted for variances are investigated

Budgeting has always been part of the activities of any business organization of any size, but

formal budgeting in its present form, using modern budgeting disciplines, emerged in the 1950s

as the numerical underpinning of corporate planning. Modern corporate planning owes much to

operations research and systems theory. A pioneer in that field, Russell L. Ackoff, worked

closely with General Electric, Anheuser-Busch, and other major corporations. His first book on

the subject, the first of four, A Concept of Corporate Planning, had a major impact.

Modern formal budgets not only limit expenditures; they also predict income, profits, and returns

on investment a year ahead. They have evolved into tools of control and are also used as a means

of determining such rewards as profit-sharing and bonuses. Unless the budgetary process is

managed with extreme skill and care, the very virtues of budgeting can turn into negatives—and

have, of late, emerged into a movement actively working to change this process.

BUDGETING AS A PROCESS

In large corporations, budgeting is a collective process in which operating units prepare their

plans in conformity with corporate goals published by top management. Each unit plan is

intended to contribute to the achievement of the corporate goals. Unit managers prepare

projections of sales, operating costs, overhead costs, and capital requirements. They calculate

operating profits and returns on the investment they intend to use. The budget itself is the

projection of these values for the next calendar or fiscal year. As part of this process, each unit

presents its plans and budget to a reviewing upper management panel and may, thereafter, make

whatever changes result from instructions from or negotiations with the higher level. Texts

presenting, documenting, and defending the rationales underlying the numbers are usually part of

the planning document. Approved budgets then become the road-map for operations in the

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coming year. Ideally monthly or quarterly budget reviews track performance against the budget.

As part of such reviews, changes to the budget may be approved. At year-end managers are

judged by their performance against the budget.

Many small businesses try to operate without a formal budget. Even some businesses that have a

budget seldom consult it, meaning they are not gaining the business advantages that they could

be through budgeting. For startup entrepreneurs, a budget is like a roadmap that can help them

set goals and assess the validity of their business concept. For established small businesses, a

budget can be used to take the pulse of the business, determining how the business is performing

through the years, and helping identify possible future investments. By regularly consulting a

budget, business leaders can compare actual figures and catch potential business shortfalls or

other problems early. Budgets can also be instrumental in winning over investors, convincing

banks your business is a good loan risk, or bringing on new partners or customers.

While budgets are developed bottom up, managers must strive to meet top-down business goals

(e.g., "Annual growth in after-tax profits of 39 percent."). Because performance is measured

based on meeting or exceeding positive projections (of sales, returns, and profits) and meeting or

coming in below negative projections (fixed and variable costs and capital expenditures)

managers have strong incentives for projecting the lowest possible "positive" and the highest

possible "negative" results. The more successful they are in understating sales and profits and

overestimating costs, the higher the likelihood of "meeting the budget." Top management's

incentives, by contrast, are to do the opposite. Therefore the budgeting process is inherently

marked by potential conflict.

Such difficulties can be, and usually are, mitigated by rational policies, good will on both sides,

and straight forward implementation. Projections should be as realistic and quantifiable as

possible. If projections are out of line with historical patterns, up or down, management must

question the planning. Thus, for instance, a sharply rising projection of costs must have some

real-world justification. Overly ambitious revenue projections must also be questioned.

Conversely, managers must resist pressures sharply to raise revenue targets unless tangible

changes in the market or compensating raises in sales expenditures are present. If the negotiating

levels are honest and realistic, the right projections will result. Ideally, operating units should not

be measured on activities over which they lack full control. An operation which does not operate

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its own debt collection, for example, should not be measured on how rapidly invoices are

collected. Since budgets are often at least 50 percent guess-work, formal budgetary review at

reasonable intervals and realistic adjustments based on actual events must be part of a well-

functioning process. All too often, the spring budgeting event is rapidly forgotten.

BENEFITS AND COSTS

The single-most potential benefit of formal budgeting lies in ensuring that responsible managers

take time each year (and then at fixed intervals throughout the year) in thinking about their

operation by looking at all of its aspects. Budgeting creates a comprehensive picture of the future

and makes both opportunities and barriers conscious. This foreknowledge then helps guide day-

to-day activities.

The chief cost of the budget process is time. In some corporations the process takes on a life of

its own and becomes a convoluted exercise of excessive complexity which, moreover, prevents

unit managers from doing any thinking: their time is consumed in efforts to comply with a vast

array of requirements dictated from above. Much of the negative attitude that has developed

concerning this activity has its roots in unnecessary bureaucratic impositions on the one hand and

unreliability because of rapid change a few months out.

TYPES OF BUDGETS

The two dominant forms of budgeting are traditional and zero-based. Business planning

is usually a combination of the two. Traditional budgeting is based on a review of

historical performance and then the projection of such findings to the future with

modifications. If inflation is high, for instance, cost trends of the last several years are

projected forward but with adjustments both for inflation and for projected growth or

decline in business activity. Historical sales patterns, using established trends in sales

growth, are projected; new sales from planned new product introductions are then

added. Zero-based budgeting is the creation of a completely new budget from the ground

up—as if no history existed. When using this method, the operation must justify and

document every item of expenditure and income anew. Brand-new operations will utilize

zero-based methods.

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In government planning, but only very rarely in business, performance budgeting is

used as a third alternative. Under this method, the budget is fixed at the outset. The

planning activity is to determine exactly what activities will be carried out using the

allocated funds. Performance budgeting is sometimes used in the corporate setting when

the advertising budget is arbitrarily set as such-and-such a percent to projected sales. The

advertising function then uses performance budgeting to allocate the budget to various

products and media.

For the small business, different types of budgets can be drafted to monitor various

financial aspects of the business.

Operational budget: An operational budget is the most common type of budget used. It

forecasts and tries to pretty closely predict yearly revenue and expenses for a business.

This budget can be updated with actual figures on a monthly basis and then you can

revise your figures for the year, if needed.

Cash flow budget: A cash flow budget details the amount of cash you collect and pay

out. This is generally tallied on a monthly basis, but some businesses tabulate this

weekly. In this budget, you track your sales and other receivables from income sources

and contrast those against how much you pay to suppliers and in expenses. A positive

cash flow is essential to grow your business.

Capital budget: The capital budget helps you figure out how much money you need to

put in place new equipment or procedures to launch new products or increase production

or services. This budget estimates the value of capital purchases you need for your

business to grow and increase revenues.

CRITIQUES OF THE PROCESS

As early as 1992, the famous guru of management, Peter Drucker, wrote in The Wall Street

Journal: "Uncertainty—in the economy, society, politics—has become so great as to render

futile, if not counterproductive, the kind of planning most companies still practice: forecasting

based on probabilities."

Uncertainty has, if anything, grown since 1992 with the expansion of the Internet, the reality of

terrorism, pressures on hydrocarbon fuels, the threat of global warming, and worldwide

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epidemics. In addition to uncertainty, formal budgeting has also come under fire for impeding

trust and empowerment, two new concepts in the evolving corporate culture, as well as for

stifling innovation. As David Marginson and Stuart Ogden recently wrote in Financial

Management (UK), "Budgets have long had a bad press, but they have attracted even more flak

recently for being at best inappropriate to modern business practice and at worst potentially

harmful…. The Beyond Budgeting Round Table (BBRT) has been one of their most vociferous

critics. It argues, for example, that the necessary conditions of trust and empowerment in today's

organizations are not possible with budgets still in place, because the entire system perpetuates

central command and control." Innovation is vital for economic survival. But "budgeting stifles

trust and empowerment, according to its critics, which in turn stifles innovation."

In a 2007 report, Dr. Peter Bunce, director of the BBRT, writes that startups and small and

medium-sized businesses are initially very responsive to their markets because either the founder

makes all the decisions or relies on a small group of highly-motivated managers. But as the

business grows, the management team gets bigger, and often "flexibility and adaptability

diminishes." "If SMEs follow this path already well trodden by larger companies they will end

up in the same position of having a management model that fails to support innovation,

flexibility and adaptability," he writes. They need to adapt a management model that allows them

to manage through continuous planning cycles, make rolling forecasts, and manage costs through

trends.

CHAPTER THREE

AUDITING

INTRODUCTION

The practice of auditing existed even in the Vedic period. Historical records show that Egyptians,

Greeks and Roman used to get this public account scrutinized by and independent official.

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Kautaly in his book “arthshastra” has stated that “all undertakings depend on finance, hence

foremost attention should be paid to the treasury”.

Auditing as it exists today can be associated with the emerging a joint stock company during the

industrial revolution. The company’s act of 1956 gives regulations regarding the audit work.

Meaning of Audit:

The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially

auditor was a person appointed by the owners to check account whenever the suspected fraud, he

was to hear explanation given by the person responsible for financial transactions. Emergence of

joint stock companies changed the approach of auditing as ownership was pestered from

management. The emphasis now is clearly on the verification of accounting date with a view on

the reliability of accounting statement.

Definition:

Spicer and Peglar define auditing as “An examination of the books, accounts and vouchers of a

business’s shall enable the auditor to satisfy himself whether or not the balance sheet is properly

drawn up so as to exhibit a true and correct view of the state of affairs of the business according

to his best of the information given to him and as shown by the book.

Mautz: defines auditing as being “Concerned with the verification of accounting data with

determining the accuracy and reliability of accounting statements and reports.”

The international auditing practices committee defines auditing as “the independent examination

of financial information of any entity whether profit oriented or not and irrespective of size/legal

form when such an examination is conducted with a view to express an opinion thereon”.

Scope of Audit.

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The scope of audit is increasing with the increase in the complexities of the busines. It is said

that long range objectives of an audit should be to serve as a guide to the management future

decisions.

Today most of the economic activities are largely conducted through public finance. The auditor

has to see whether these larger funds are properly used. The scope of audit encompasses

verification of accounts with a intention of giving opinion on its reliability. Hence it covers cost

audit, management audit, social audit etc. It should be remembered that an auditor just expressed

his opinion on the authenticity of the account. He has no power to take action against anybody,

in this regard its said that “an auditor is a watch dog but not a blood hound”.

Objectives of Auditing.

Auditors are basically concerned with verifying whether the account exhibit true and fair view of

the business. The objectives of auditing depends upon the purpose of his appointment.

Primary Objective.

The primary objective of an auditor is to respect to the owners of his business expressing his

opinion whether account exhibits true and fair view of the state of affairs of the business. It

should be remembered that in case of a company, he reports to the shareholders who are the

owners of the company and not tot the director. The auditor is also concerned with verifying how

far the accounting system is successful in correctly recording transactions. He had to see whether

accounts are prepared in accordance with recognized accounting policies and practices and as per

statutory requirements.

Secondary Objective:

The following objectives are incidental to the main objective of audting.

1. Detection and prevention of errors: errors are mistakes committed unintentionally because

of ignorance, carelessness. Errors are of many types:

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a. Errors of Omission: These are the errors which arise on account of transaction into

being recorded in the books of accounts either wholly partially. If a transaction has been totally

omitted it will not affect trial balance and hence it is more difficult to detect. On the other hand if

a transaction is partially recorded, the trial balance will not agree and hence it can be easily

detected.

b. Errors of Commission: When incorrect entries are made in the books of accounts either

wholly, partially such errors are known as errors of commission. Eg: wrong entries, wrong

Calculations, postings, carry forwards etc such errors can be located while verifying.

c. Compensating Errors: when two/more mistakes are committed which counter balances

each other. Such an error is know an Compensating Error. Eg: if the amount is wrongly debited

by Rs 100 less and Wrongly Credited by Rs 100 such a mistake is known as compensating error.

d. Error of Principle: These are the errors committed by not properly following the

accounting principles. These arise mainly due to the lack of knowledge of accounting. Eg:

Revenue expenditure may be treated as Capital Expenditure.

e. Clerical Errors; A clerical error is one which arises on account of ignorance,

carelessness, negligence etc.

Location of Errors: It is not the duty of the auditor to identify the errors but in the process of

verifying accounts, he may discover the errors in the accounts. The auditor should follow the

following procedure in this regard.

1. Check the trial balance.

2. Compare list of debtors and creditors with the trial balance.

3. Compare the names of account appearing in the ledger with the names of accounting in

the trial balance.

4. Check the totals and balances of all accounts and see that they have been properly shown

in the trial balance.

5. Check the posting of entries from various books into ledger.

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2. Deduction and Prevention of Fraud: A fraud is an Error committed intentionally to

deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.

a. Misappropriation of Cash: This is one of the majored frauds in any organisation it

normally occurs in the cash department. This kind of fraud is either by showing more payments/

less receipt.

The cashier may show more expenses than what is actually incurred and misuse the extra cash.

Eg: showing wages to dummy workers. Cash can also be misappropriated by showing less

receipts

Eg: not recording cash sales. Not allowing discounts to customers. The cashier may also

misappropriate the cash when it is received. Cash received from 1st customer is misused when

the 2nd customer pays it is transferred to the 1st customer’s account. When the 3rd customer

pays it goes forever. Such a fraud is known as “Teaming and Lading”. To prevent such frauds

the auditor must check in detail all books and documents, vouchers, invoices etc.

b. Misappropriation of Goods: here records may be made for the goods not purchase not

issued to production department, goods may be used for personal purpose. Such a fraud can be

deducted by checking stock records and physical verification of goods.

c. Manipulation of Accounts: this is finalizing accounts with the intention of misleading

others. This is also known as “WINDOWS DRESSING”. It is very difficult to locate because its

usually committed by higher level management such as directors. The objective of WD may be

to evade tax, to borrow money from bank, to increase the share price etc.

to conclude it cab be said that, it is not the main objective of the auditor to discover frauds and

irregularities. He is not an insurance against frauds and errors. But if he finds anything of a

suspicious nature, he should probel it to the full.

ADVANTAGES OF AUDIT:

1. Audited account are detected as an authentic record of transaction.

2. Errors and frauds are detected and rectified.

3. It increases the morale of the staff and thus it prevents frauds and errors.

4. Because of his expertise the auditor may advise on various matters to his clients.

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5. An auditor acts as a trustee of his shareholders. Hence he safeguards their financial interest.

6. For taxation purpose auditing of account is amust.

7. In case of any claim is to be made from the insurance company only audited account should

be submitted.

8. Even in case of partnership firm auditing of accounts helps in the settlement of claim at the

time of retirement/death of a partner.

9. Auditor account helps in managerial decisions.

10. They are useful to secure loan at the of amalgamation, absorption, reconstruction etc.

11. Auditing safeguards the interest of owners, creditors, investors, and workers.

12. It is useful to take certain financial decisions like issuing of shares, payment of dividend etc.

TYPES OF AUDIT:

1. Statutory Audit: any audit carried on as per the requirement of law is called as a statutory

audit. eg: all companies have to get their accounts audited as per the provision of the company’s

Act of 1956.

2. Periodical/ Annual Audit: it is a kind of audit where the auditor verifies the account at the

end of the financial year. He starts the audit work after the closure of financial year. This is a

common audit and is mostly used by small organizations.

3. Interium audit: its an audit conducted in the middle of the accounting year before the

accounts are closed. In other words any audit conducted between two financial audit is known s

interium audit. The objective is to get periodical results, to declare interium dividend.

4. Partial Audit: when an auditor is asked to audit only a part of the account system. Its called

partial audit. Eg: he may be asked to audit only the payment side of cash book.

5. Balance sheet audit: it’s a kind of partial audit and is concerned with the verification of only

those items appearing in the Balance Sheet. It is more popular in the USA. Infact while verifying

BS items the auditor verifies/ checks all related items/accounts.

6. Cost audit: cost audit is defined as the verification of cost accounting records. Data and

techniques for its accuracy and authenticity. It gets as effective managerial tool for the detection

of errors and frauds in cost accounting records. The companies act implies the central

government to order cost audit incase of specifies companies.

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7. Management audit: Management audit may be defined as a comprehensive examination of

an organizational structure of a company, institution/government and its plans and objectives it

means of operations and use of human and physical facilities. The main objective of mgt audit is

to see how far the objectives of mgt are fulfilled. It aims to ascertain whether sound mgt prevails

throughout the organisation and evaluates its efficiency in the system of its operation.

8. Continuous audit: a continuous audit is one in which the auditor visits his clients office at

regular intervals through out the year to verify the account. The objective of CA may be-

a. To get final account audited immediately after the closure of accounting year.

b. When the business is very large.

c. When interval control system is into effective.

d. When regular final accounts are required.

ADVANTAGES:

1. Errors and frauds are discovered and rectified quickly.

2. The chances of fraud are reduced.

3. The workers will be careful in their work.

4. Continuous audit acts as a valuable morale check on the staff.

5. Final audit becomes easier and faster.

6. If the company wants to declare interium dividend its easier to prepare interium account.

7. It increases the efficiency and accuracy in the accounts.

DISADVANTAGES:

1. After the auditor’s visit is over, alternative may be made.

2. It affects the regular work.

3. Its not suitable for small organizations.

4. The auditor may loose the line of work if he does not complete his work in a visit.

Precautions to be taken for continuous audit:

1. He should record important balances, totals etc and verify the same in his next visit.

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2. Strict instructions should be given prohibiting the alteration of figures after checked by

the auditor.

3. For each visit special ticks should be used.

4. Its always better to verify the nominal account at the end of the year.

5. An exhaustive audit programme must be prepared.

6. He should ensure that normal working is not affected.

7. As far as possible, he should pay surprise visits.

Preparation before commencement of the audit:

An auditor after receiving the appointment letter should communicate his acceptance/otherwise

in writing to the company. The following steps are necessary to commence the audit work:

1. If it is not a statutory audit, he should find out the exact nature and scope of his duties i.e.,

whether he has to audit the account/prepare accounts also.

2. He should inform his clients to close all the books of account and keep them ready for

verification.

3. He should acquaint himself with the nature of his client business.

4. He should examine the efficiency of the internal control system.

5. He should obtain the names of directors their power duties etc.

6. He should obtain a complete list of all books and documents maintained by the clients.

7. He should obtain a copy of previous year’s audit report.

8. He should go through various documents like MOA, AOA, prospectus etc.

Audit Programme: before commencing the audit he should plan his work so that is over

without delay. For this purpose the auditor chalks out a detailed programme explaining the

procedure to be followed for audit. It explains the work to be done by the audit staff. an audit

programme is defined as “a detailed plan of the auditing work to be performed, specifying the

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procedure to be followed in verification of each item in the financial statements, and giving the

estimated time required’.

Hence an audit programme is a statement giving instructions and guidance to the audit staff as to

the audit procedure. It arranges and distributes the work among the audit staff.

ADVANTAGES:

1. It provides the audit staff clear instructions about their duties.

2. It promotes division of work in a well organized manner.

3. It helps the auditor to monitor the progress of the work.

4. It will be easier to fix responsibilities for omissions and commissions.

5. It serves as a valuable evidence for the work done.

6. It serves as a guide for future audit.

7. It ensures that audit process in a systematic manner.

8. It eliminates inefficiency and saves time.

9. Incase if any audit assistant goes on leave, his work can be easily continued by others.

10. It avoids duplication of work.

Disadvantages of Audit Programme.

1. The audit work becomes mechanical.

2. It kills the creativity of the audit staff.

3. Chances of work not done properly/ high as the scope is to be completed within a scheduled

time.

4. A rigid programme may not be suitable for all kinds of business.

The above disadvantages can be minimized if the audit programme is made more flexible and

audit staff encourages to go beyond the work mentioned in the audit programme. The auditors

should also periodically review the programme in the light of experiences gained in the previous

year. He should impress upon the audit staff. The audit programee is only guidance and they

should use their initiatives, intelligence and comman sense at all times during the course of the

audit.

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Audit Note Book: an audit note book is one of the most important document maintained by the auditor. It

is defined as a record used mainly in recording audit, containing data on work done and comments made.

Audit Note book contains information regarding the day to day work performed by the audit staff, notes

about errors, explanations required etc. the auditor can use it as an authentic evidence in the court if there

is any case against him.

Contents of Audit Note Book:

1. Nature of business and important documents such as MOA, AOA, Partnership deed etc.

2. List of books of accounts.

3. List of officials, their duties and responsibilities.

4. Copy of the audit programme.

5. Information on missing receipts, vouchers etc.

6. Details of errors discovered.

7. Explanations sought from the officials.

8. Points to be included in the audit report.

An audit note book should be preserved by the auditor as it contains valuable information in respect of the

work done by its staff.

Audit Working Papers:

Audit working papers are those papers which contain essential facts about accounts, which are being

audited. Its defined as the file of analysis, summaries, comments and correspondence build up by the

auditor during the course of audit.

The auditor maintains papers as supporting evidence to the audit work. The institute of chartered

accountants of India states that “an auditor is expected to maintain evidence of work done by him and his

staff”.

Usually, audit working papers contains a copy of the trial balances, schedule of debtors and creditors,

reconciliation statements important correspondence etc.

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Purpose of maintaining working paper:

1. They show the extent to which accounting principles and auditing standards have adhered to.

2. They provide the required support for the auditors report.

3. They also reveal the efficiency with which the audit work was done.

4. They can be used as evidence in the court to defend himself against negligence in his duty.

5. They help the auditor in finalizing his report quickly.

6. They help the auditor to understand the efficiency of the accounting system, internal check

system etc.

Working papers should be clear complete, and contain the necessary information so that they

may be of maximum utility. They should be properly organized, documented and signed. In this

regard its said hat “an auditor is often judged by the quality of the working paper prepared by

him under his guidance”.

working papers are confidential documents hence he should not disclose the facts to others.

Doing so results in professional misconduct. Working papers should be preserved properly

because they are important documents.

OWNERSHIP OF WORKING PAPERS:

The auditor who collects information through working papers for his audit work. Usually claims

that he is the owner of the working papers. On the other hand the company claims that the

auditor was appointed by and he only acts as its agent. Hence, all the documents that the auditor

had collected should belong to the company several cases have been referred to the courts

regarding the ownership in one of the cases it was decided that the working papers belong to the

auditor because he was an independent professional and not an agent of the client. In another

case also, it was held that the working papers belong to the auditor.

Auditors Lien:

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The auditors if has into been paid his audit fees has the right to keep the books of accounts and

other related documents in his possession till his dues are paid. Such a right is known as Auditors

Lien.

Differences between Accounting and Auditing.

Accounting Auditing

1. It’s a continuous process carried out

throughout the year.

1.It’s a one time activity after the closure of

accounting year.

2. No prescribed qualification is required to

be an accountant.

2. He must be the member of Institute of

Chartered Accountants of India to become an

auditor.

3. An accountant is a employee of the

company.

3. An auditor is an independent professional.

4. An accountant gets regular salary for his

work.

4. He gets remuneration for his professional

work. Audit fees.

5. Accounting is concerned with recording of

business transactions systematically.

6. Accounting precedes, auditing.

5. Its concerned with verification of accounts

prepared by the accountant.

6. Auditing succeeds accounting.

Usually an auditor confines his work only to the verification of accounts. In small organizations

he may also be asked to finalize accounts. In this case he acts both as an accountant and as an

auditor but the audit work commences only when the accounting work is over. Hence, its said

that “Audit begins where accounting ends”.

INTERNAL CHECK

The term internal check implies that the work of various members of the staff is allocated in such

a way that the work done by one person is automatically checked by another. It is defined as

“such an arrangement of book keeping routine where in errors and frauds are likely to be

prevented or discovered by the very occupation of book keeping itself’.

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Internal check is a system under which accounting methods and details of an establishment are

laid out that the accounts and procedures are not under the absolute and independent control of

any one person or the contrary the work of one employee is complementary to that of another.

The system of IC is based upon the principle of division of labor, where in performance of each

individual is automatically checked by another. This is possible by properly allocation the work

and integration of function of the employees in such a manner their work complements each

others.

OBJECTIVES OF INTERNAL CHECK:

1. Eliminates frauds and errors to prevent misappropriation of goods in cash.

2. To encourage specialization of labor.

3. To reduce the time spent on a particular work.

4. To exercise moral pressure over staff members.

5. To make accounting system more reliable.

Points to be Considered in Framing a Good Internal Check.

1. No single employee should have independent control over any important aspect of the

business. In other words the work of employed should be automatically received by another.

2. The duties of the employees should be changed from time to time without prior notice.

3. Employees who control physical assets should not have assets to goods of account.

4. It’s better to follow a system of self balancing ledger.

5. Account must be periodically verified.

6. The allocation of work must be carefully done and the position must be reviewed

periodically.

7. While stock taking the pricing and evaluation of stock should be done by the people who are

not connected to stores department.

8. A cashier should not be in charge of maintaining accounts complete bank transactions etc.

Internal check and the Auditor:

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The auditor before starting audit work evaluates the system of internal check. If it is efficient he

may avoid detailed checking of the transactions and he can carry out a few test check of the

transactions to what extent should an auditor rely upon the system of internal check will depend

upon the degree of effectiveness with which, the system is followed as well as the size of the

business. If the internal check system is inefficient, he had to check in detail all transactions. It

should be remembered that even if the internal check system is efficient he should still test its

existence and efficiency.

Efficient internal check system reduces his work but not his responsibility. If in the process of

examination of accounts if he finds any weakness in his system, he should report it to his client.

Thus the existence of a good internal check system may help an auditor to a great extent, but

does not reduce his legal liability. If any fraud is discovered subsequently he may be held quietly

of negligence. He can’t defend himself saying that he relied upon the efficient internal check

system that existed in the business.

Internal check regarding: CASH SALES.

Sales over the counter. The following is the internal check system regarding sales over the

counter.

1. Each counter should have a separate salesman.

2. Each salesman should be given a separate sales memo book. Usually different color is used

for different counters,

3. Sales memo should be prepared by the salesman in 4 copies.

4. The sales memo is checked by another clerk before being handed it over to customer. A copy

is retained by the clerk.

5. Payment is made at the cash counter.

6. One copy of cash memo is returned to the internal duly stamped as cash paid 2 copies are

return the cashier.

7. The cashier records days total sales in cash sales register.

8. Every salesman should prepare total sales summary of the respective counters. At the end of

the day total sales as recorded by salesman, total cash received and total sales as per register

must agree with each other.

Postal Sales:

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A separate register should be maintained to record details of postal sales. Cash may be received

either with order (cwo) or at the time of delivery (cod). Proper records will be made in this

regard for cash received and due. Usually, goods are sent by VPP (value payable post). The sales

register must be checked in detail by a senior officer.

Sales by Traveling Agents:

1. Traveling salesman should not be allowed to issue final receipts to customers.

2. Amount received must be remitted to H.O. account on daily basis.

3. Salesman should not be allowed to deduct their expenses or commission from the sale

proceeds.

4. The salesman should submit periodical sales report which must be examined in detail.

Internal check regarding Wages:

In a large organization, expenses on wages with form one of the major portions of expenses. The

chances of frauds are also high in this regard. In this background, a good system of internal

check assumes significance.

a. frauds might be in the form of recording more wages than actually paid.

b. Payment of wages to dummy/ghost workers.

c. Recording wages for which no payment has been made etc.

The design of internal check system should try to prevent the above fraud. The following internal

check system is suggested in this regard.

1. Maintaining Time Records: A department is in charge of recording the time spent by the

workers should be constituted as far as possible. Manual system of time keeping must be

avoided. This brings down the fraud regarding the payment of wages for which no work is

done.

The time keeping check and the foremen should separately prepare the time recorded sheet

recording the name of the worker, time of entry, names of absentees etc.

In case if the workers are paid on piece rate system proper system of time booking must be

followed each worker should be given a job and counter assigned by the supervisor.

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In case if workers work overtime, the overtime slips must be issued which is authorized by

the concerned official. No worker should be allowed to work Over Time if he is not

authorized to do so.

2. Preparation of Wage Sheets:

Large scale organizations should evolve in an internal check system in such a manner that the

chances of over payment, under payment, wrong payment to workers are minimized and

prevented. Preparation of wage sheets should be the responsibility of a separate department.

Separate wage sheets should be maintained for workers under time rate system and price rate

system.

Two clerks should examine the time and price wage records. Over time records etc another

clerk should be in charge of preparing wage sheets of individual works. The 4th clerk checks

the calculations deduct amount for PF, IT, etc to arrive at net amount to be paid to workers.

All officials involved in the process, should sign the statements which will be approved by

the work manager/ the production manager.

Payment of Wages: a person is not involved either in maintaining time records preparation

of wage sheets should be in charge of payment of wages. Usually the cashier in the accounts

department will allot the wages, according to the information given by the wage sheet. As far

as possible wages should be distributed personally to the workers who sign the Wage

Register. Absentee workers should be paid through others workers only after written

authorization is received. A list of unpaid wages should be prepared after the distribution of

wages. If there are casual workers, payment should be made to them separately on a different

day.

Internal Check as Regards Purchase.

The purchase dept, will be responsible for proper control over purchases as far as possible.

Purchases must be centralized for the purpose of internal check. The purchase process may

be divided as:

1. Purchase.

2. Storage.

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3. Issues of Materials.

1. Internal Check regarding Purchase of Materials: The concerned dept, head will send

requisition letter to the purchase dept, for each dept, a separate file must be maintained

for requisitions. Based on the requisition the purchase committee, purchase dept, calls for

tenders from approved suppliers. These tenders must be opened by the purchase

committee and the least bidder will be chosen.

Purchase order has to be sent to the selected suppliers. Usually, purchase order will be

prepared by the purchase dept, a copy of which will be sent to the supplier, second to the

stores, third to the accounting dept, and the fourth is retained by the purchase dept.

When goods are received the stores keeper inspects them and compared with the

purchase order. If goods are acceptable he enters them in goods inward book and issues

the acceptance letter. A copy of the acceptance letter will go to the accounts dept, which

will again compare goods approved letter with the purchase order. The accounts manager

if satisfied authorizes for its payment.

2. Internal Check Over Storage of Goods: The stores keeper should maintain proper

records, regarding storage of goods. He usually maintains bin cards and stores ledger

surprise.

3. Internal Check as regards to issue of Materials: Materials should always be issued

against material requisition note. After each issue, and purchase proper record must be

made in bin cards and stores ledger.

Internal Control:

Internal control is a broad term which is normally used to control financial and non-financial

activities. It involves a number of checks and controls exercised in a business to ensure efficient

and economic working.

Definition:

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Internal Control is defined as “the whole system of controls, financial and otherwise established

by the management in the conduct of a business including internal check internal audit and other

forms of control.

Objective advantages of Internal Control:

1. From the clients point of view.

a. Internal control system provides authentic and reliable data useful to take business

decisions.

b. It safeguards the physical and non-physical assets in the form of records, documentation

etc.

c. It promotes operational efficiency, by preventing waste, duplication of work and

inefficient use of resources.

d. A good system of internal control provides that the company follows the procedures and

rules as required by the law.

2. From auditors point of view.

An auditor evaluates a system of control before commencing an audit work his work

becomes easier if the control system is efficient. He can also decide whether detail

verification is necessary or not.

Disadvantages of Internal Control:

1. It involves expenditure which may not be affordable by the small organizations.

2. Internal control is concerned with routine transactions many times unusual transactions may

be over looked.

3. The system of internal control may be weakened due to inefficiency in handling of the

system.

4. There are chances of diverse objectives among employees in the departments and staff in

charge of internal control.

5. Management may manipulate the operation of internal control system.

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Elements, features characteristics principles of a good Internal Control System:

An effective internal control system should have the following factors:

1. Competent and trust worthy staff: people in charge of internal control system must be

reliable and highly competent about the work. Lack of knowledge and dishonesty will spoil

the efficiency of the system.

2. Records of financial and other organizational plans: A good internal control system must

have good documentation system. Filing, recording, classifying, etc will help in this regard.

3. Segregation of duties: normally, there should be a separate department for internal control

this reduces frauds, bias etc. normally, a clerk in charge of accounting function should not be

in charge of assets also.

4. Supervision: proper reviewing of the operations of the company regularly makes the control

system effective.

5. Authorization: all transactions must be properly authorized. In other words, the authority of

each person should be well defined.

6. Sound practices: the company should have well established procedures, policies,

delegations organizational manuals etc.

7. Internal Audit: it’s a part of internal control and it should be independent of internal check.

8. Accounting Controls: proper accounting information systems should be established so that

the information relating to accounts is properly collected, recorded and accounts prepared.

Scope of Internal Control or Areas of Internal Control:

1. General financial Control: It’s concerned with control over all finance functions i.e.,

planning, acquiring and investing funds and management of profits. It deals with accounting

supervision recording etc of the finance department.

2. Cash Control: it’s concerned with proper control over receipts payments and balance of

cash. The control system must ensure that misappropriation of cash is prevented.

3. Control over wages: this includes maintenance of time records, wage records, and payment

to workers. The main area of concern in this regard is the check payment to wages for the

work not done and misappropriations of cash.

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4. Control over purchases: the system of internal control regarding purchases should be

developed in such a manner that purchasing accounting, handling and issuing of goods are

properly controlled.

Internal Audit:

Large scale organizations usually develop a system to review their activities to identify areas of

non performances. Internal audit is a tool used in this regard.

Definition:

Internal auditing involves a continuous critical review of financial and operating activities by a

staff of auditors functioning as full time salaried employees.

Objective of Internal Audit:

1. To comment of the effectiveness of the internal control system in force and means of

improving it.

1. To verify correctness accuracy and authenticity of the records presented to management.

2. To facilitate early detection of errors and frauds.

3. To ensure that standard accounting practices are followed.

4. To ensure that assets are properly acquired, safeguarded and accounted for.

5. To investigate in the areas as requested by the management.

6. To see that exhibited liabilities are valid.

Advantages of Internal Audit:

1. Internal Audit makes the system of internal control more effective and efficient.

2. It makes the auditor’s work more simple.

3. Errors and Frauds are detected early.

4. It increases the morale of the employees.

5. Employees will be more careful as their work will be audited immediately.

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Disadvantages of Internal Audit:

1. Small organizations cannot afford to have internal audit system as it’s expensive.

1. The regular work of the organization will be affected.

2. Internal auditor acts as a staff manager hence there are chances of differences of opinion

between the internal auditor and the employees of the company.

Difference between Internal and Independent Audit:

Internal Independent.

1. An internal auditor is a regular employee of

the company.

1. He is a professional auditor appointed by the

company who is not an employee.

2. His duties, rights and responsibilities are

determined by management.

2. The scope of audit work liabilities, duties etc

are explained by concerned statutes.

3. He is appointed by the management. 3. He is appointed either by shareholders or by

govt.,

4. It’s not compulsory. 4. It is compulsory for all companies.

5. Internal auditor acts as an advisor to the

management.

5. He is independent of the management.

6. To become an internal auditor professional

qualification is not necessary.

6. An independent auditor must have

professional qualification as per the act.

7. Internal Auditor ensures that the system of

accounting is efficient.

7. the internal auditor comment on the true and

fair view of business.

8. An internal auditor reports to the

management.

8. The Internal Auditor reports to the

shareholders.

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9. Internal audit is a continuous process. 9. It’s a periodic process.

To conclude, it can be said that “the internal auditor’s responsibility is to the management and he

is not a servant of the independent auditor. His scope will be decided by the management and eh

should be free to communicate to the external auditor but should not involve himself with the

work of independent auditor.

Difference between internal checks and internal audit

Internal Check Internal Audit.

1. It is an arrangement of duties allocated in such a

way that the work of one person is

automatically checked by another.

1. It is independent appraisal of operation and

records of the company.

2. The purpose of IC is to prevent minimize

possibilities of errors and frauds.

2. The purpose is to detect errors and frauds that

are already committed.

3. IC doesn’t require separate staff. It represents

only the arrangement of duties.

3. It requires separate staff employed only for this

purpose.

4. IC is a continuous process. 4. The Internal auditor has to report periodically

about various inefficiencies and suggest

improvements.

5. IC begins along with the recording of

transactions.

5. It begins when the accounting process ends.

6. It is devices of doing the work. 6. It is a device for monitoring the work.

7. Scope of Internal Check is limited especially to

the accounting department.

7. The scope of internal audit goes on beyond

accounting department.

Internal check in a Department Store

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A department store is a large scale retail organisation working on self service basis selling the

daily requirements of the customers. These are centrally located and attract customers.

Operation of Department Stores

As the name itself suggests a dept., store is divided into many small departments, each

department offering a specific product line. These depts., are headed by supervisors assisted by

stock assistants. While the accounting departments, takes care of recording all transactions, in the

cash dept, will be in charge of receipts and payments of cash. As it operates on self service basis

cash is paid by the customer at the counter.

Internal Check as regards Purchase

Goods are to be purchased as per the order of the G.M. The General Manager prepares purchase

order based on the requisition notes sent by the supervisor. No supervisor should be given

independent charge of purchase. A copy of the purchase order is sent to the accounting

department and stores dept., when once the goods are received the store keeper verifies them

with the order and approves for payment. The accounts department makes the payments after

verifying the Purchase order and goods.

Internal Check regarding Cash Receipts

usually the cash counters are computerized which brings down the human errors. The customers

make the payments directly at the counter. The counter clerk prepares the bill and receives the

cash. Chances of error and fraud are less as goods are coded and price is mentioned against

codes.

As far as petty cash expenses are concerned, the cashier should be in charge of petty cash

expenses, which are recorded on daily basis. The goods are delivered after verifying the bill.

Verification and Valuation of Assets and Liabilities

Verification

Verification is a process carried out to confirm the ownership valuation and existence of items at

the balance sheet date.

Spicer and Pegler define verification as, “the verification of assets implies an inquiry into the

value, ownership and title, existence and possession and the presence of any charge on the assets.

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It is also defined as a process by which the auditor substantiate the accuracy of the right hand

side of Balance Sheet and must be considered as having 3 distinct objects, i.e., verification of the

existence of assets, the valuation of assets and authority of their acquisition.

The auditor is required to report whether the Balance Sheet exhibits the true and fair view of the

business. For this, he has to examine and ascertain the correctness of money value of assets and

liabilities as shown in the Balance Sheet. In the case of London Oil Storage Company Ltd, it was

held that it is the duty of the auditor to verify the existence of assets, stated in the Balance Sheet

and that he will be liable for any damage suffered by the client, if he fails in this duty.

The Institute of CA of India, states that the verification of assets should be aimed at establishing

their:

a. Existence

b. Ownership

c. Possession.

d. Free from Encumbrance.

e. Proper recording and proper verification.

Difference between Verification and Vouching

1. Vouching Proves the accuracy of book entries but certification on balance sheet can be made

only after verification.

Vouching Verification

1. Vouching examines the entries

relating to transactions recorded in

books of accounts.

1. Verification examines the assets and

liabilities appearing in the Balance

Sheet.

2. Vouching is done throughout the

year.

2. It takes place at the end of the year.

3. Vouching is bases on only

documentary examination.

3. Verification is based on personal as

well as documentary examination.

4. It does not include verification. 4. It includes valuation.

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5. Vouching is normally done by audit

assistant.

5. It1 is done by the auditor himself.

Valuation: The accuracy of B.S depends on the correctness of estimation of value of assets. A

company’s BS is not drawn for the purpose o showing what the capital would be worth if the

assets were realized and liabilities paid off. But to show how the capital stands invested. It’s the

responsibility of the auditor that items in the BS are neither over valued nor undervalued.

Auditor Position Regarding Valuation:

An auditor can obtain the certification of valuer and other competent persons. Usually, the assets

are valued by responsible officials. An auditor audits many types of companies and he can’t be

an expert to value all kinds of assets.

An auditor is not a valuer, and can’t be expected to act as such. All that he can do is to verify the

original cost price and to ascertain as far as possible the current values are fair and reasonable

and are in accordance with accepted principles.

It must be borne in mind that the actual valuations are made by officials who have a practical

knowledge of such assets and that an auditors duty is confined to testing the valuations as far as

he can and in this way satisfy himself with correctness of the BS position. However, he can’t

guarantee the accuracy of valuations.

In simple words, In the absence of suspicious circumstances he can rely on the trusted officials

of the company but this will not relive him from his responsibilities if assets are incorrectly

valued. He should exercise reasonable care and skill, analysis critically all the facts and satisfy

himself that generally accepted. Accounting principles are followed. He should not certify what

he believes to be incorrect.

Method of Valuation:

Assets may be valued in any 1 of the following methods.

1. Cost Price: Its price paid to purchase an asset including installation and other expenses

incurred to make the asset into workable condition.

2. Market Value: Its value of which an asset can fetch in the market when it is sold.

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3. Replacement Value: It’s the price at which a particular asset can be replaced.

4. Book Value: It’s the value of an asset, as shown in the Balance Sheet.

Differences between Verification and Valuation.

Verification. Valuation.

1. Verification is done to prove the existence,

ownership and title to assets.

1. It certifies the correct value of the asset at

the date of the BS.

2. Verification is done or both assets and

liabilities.

2. Usually only values of assets are certified.

3. Verification is done by the auditor. 3. It’s done by the experts and responsible

officials.

4. Verification is made on the basis of

evidence.

4. Valuation is made based upon the certificate

issued by the officials.

Verification and Valuation of Assets.

A. Intangible Assets:

i) Goodwill: goodwill is an intangible assets representing the value of the reputation of

the firm which enables it to earn more than normal profit. The value of goodwill varies

with the earning capacity of the business.

When a business has been purchase and goodwill is paid for the auditor should verify

the agreement with the vendors. Whenever a business is acquired, goodwill is the

difference between the value of acquisition and cost of acquisition.

Sometimes, goodwill may also be created by spending huge amounts to innovate new

products. Such goodwill is known as Deferred Goodwill. Its capitalized over a period of

time. Goodwill is shown in the books at cost less the written off amount.

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ii) Patents: patent rights should be verified with the certificates granting such rights. If a

patent is purchased, he should verify the assignment deed. He should see whether the

deed is registered in the name of his client and patents are the property of the client.

The auditor should also examine whether fees paid to purchase patents are treated as

capital expenditure. If renewal fees is paid, it should be treated as revenue expenditure.

If the client has number of patents he should get the list of patents with details such as

the date of acquisition, the period of which its acquired etc.

Patents are written off over the period of which they are acquired. Hence, they are

shown in the BS at cost less written off amount.

iii) Copy Rights: copy rights are those rights to produce or reproduce any creative work.

The auditor should verify the agreement between the holder of the copy right and his

client. Copy right is shown is BS at cost price less written off amount.

iv) Trademarks: they are registered brands. It gives the holder exclusive right to own the

brand and protect it from imitation. An auditor should verify the certificate issued by

the concerned authority, the fees paid for renewal etc trademarks are valued at cost

price less written off amount.

B. Fixed Assets.

i) Land and Building: For verifying land and building the auditor should differentiate

between free hold and lease hold properties.

a) In case of free hold land and building, the auditor should verify with the title deeds to

ensure that the property is in the name of the client.

He should check the other documents like the life encumbrance certificate etc to see

whether the property is free of any charge. If it is mortgaged he should verify the

mortgage deed. As long as the title deeds are in order the auditor can’t be held liable

for frauds. However, the auditor should obtain a certificate from the client’s legal

advisor confirming the validity of ownership.

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Land is valued at cost price which includes purchase, price, commission pay

registration and legal charges, etc. it should be remembered that the land is not

depreciable assets.

On the other hand building is always valued at cost less depreciation. It should be

remembered that is to be charged even if the building is not used during the year.

In case of building under construction valuation is made based upon the architect

certificate.

b) Lease Hold Property: In case if the property is held in lease he should verify the lease

agreement and see whether its registered or not it is valued at cost less depreciation.

ii) Plant and Machinery: He should obtain a schedule of plant and machinery certified by

responsible official. It gives all details about each machinery. He should compare the

schedule with the plant register. If machinery is acquired under hire purchase he should

verify the hire purchase agreement. If the machinery is imported he should verify the

export license copy of invoice, permission of RBI from foreign exchange payment.

Plant and Machinery is valued at cost less depreciation. Depreciation rate is decided by

the management. The only duty of the auditor here is to see whether depreciation is

charged as per the provision of the IT Act.

iii) Furniture and Fixtures: Furniture is a movable asset where as fixtures becomes a part

of another asset. It any addition is made during the year, he should verify the invoice

and pass book. He should also verify the schedule of furniture and see whether they are

properly numbered and proper accounts are maintained. Repairs to furniture should be

treated as revenue expenditure and hence debited to P&L a/c. furniture is always valued

at cost less depreciation at a reasonable rate. He should verify the method of

depreciation. The amount of depreciation varies with the usage.

Eg. Furniture used in Canteen requires more depreciation than furniture used in office.

Hence the auditor must verify carefully to satisfy himself about the adequacy of

depreciation.

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Motor Vehicle: if the company has more number of vehicles he should verify the

schedule of vehicles. He should verify the registration book of each vehicle. He should

check the insurance paid on the vehicle etc. motor vehicles are valued at cost less

depreciation. He should see that reasonable depreciation is provided.

C. Current Assets.

i) Cash in Hand: Cash in hand is verified by actually accounting it on the date of Balance

Sheet. The counting must be done in front of the cashier. To avoid frauds the auditor

must ask the cashier to deposit all the cash except petty cash into bank account. This

makes verification easier. In case of temporary advances, enough care must be taken in

verifying the delays. Auditor will be held responsible for any negligence in this regard.

In the case of the London Oil Storage Co., Ltd it was found that the auditor had

committed breach of duty in not verifying the petty cash balance properly. The institute

of CA of India had clearly stated that the auditor should actually count the cash. It

further states that verification of cash should be of surprise nature and if cash in hand

doesn’t agree with the balance as shown in the Balance Sheet he should qualify his

report by mentioning the same.

ii) Cash at Bank:

The following steps are taken in verifying cash at bank:

i) Comparison of B.S as shown in the cash book and the pass book.

ii) Preparation of Reconciliation Statement.

iii) Obtaining a letter of confirmation from the bank.

iii) Bills Receivable: B/R is the acceptances given by Debtors. The objectives of verifying

bills receivable are:

i. To establish the accuracy of amounts.

ii. To know the validity of the bills.

iii. To know whether they are reliable and to see whether there is a fair disclosure in the

BS.

While verifying the BS the auditor

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a. should examine bills receivable book.

b. to see whether any bill is honored after the BS is prepared but before auditing for this

he should vouch the cash book.

c. I bills are discounted; he should vouch the cash book and should see whether it is

shown as a contingent liability in the BS with proper provision.

d. He should see that bills receivable dishonored and not renewed are not shown in the

bills receivable book.

iv) Book Debts/ Sundry Debtors: Book debts are to be classifies as good, bad and

doubtful. The auditor should see the accuracy, validity, and collectability and

confirmation letters directly from the debtors. For any balance for which no

confirmation is received, he should carefully verify the account. He should see that

proper provision is made for bad debts. Failing to do so the auditor will be held guilty

for negligence.

v) Stock/ Inventories: Stock is the life blood of the business. It consists of stores and

spares, raw materials, work in progress, and finished goods. If stock is incorrectly

recorded, verified or valued, the P&L a/c doesn’t show correct balances. It also affects

the BS if stock if overvalued profit is inflated and if its understated it encourages

creation of secret reserves.

The objective of verifying stock is to see that it exists and is correctly valued. It may

not be possible to verify the entire stock. Hence he has to go for the checks to ascertain

the accuracy of stock. In the case of Kingston cotton mills co., ltd the judge observed

that, “it is no part of the auditor’s duty to take stock, he must rely on other people for

details of stock in trade.”

It was further observed that “an auditor is not bound to b a detective. He should not start

his work with a foregone conclusion that there is something wrong. He is a watch dog

and not a blood hound to be a detective. He is justified in believing in trust worthy

servants of the company provided it takes reasonable care”.

In another case it was decided that ‘it is certainly not the duty of the auditor to take

stock. He should check the calculation with proper care’.

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While verifying stock:

a. He should review the procedure for maintenance of stock and records.

b. Examine the efficiency of internal check and control system.

c. See whether stock verification process contains adequate safeguards against possible

errors and frauds.

d. Test check the physical existence of a part of the stock. Stock is valued at cost price/

market price whichever is lower/less.

vi) Investment: It may consist of govt., bonds, shares, securities etc. The auditor should

examine whether the company is authorized to make investments. He should see

whether the legal formalities have been completed. If the investments are larger in

number he should obtain the schedule of investments certified by a responsible official.

The statement should include name of the investment date of purchase, book value,

market price, rate and date of interest, tax deducted etc. It is advisable to verify all

investment at a time. It is always advisable that the auditor should personally inspect

the investments in the case of city equitable fire insurance company limited. Where the

investments were in the possession of brokers who had pledged them, the judge

observed that “had the auditors not depended on the certificate form, their brokers and

had demanded the actual production of securities, the fraud might have been detected.

Dividend received on investment should be examined by checking the counter foils of

dividend warrants. Investments are valued depending upon the purpose for which they

are held. If they are held as fixed assets (eg: trusts) they are valued at cost price, if they

are held as current assets, they are valued at cost price or market price whichever is less.

Miscellaneous expenses and losses:

1. Preliminary expense: all expenses incurred in the formation of a company are called

preliminary expenses. The auditor should vouch the payments made and see whether

these expenses are written off regularly. The portion of preliminary expense not written

off will be shown in the balance sheet on the assets side.

2. Discount on issue of shares and debentures: whenever shares and debentures are

issued at discount, the company shows discount amount of the asset side till it is written

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off. The auditor should verify the relevant accounts and documents and see whether

discount on the issue in particular on the re issue of forfeited share is as per the

provision so act.

3. Verification of liabilities: if liabilities are not properly exhibited account do not show

fair view of the business. While verifying liabilities the auditor should ensure that:

a. all the liabilities in the Balance Sheet are actually payable.

b. They are actually recorded.

c. They have arisen out of natural business operation.

d. There is a proper disclosure.

He should obtain a certificated from the responsible official of the company about the

existence of liability. In the case of West Minster Road Construction Company limited,

it was held that the auditor must take reasonable care to satisfy himself that all liabilities

have been brought into account. It was further observed that “If the auditor finds that a

company in the course of its business was incurring liabilities of a particular kind it

becomes his duty to make specific inquiries as to the existence of such liability before

he signs his report.

i) Verification of Share Capital: Share capital constitutes the amount contributed by

the owners. He should verify the MOA, AOA, and Minutes Book of board meetings,

cash book and pass book. If the shares are issued for 1st time (IPO) he should go for

detailed checking of all transactions. He should also verify records regarding calls in

arrears, forfeiture of shares and their re-issue.

ii) Debenture: A debenture is a certificate issued by a company acknowledging its

debt to the authorized holder. It carries a fixed rate of interest. Usually paid once in

6months. The auditor should verify the minutes of directors meeting the authorizing

the issue. He should also verify cash book, pass book etc.

iii) Loans: Loans may be either secured or unsecured. The auditors should verify the

MOA and AOA and verify the borrowing powers of the company. In case of

mortgage loans, he should see that the assets are mortgaged as per the provisions of

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the law. Its advisable to get confirmation from lending institution with a respect to

amount of loan, security, interest etc.

Current Liabilities.

i) Creditors: The auditor should obtain the confirmation statement from the

creditors and compare this with the statement of creditors as sent by the

company. He should verify purchase ledgers, invoice etc. It is advisable to have

a test check of all purchases mode during the year.

ii) Outstanding Expenses: The auditor should obtain a statement of all

outstanding expenses signed by a responsible official. He should see whether

these expenses have been properly disclosed. He should ascertain the accuracy of

the accounting records.

iii) Bills Payable: Bills Payable are negotiable instruments acknowledging the debt.

He should get a statement of bills payable and compare it with the bill payable

book. If any bills payable has been paid after the balance sheet date but before

the audit, he should verify cash book and pass book. Such bills should not be

included in the balance sheet.

iv) Contingent Liability: A future uncertain liability which is dependent on the

happening of some event is called Contingent Liability. It may or may not arise

in future. Eg: Bills receivable discounted claims against the company etc. the

auditor should see whether all contingent liabilities are disclosed in the Balance

Sheet.

AUDITOR’S REPORT / AUDIT REPORT.

The main objective of audit is to report to the owners on the true and fair position of the

business. Audit report is the medium through which an auditor expresses his opinion on the

financial state of affairs of the clients business. It summarizes the results of the audit work

conducted by the auditor.

Importance of Audit Report.

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In case of a company management is separated from the ownership share holders appoint the

auditor to check the accounts and submit a report to them. However, the report doesn’t guarantee

accuracy of the accounts. The auditor is neither a guarantor nor an insurer. In one of the cases it

was held that “the auditor must not be held liable for not tracing fraud, when there is nothing to

arouse their suspicion and when those frauds are perpetrated by the trusted servants of the

company”.

The auditor is expected to act honestly with reasonable skill and care. Audit report is an

extremely significant document as share holders rely upon it. The auditor will be guilty of

professional misconduct if he deliberately fails to disclose material facts known to him. Conceals

misstatements and fails to obtain necessary information to complete his audit.

TYPES OF AUDIT REPORT.

1. Clean Report: Its also known as Unqualified Report. It is given by the auditor if he is

satisfied with the fairness of Balance Sheet and Profit and Loss account with all the

contents of the financial statements and he is satisfied with evidences, documents and

explanation given by his clients.

Specimen of Clear Report.

To,

The Share Holders of ABC Ltd.

We have audited the attached Balance Sheet of ABC Ltd as on 31.03.2009 and also Profit

and Loss account annexed there to for the year ended on that date.

1. We have obtained all the information and explanation which to the bet of our

knowledge and belief were necessary for the purpose of audit.

2.Proper books of accounts are required by the law have been kept by the company so far

as it appears from our examination of books and proper return adequate of our audit have

been received from branches not visited by us.

3. The Balance Sheet and P&L account dealt with by his court are in agreement with the

books of accounts and returns.

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4. In our opinion and the to the best of our information and according to the explanation

given to us the said Balance Sheet together with the notes thereon given the information

required by Act of 1956 in manner so required and gives a true and fair view.

Date: Signed

Place: (Name, partner XY Associates)

Charted Accountant.

2. Qualified Report: When the auditor is not satisfied with the accounts presented to him if

he finds any discrepancy in the recording of the transaction, if he thinks that the Balance

Sheet and P&L account do not exhibit true and fair view of the business then he submits

Qualified Report.

It means he submits his report with certain qualification (observation) a qualified report

may be submitted in many cases such as improper valuation of assets, inadequate or

excess depreciation, not following accounting standards etc.

The company Act doesn’t lay down any specific requirement regarding the manner in

which the auditor should qualify his report. It should not lead any confusion to the reader.

Before submitting a qualified report he should discuss the issued with that of the

management. He should see that qualified report is free from ambiguity, vague statements

etc.

Specimen of Qualified Report.

To,

The Share Holders of ABC Ltd.

We have audited the attached Balance Sheet of ABC Ltd as on 31.03.2009 and also the

P&L account of the company for the year ended on that date and report that:

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1. We have obtained all information and explanation which to the best of our knowledge

and belief were necessary for the purpose of our audit.

2. In our opinion proper books of accounts as required by law have been kept by the

company so far as appears from our examination of the books subject to the comments

given here under:-

In the absence of stock register, adjustments relating to balances on the registers have

been accepted on the basis of management decision.

3. The Balance Sheet and P&L account dealt with by the report are in agreement with the

books of accounts and returns.

4. Subject to the qualification given below in our opinion and to the best of our

information and according to the explanation given to us the accounts together with the

notes there on and documents attached there to give the information required by the

company’s Act of 1956 in the manner so required and give a true and fair view.

a. The provision for depreciation of fixed assets is inadequate.

b. Stock has been valued at market price which is higher than the cost price.

Audit under Computerized Environment.

The process of account has undergone rapid changes in the recent years. The recording of

business transaction has changed from Manual System to Computerized system. Computers are

used for processing all kinds of accounting information. Useful to the management in its function

of decision making. Most of the companies follow computerized accounting system to record,

process and present accounting transactions. An auditor should see how efficient is the

accounting information system is. It should be remembered that a computer does not take

decision on its own, but only facilitate the process of decision making. Hence, the efficiency of

accounting information system depends upon the knowledge of people related to it regarding

computerized accounting.

Limitations or Problems associated with the computerized accounts.

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1. In case of computerized accounts the auditor may not go for in depth auditing. In other

words, he may not go to the original data to vouch and verify.

2. Knowledge of computer is a major deficiency in our country.

3. Each type of business has its own method of computerized auditing. This makes the auditor’s

work more difficult.

4. Documentation is completely different in case of computerized accounting which requires

complete knowledge of input and output document.

Its therefore necessary that an auditor needs to be familiar himself with computerized accounting

system and its environment. He has to review the system of internal control prevailing in

existence, in recording, transmitting and processing of the data.

Internal Control System Under Computerized Audit:

The auditor should study the internal control system existing in a business where computerized

accounting is followed. He should verify allocation of duties, systems of authorization etc.

Its necessary to identify and decide the extent to which the internal control is reliable. It should

be understood that computerization of accounts does not eliminate errors and frauds. Its

advisable that he management should consult the auditor while installing the system of

computerized accounting. This helps the auditor to satisfy himself as to its adequacy from the

point of view of audit work. The control systems may be of the following types:

a) Organizational Controls:

It is necessary to have an effective control system at various levels of organization. Eg: A

programmer can always manipulate facts if he desires to do so, if the organization has a weak

control system.

Its advisable to divide the work in such a manner that functions like programming, system

design and analysis, testing, operating etc are assigned to different people. It is always

necessary that the programmer does not have access to the data files.

b) Control Over Documentation, Testing etc:

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This includes preparation of flow chart, instruction to operations etc. the control should be in

such a manner that no alteration is allowed in programmes without authorization. For new

programming and changing the existing programme a proper procedure should be laid out.

c) Input Control:

Quality of output depends upon the quality of input. It must be ensured that only authorized,

accurate, and complete input data are fed into the system. Errors in these areas results in

unreliable output.

control over creation of original documents to overcome the entry errors or error and frauds

at the input level. Companies can develop a system of indentifying such errors at the entry

level only before original documents are forwarded to data processing centre. A senior

officer should review the documents to ensure their correctness.

d) Control over handling and movement of Original Documents:

To prevent loss of document either at data processing centre of while transferring them to the

following controls are suggested:

i) Documents should be sent in a well defined process or routing system.

ii) The document sourced from one department should be consecutively numbered.

iii) It should be verified whether number of documents sent agree with the number of

documents processed.

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COMPANY AUDITOR

According to Section 224 of the Companies Act, every company whether private or public must appoint

an Auditor or auditors to audit the final accounts. The provisions relating to the appointment of auditor

are as follows:

1. Board of Directors:

The first auditor of a newly floated company is appointed by the board of directors, within one month

of registration of the company. Such an auditor or auditors shall hold office till the conclusion of the

first annual general meeting.

The directors are also empowered to fill a casual vacancy of an auditor if it is not caused by

resignation. The auditor so appointed shall hold office till the conclusion of the next annual general

meeting. But in case, if the vacancy is caused by the resignation of an auditor, it shall only be filled by

the company in its annual general meeting.

2. Annual General Meeting:

The auditor or auditors are appointed in the annual general meeting under the following circumstances:

1) If the board of directors fail to appoint an auditor, the shareholders shall make an

appointment in the annual general meeting.

2) Every company shall at each annual general meeting appoint an auditor to hold office from

the conclusion of that meeting until the conclusion of the next annual general meeting.

3) The company has to give intimation to the auditor so appointed within seven days of his

appointment.

4) The auditor so appointed shall within 30days of the receipt of intimation from the company

regarding his appointment, has to inform the registrar of the company in writing whether he

has accepted or refused the appointment.

In every annual general meeting the appointment of the company’s auditor is made by the simple

majority of votes by the present members.

3. Central Government:

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According to section 224 (3), if the auditor has not been appointed in the annual general meeting, the

company has to inform within seven days to the Regional Director to whom the Central Government’s

power to appoint an auditor in such an event has been delegated under section 637.

The said application must disclose in sufficient detail the reasons why the company could not appoint

the auditor at its general meeting. In the case of default, the company and every officer of the company

who is in default shall be punishable with a fine which may extend to Rs.500 as per section 224(4).

Appointment of Auditor by Special Resolution.

In 1974, Companies Act 1974 was amended by adding sub section A to section 224. After that, in some

cases, the appointment of auditors or auditor requires special resolution. That is in case of a company, in

which not less than 25% of the subscribed share capital is singly or jointly held by.

a. A public financial institution or a government company or the central government or any

state government or

b. Any financial or other institution established by any provincial or state Act in which a state

government holds not less than 51% of the subscribed share capital or

c. A nationalized bank or an insurance company carrying on general insurance business.

In the above mentioned circumstances, the appointment of an auditor shall me made by passing a special

resolution (that is 75% or more of the members present should agree for the resolution). If not, it shall be

deemed that the appointment has not been made and the central government will get the right under

section 224(3) of the Companies Act to make an appointment.

Compulsory Reappointment.

Section 619 of the Companies Act specifies that in the case of government companies, the appointment or

reappointment of an auditor by the central government can be made only on the advice of the comptroller

and Auditor General of India.

In other cases, that is, whether auditors are appointed by the board of directors in the annual general

meeting or by he central government, the retiring auditors are compulsorily reappointed, unless

1. He is not qualified for reappointment.

2. He has given a notice in writing to the company of his unwillingness, to be reappointed

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3. Where a notice has been given or an intended resolution to appoint some other person in the

place of the retiring auditor and by reason of death, in capacity or disqualification of that

person or of all the persons as the case may be, the resolution cannot be proceeded with or

4. A resolution has been passed at that meeting, appointing somebody instead of providing

expressly that he shall not be reappointed. This is as per section 224(2) of the Companies

Act.

Ceiling on Number of Audits

In 1974, a group of young charted accountant, academicians and other sections of the public

argued that the opportunities of professional practice are concentrated in the hands of a few well

established and leading chartered accountants of the country. They demanded this monopoly be

liquidated in the general interest of the profession thereby providing an opportunity to young

chartered accountants also to earn their living. Therefore, the companies act was amended in

1974, by introducing section 224 (1- B). This came into effect from February 01, 1975 to ensure

a more equitable distribution of audit work among all the practicing chartered accountants and to

avoid the concentration of audit work in few leading firms of chartered accountants.

Therefore, according to section 224( 1-B) of the Companies Act, no individual and no partner of

the firm of auditors shall hold office as auditors of more than 20 companies of which not more

than 10 be companies with paid up share capital of Rs.25 lakhs or more.

Filling of Casual Vacancies [Section 224(6)]

1. A vacancy caused by the resignation of an auditor shall only be filled by the members in the

annual general meeting.

2. If a casual arises for any other reason (that is, death, insanity or insolvency) it can only be

filled by the board of directors.

3. An auditor appointed to fill up the casual vacancy shall hold office until the conclusion of the

next annual general meeting of the company.

Qualification of Auditor.

According to Section 226(1) and 226(2) of the Companies Act, the prescribed qualifications of

an auditor are as follows:

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1. A person who is a chartered accountant within the meaning of the Chartered Accountant’s

Act 1949.(Section 26(1)]

2. A person who holds a certificate under the Restriction Auditors Certificate Rules 1956 is also

qualified to act as an auditor of a company. Such persons are also known as certified auditors

and are always subject to rules made in this behalf by the central government [section 226(2)]

The central government in empowered to frame rules relating to granting renewals,

suspension or cancellation of such certificates.

Disqualification of a Company Auditor.

According to section 226(3) of the Companies Act, the following persons shall not be appointed

as auditors of a company.

1. A body corporate.

2. An officer or an employee of the company.

3. A person who is a partner in the business.

4. A person who is indebted to the company for an amount exceeding more than Rs.1000/- or

who has given any guarantee or provided any security in connection with the indebtedness of

any third person to the company for an amount exceeding Rs.1000/-.

If an auditor, after his appointment becomes a subject of any of the above mentioned

disqualifications, he shall be deemed to have vacated his office forthwith.

Removal of an Auditor.

1. The first auditors appointed by the directors prior to the first annual general meeting of the

company may be removed by the members in the annual general meeting even if there tenure

of office has not expired.

The general meeting may in their place, appoint any other person, notice for whose

nomination has been given by any member not less than 14days before the date of the

meeting.

2. In any other case, the auditor may be removed from office before the expiry of his term by

the company in the annual general meeting after obtaining the previous approval of the

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central government in this behalf. This provision is as per section 224(7) of the Companies

Act.

3. But section 225 of the Companies Act makes special provisions in this respect, in order to

safeguard the interests of an independent auditor against unfair and unjust removal at the

hands of an unscrupulous management.

The procedure so laid down is as follows:

a. Special notice of intention to make such resolutions to remove the existing auditor must be

given to the company by the shareholder not less than 14days before the annual general

meeting.

b. On receipt of such a notice, the company must forthwith send a copy to the retiring auditor.

c. The retiring auditor has the right to send a representation to the company which he can ask

the company to send to the shareholders.

d. If a copy of the representation is not sent to the members, either because it was received too

late to be thus sent, or because of the default of the company, the auditor may insist that the

representation shall be read out in the meeting.

e. The auditor, who is proposed to be removed, has the right to attend the general meeting

where his removal is to be discussed. He also has the right to speak at such a meeting.

f. As a matter of professional conduct, the auditor so appointed in place o another should

communicate with the retiring auditor in writing before accepting the appointment. If he

does not do that, he may be held liable for disciplinary action as per the regulations of the

Institute of Chartered Accountants of India.

Remuneration of an Auditor.

1. The general rule is that the appointing authority is authorized to fix the remuneration f an

auditor as per Section 224(8)

2. In the case of a new company where the auditors are appointed by the board of directors, the

remuneration will be fixed by the board of directors.

3. Similarly, if an auditor is appointed to fill a casual vacancy the remuneration will be fixed by

the board of directors.

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4. When an auditor is appointed by the Central Government the remuneration will also be fixed

by the Central Government.

5. If the auditor’s appointed at the annual general meeting, the remuneration is also fixed at the

annual general meeting.

6. Remuneration includes the sum paid by the company in respect of the auditor’s expenses.

7. Where the auditor is reappointed in the next annual general meeting, the amount fixed in the

previous year is considered for the currency year also, if nothing more is specifically

provided as remuneration in the current annual general meeting.

8. A part from the routine audit work, if a chartered accountant is entrusted with the work of

taxation, writing up of the account books and other professional services then the auditors

and the board of directors can fix up the remuneration mutually for the additional work.

Moreover, the sanction of the share holders is not needed for the same.

9. Any remuneration paid for services other than routine audit work should be explained in the

Profit and Loss account separately as under:

i. Remuneration as an Auditor of the company.

ii. In the capacity of an adviser in respect of:

a. Taxation representation.

b. Company Law matters

c. Management Services.

d. Internal Auditing

e. Other professional services and

f. For travelling and out of pocket expenses.

Rights of Company Auditors.

According to Section 227(7) of the Companies Act, a company auditor has the following rights.

1. Right of Access t Books of Accounts:

As per Section 227(1) of the Companies Act every auditor of the company has the right to

access at all times to the books of accounts and vouchers of the company, whether kept at the

head office of the company or elsewhere.

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Under section 209(1) (d), a company auditor has the right to examine the cost records also

which are required to be maintained by certain companies relating to production sales, stores

etc.

2. Right to Obtain Information and Explanations:

An auditor can call for any information or explanation from different officers of the company

which he may think necessary for the performance of his duties.

Under section 221, apart from the auditor’s right to obtain information and explanation it is

the duty of every officer of the company to furnish without delay the information to the

company auditor.

The power is so wide; the decision as to what information and explanation is left entirely to

the discretion of the auditor. If the directors or officers of the company refuse to supply some

information on the ground that in their opinion it is not necessary to furnish it, then the

auditor has the right to mention that in his audit report.

3. Right to Receive Notices and Other Communication Relating to General Meetings and

to attend them.

According to section 231, of the companies act an auditor of a company has the right to

receive notices and other communications relating to the general meetings in the same way as

that of the members of the company.

Similarly an auditor also has the right to attend any annual general meeting and also to be

heard at those meetings which he attends and which concerns him as an auditor.

The auditor also has the right to make a statement or explanation with regard to the accounts

he has audited. But he auditor is not expected to answer questions in the general meeting.

4. Right to Visit Branches.

According to section 228 of the companies act the auditor of the company has the right to

visit the branch office or offices of the company.

He can also audit such accounts of eh offices of the company provided that there is not

qualified auditor to audit the accounts of the branch office or offices of the company, in such

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cases, the auditor has the right to access at all times to the books of accounts and vouchers

that the company maintains at branch office or offices.

Moreover section 226 of the companies act provides that in case of the company gets the

branch accounts audited by some of the local auditors, even the auditor has access at all

times, to the books, accounts an vouchers of the company and he can also visit the branches,

if he feels necessary.

5. Right to Correct Any Wrong Statement.

The company auditor is required to make a report to the members of the company on the

accounts examined by him of the final accounts and the related documents which are laid

down before the company in the general meeting.

Similarly, the auditor can advice the directors to amend their system of maintaining accounts.

If the suggestions are not carried out, he has the right to refer the matter to the members and

also to report that in the audit report.

6. Right to sing the Audit Report

As per section 229 of the companies act only the person appointed as auditor of the company

or where a firm is so appointed, only a partner in the firm practicing in India, may sign the

audit report or authenticate any other document of the company required by law to be signed.

7. Right to Being Indemnified.

Under Section 633 of the Companies Act, an auditor is considered to be an officer of the

company and he has the right to be indemnified out of the assets of the company against any

liability incurred by him in defending himself against any civil and criminal proceedings by

the company if it is proved that the auditor has acted honestly or the judgment is delivered in

his favour.

8. Right to seek Legal and Technical Advice.

The company auditor has the full right to seek the opinion of the experts and to take their

legal and technical advice so as to discharge his duties efficiently.

9. Right to Receive Remuneration.

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As per Section 224(8) of the Companies Act, the company auditor has the right to receive

remuneration provided he has completed the work which he has undertaken to do so.

Duties of Company Auditor.

The various duties of the company auditor are as follows:

1. To make special enquiries and investigation: in connection with the following matters

under section 227(1-A) of the Companies Amendment Act 1965.

A company auditor shall enquire:

a. Whether loans and advances made by the company on the basis of security have been

properly secured and whether the terms of which they have been made are not prejudicial

to the interests of the company or its members.

b. Whether the transactions which are not supported by any fact or evidence, though

recorded in the books are not prejudicial to the interests of the company.

c. Whether personal expenses have been charged to the revenue account.

d. Whether it has stated in the books of accounts of the company that any shares have been

allotted for cash and whether cash has actually been received in respect of such

allotment, and if no cash has actually been received, whether the position as stated in the

account books and the Balance Sheet is correct and regular.

2. Duty to make a Report to the Shareholders.

Under Section 227(2,3,4&5) of the Companies Act, the auditor shall report to the share

holders about the accounts examined by him. The report so mentioned shall contain the

following.

a. Whether in his opinion, the Profit and Loss Account referred to in his report exhibits a

true and fair view of the profit or loss.

b. Whether in his opinion, the Balance Sheet referred to in his report is properly drawn up,

so as to exhibit a true and fair view of the state of affairs of the business according to the

best of his information and explanations given to him and as shown by the books of

accounts.

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c. Whether he has obtained all the information and explanation which to the best of his

knowledge and belief were necessary for the purpose of his audit.

d. Whether in his opinion, proper books of accounts as required by law have been kept by

the company and proper returns adequate for the purpose of his audit have been received

from branches he visited or not.

e. Whether report on branch accounts audited under section 28 by a person other than the

company’s auditor has been forwarded to him as required by clause (c) sub section (3) of

that section and how he had dealt with the same in preparing the auditor’s report.

f. Whether the company’s Balance Sheet and Profit and Loss Accounts dealt with by the

report are in agreement with the books of accounts and returns.

If the answer to any of the above mentioned questions is in the negative, the auditor

should submit his report accordingly.

3. Duty to comply with the Directives of the Central Government.

It is the duty of the auditor to comply with the various directives issued to the auditor of the

joint stock companies from time to time to give specific reports on the financial accounts of

the companies.

For example in 1975 it was made compulsory for some of the specified companies which are

engaged in any of the below mentioned activities to conduct cost audit, that is, those

companies engaged in

a. Manufacturing, mining or processing.

b. Supplying and rendering services

c. Trading

d. Business of financial investments, chit funds, nidhi or mutual benefit societies.

4. Duty to sign the Audit Report.

As per section 229 of the companies act 1956, it is the statutory duty of the company auditor

to sign the report prepared by him. Only a partner practicing in a firm in India can sign the

audit report for and on behalf of a partnership firm practicing as chartered accountants.

5. Duty to give a Statement in the Prospectus.

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As per section 56(1) of the companies act, the prospectus issued by an existing company shall

contain a report from the auditor of the company regarding

a. Profits and losses during the previous year.

b. Assets and liabilities of the company and its subsidiaries and

c. The rate of dividend paid by the company in respect of each class of shares in the

company for each of the five financial years preceding the issue of prospectus.

So it is the statutory duty of the company auditor to submit his report containing the

above mentioned points.

6. Duty to Certify the Statutory Report.

According to section 165(4) the auditor of the company has to certify the statutory report

regarding the shares allotted by the company, the cash received in respect of shares, and the

receipts and payments of the company. The statutory report should also be certified as correct

by two directors, one of whom shall be managing director.

Every company shall within a period of not less than one month and not more than 6months

from the date which the company is entitled to commence business has to conduct a general

meeting of the members of the company which is known as the statutory meeting.

7. Duty to make a declaration of Solvency, if the company Goes into Voluntary Winding

up

When a company goes into voluntary winding up, then a declaration of solvency is to be

made by the directors of the company. Under section 488(1) of the Companies Act, this

declaration is to be accompanied by the report of the auditor of the company under the

section 488(2) of the companies act. So it is the duty of the auditor to make such reports.

8. Duty to produce information and to assist the investigation, if any investigation is

conducted regarding the working of the company.

Under section 240(6) (b), it is the duty of an auditor to preserve and produce to the inspector

or any other person authorized by him in this behalf with the previous approval of the central

government, all books and papers of or relating to the company or as the case my be, of

relating to the other body corporate which are in their custody or power and other wise to

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give to the inspector all the assistance in connection with the investigation which they are

reasonably able to give.

9. Duty to perform the contract

It is the duty of the auditor to discharge the duties according to the terms of contract between

the auditor and the party who has appointed him. It is to be remembered that the scope of

statutory duties of a company auditor cannot in any way be curtailed. But on the other hand,

the scope of duties of the auditor can be enlarged by passing a resolution at the annual

general meeting making a provision in the Articles of Association of the company. If so, it is

the duty of the auditor to perform the additional work.

10. Duty to care and caution.

The auditor is appointed in the capacity of an expert, therefore, he must act honestly and

exercises cure care and caution in the performance of his duties. The auditor can never give

ignorance as an excuse for defense. So the auditor must prove that in the course of his audit

work, he has employed skills that would reasonably be applied by any other auditor.

Special Audit of Companies.

As per section 233 A of the companies act, the central government has the power to direct

special audit in the following cases for a specified period. That is, when the central government

is of the opinion.

1. That the affairs of any company are not being managed in accordance with sound business

principles or prudent commercial practices or

2. That any company is being managed in a manner likely to cause serious injury or damage to

the interests of the trade, industry or business to which it pertains or

3. That the financial position of any company is such as to endanger its solvency.

Auditor appointed under this section under the above mentioned circumstances are known as

Special Auditors. Special audit is entirely different from investigation as per section 235. For

example: the audit firm Lovelock and Lewies was asked by the central government to

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conduct a special audit for ITC company for which they audited the accounts and to submit a

report when the ITC scam was reported.

Powers and Duties.

The powers and duties of the special auditors are identical to the rights and duties of a company

auditor as specified in section 227.

Remuneration.

Although the special auditor is appointed by the Central Government his remuneration is paid by

the company as determined by the Central Government.

Report

Special auditors have to submit their report to the Central Government to take necessary action

as per the provisions of the Companies Act. But if the Central Government does not like to take

any action on the submitted report within four months, in that case, the central government will

send the copy of the report or its relevant extracts with comments to the company to be

circulated to the members or to put such copy or extracts in the company’s next annual general

meeting.

The Liabilities of a Company Auditor.

1. Civil Liability of an Auditor for negligence.

The liability of an auditor to pay damages are known as Civil Liabilities. Every auditor in the

performance of his job is expected to exercise reasonable care and skill as per the

circumstances, because the shareholders of the company appoint the auditor as their agent

and therefore, he must exercise reasonable degree of skill and care in the performance of his

duties. If not, the auditor will have to face the consequences.

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Therefore, we can conclude that an auditor can be held liable for negligence of his duty if it is

proved that

a. There has been a negligence in the performance of his duty and it may be due to the

absence of requisite professional skills or failure to exercise it.

b. There happens to be a loss or damage as a result of his negligence and

c. The loss was suffered by his client.

However, the court has the power to grant relief, wholly or partly to an auditor. We can

also present the situation as given below.

1. Loss without negligence and

2. Negligence without loss.

a. Liability of the Auditor for Mis-statements in the Prospectus.

As per section 65 of the companies act 1956, an auditor may be held liable for damages

suffered by those persons who subscribed to the shares or debentures of a company or

debentures of a company proposing in the faith of the prospectus, which included auditor’s

report containing some untrue statements or facts. The auditor and every person who has

authorized the issue of the prospectus shall be punishable with imprisonment for a term

which may extent of 2years or with fine, which may extend to Rs. 5000 or with both, for

the damages sustained directly resulted from those untrue statements. For the purpose of

this clause, even those statements shall be taken to be untrue which are misleading in form

and the context in which they are included.

But the auditor can escape from his liability if he is able to prove:

i. That he withdrew his consent in writing before the delivery of the copy of the

prospectus for registration.

ii. That he withdrew his consent in writing from such a prospectus on coming to know of

the untrue statement by giving a reasonable public notice before the allotment of shares.

iii. That he was competent to make the statement and that he has reasonable grounds to

believe up to the time of allotment of the shares, that the statement was true or he relied

upon the opinion of an expert whose name he has quoted in his certificate.

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b. Civil Liability of an Auditor for Misfeasance.

By misfeasance we mean breach of trust or duty imposed by law for negligence in the

performance of duties, which results in some loss or damage to the company. If an auditor

does something wrong in the performance of his duties resulting in financial loss to the

company he is guilty of misfeasance.

As per section 543 of the companies act. The liquidator can bring the suit in the name of

the company against the auditor, that is “in the course o winding up of a company, it

appears that any officer, including eh auditor or any other person associated with the

promotion or the management of the company has misapplied or retained wrongfully, any

property of the company or is guilty of breach of duty, he can be held liable for the

damages caused to the company”

But section 633 grants relief to directors, officers, and auditors of the company against

liability in respect of negligence, default, breach of duty, misfeasance or breach of trust.

But for getting any relief there under, it must be proved by the person concerned.

a. That he has acted honestly.

b. That he has acted reasonably and

c. That having regard to all the circumstances of the case, he ought fairly to be excused.

2. Criminal Liabilities of a Company Auditor.

The auditor of a company becomes criminally liable for various offences during the course of

his audit. Criminal liability of an auditor will arise when he is found to be guilty of willful

non compliance under the provisions of law. Under the criminal liabilities, he may be

imprisoned, fined or punished with both as per the companies act, income tax act, and the

Indian Penal Code. Criminal liability of an auditor arises from errors in the performance of

audit.

The auditor can be held criminally liable under:

1. The Companies Act.

2. The Income Tax Act.

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3. The Chartered Accountant Act

a) Criminal Liabilities under the Companies Act.

i. Section 233

If the auditor does not comply with the requirement of section 227 and 229 as to make

of his report, of signing or authenticating any document and if such default on his part

is willful, he shall be punishable with fine which may extend to Rs. 1000

ii. Section 240

If the auditor of a company doesn’t give the required assistance to an inspector

appointed by the central government to investigate into the affairs of the company, the

auditor of the company is punishable with imprisonment up to 6months or fine up to

Rs.2000 or both. For persistent default a further fine at Rs. 200 per day may also be

charged.

iii. Section 242

When on the basis of the report submitted by an inspector, the central government takes

action and prosecutes any person connected with the affairs of the company is required

to assist the prosecution. If he does not do so, he is guilty of contempt of court and

punishable to the extent of imprisonment for 6months of fine of Rs 500 or both.

iv. Section 477

When the company is wound up, the auditor is subjected to a private examination by the

court and is also liable to return to the court any books and documents of the company

in his possession. If he does not appear before the court he can be arrested.

v. Section 478

On an application from the official liquidator, the auditor of a company is liquidation

can be publicly examined in high court. Notes of the examination shall be taken down

in writing and that should be signed by the auditor which may thereafter be used as

evidence against him in any other civil or criminal proceedings.

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vi. Section 539

If an auditor destroys, mutilates, alters, falsified or secretes or is a partly to the

destruction mutilation alteration or falsification or secreting of any books papers or

securities or makes or is a party to the making of any false or fraudulent entry in any

register books of accounts or documents belonging to the company, he shall be

punishable with imprisonment for a term which may extend to 7years and also be fined.

vii. Section 545

The court may direct the liquidator of a company in winding up to prosecute the auditor

if he is found guilty of any criminal offence in relation to the company.

viii. Section 628

An auditor is also liable to criminal prosecution, if he in any return, certificate, balance

sheet, prospectus, statement or any other document required by or for the purpose of the

act makes a statement.

1. Which is false in any material, particularly knowing it to be false.

2. Which omits any material fact knowing it to be material.

The punishment on conviction is imprisonment for a term which may extend up to

2years and shall also be fined.

ix. Section 629

If any person including an auditor intentionally gives false evidence upon nay

examination up on oath or solemn affirmation authorized under the act or in any

affidavit, deposition or solemn affirmation in or abut he winding up of any company

under he act, he shall be punishable with imprisonment for a term which may extend to

seven years and shall be liable to fine also.

Conclusion.

If the Articles of Association or any special agreement between the company auditor and

the company contains any provision which exempts the auditor from any of the above

legal liabilities for negligence, defaults, misfeasance, breach of trust, breach of duty etc it

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shall be considered void. However, according to section 633 the company can indemnify

such officers including he company auditor for any of the losses suffered by him.

b) Criminal Liabilities under the Income Tax Act.

A qualified chartered accountant or the auditor of the company can act as authorized

representative and may attend the Income Tax Authority or the Appellate Tribunal in

connection with the proceedings under the Income Tax Act.

a. Section 288

This section provides that if a person who is convicted of an offence in connection

with taxation proceedings will be disqualified from representing an assesse. The

commissioner of Income Tax has been empowered to determine the period of such

disqualification.

If the council of the Institute of Chartered Accountants of India finds that any

chartered accountant is guilty in his professional misconduct, default in taxation etc.

the institute can also declare him disqualified for certain specified period.

b. Section 277

As per this section 2years imprisonment may be imposed on the auditor if he auditor

submits knowingly any false statements in the form of accounts for the preparation of

income tax returns.

c. Section 278

As per this section any person who induces in any manner any other person to make

and deliver to the income tax authorities, some false statements or declaration relating

to chargeable income tax, highlighting the fundamental principle of criminal law that

any person who aids, counsels or procures the commission of an offence is liable to be

punishable with rigorous imprisonment for a minimum period of 3months and

maximum of 3years with fine. In case the amount of tax to be evaded is in excess of

Rs. 100000 the minimum and maximum period of rigorous imprisonment will be

6months and 7 years maximum with fine.

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c) Criminal Liabilities of an Auditor under the Chartered Accountants Act 1949.

1. If a person not being a chartered accountant within the meaning of chartered

accountants act of 1949 acts as an auditor of a company and signs any documents, then

he may be held liable for criminal prosecution under section 29 of the chartered

accountants act 1949. The punishment for this is fine which may extend to Rs.1000 on

first conviction and with imprisonment extending to 6months or fine amounting to

Rs.5000 or both on any subsequent conviction.

2. According to Part III of the first schedule of Chartered Accountants Act 1949 a member

of the institute whether in practice r not, shall be deemed to be guilty of professional

misconduct if he:

a. Includes in any statement return or form to be submitted to the council any particulars

knowing them to be false.

b. Not being a fellow styles himself as fellow

c. Does not supply he information called for or does not comply with the requirements

asked for by the council or any of its committees.

3. Auditors Liabilities to Third Parties.

Besides the client, the creditors, bankers, prospective share holders, tax authorities etc

depend fully upon the final accounts certified by the auditor and do different dealings

with the company.

The liability of an auditor towards third parties can be discussed under 2circumstances.

a. For Frauds.

If in case there is any fraud on the part of the company’s auditor, the third parties can

however hold him liable. This 3rd party can sue the auditor if the report of the auditor

is of such a nature, as amounts to fraud, even in there is no contractual obligation

between the auditor and the 3rd party.

It was decided in the case of Derry Vs Peek (1882) that the auditor can be held liable

to 3rd partied only when the following facts are proved against him.

i. That the statement or balance sheet signed by the auditor was materially untrue

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ii. That the statement or the Balance Sheet was made an intention that a 3rd party

should act on it.

iii. That the auditor knew that the statement of balance sheet was untrue.

iv. That the 3rd party acted upon such a statement and consequently suffered a loss.

v. That the auditor gave his consent for the inclusion of such a statement in the

prospectus.

b. For Negligence.

An auditor in general is not liable to 3rd parties for negligence of duty as no

contractual obligation exists between the auditor and the 3rd party. As he is not

appointed by them, he owes no duty towards them and hence there is no question of

any type of liability.

DISTINCTION BETWEEN PROFIT AND DIVISIBLE PROFITS:

One should clearly understand the difference between these two terms. All the profits of a company are

not divisible. Only those profits, which can be legally, distributed in the form of dividend to the

shareholders of the company are called as Divisible Profits. There is no definition of the term divisible

profit in the companies act.

There are two main principles which he observed before declaring dividends to the shareholders:

1. In every case, dividend must be paid in accordance to the provisions of section 205 of the

companies act and of the company’s memorandum of association and articles of

association. If the articles of association of a company are silent on this matter, dividend

must be paid according to Regulations 85 and 94 of table A schedule 1 appended to the

companies act.

2. Dividends should not be paid at the cost of creditors or debenture holders of the company.

BASIC CONSIDERATIONS FOR DIVISIBLE PROFITS:

There are many factors involved in calculation the divisible profits. However, the following basic

considerations must be followed for an amount to be legally distributed as dividends. They are:

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1. Memorandum and Articles of association of the company.

If the provisions contained all the articles and memorandum of association of the company are silent

about this (that is determination of divisible profits) then schedule 1, clause 85 to 94 will apply. These

are as follows:

Clause 85: this clause says, the company in general meeting may declare dividend, but no individual

shall exceed the amount recommended by the board.

This means that the authority to recommend dividend is the board of directors, but the declaration as

to final dividend is within the jurisdiction of the general meeting of the shareholders. However, the

general meeting cannot increase the amount of dividend as recommended by the board. If the board

doesn’t recommend any dividend in any year, the shareholders in general meetings can’t on their own

declare it. Declaration of final dividend constitutes an enforceable debt against the company and it

cannot be revoked.

Clause 86: this states that the board may from time to time pay to the members such interim

dividends as it appears to be justified by the profits of the company.

But unlike final dividend doesn’t not create a debt against the company, and the board may

subsequently revoke the resolution and cancel the announcement.

Clause 87:

1. The board may before recommending any dividend set aside out of the profits of the

company, such sums as it thinks proper, as reserve or reserves which at the discretion of

eh board be applicable for any purpose t which profits of the company may be properly

applied, including provisions of the meeting contingencies or for equalization of

dividends, an pending such application may at the like discretion either be employed in

the business of the company or be invested in such investments as the board may from

time to time think fit.

2. The board may also carry forward any profit which it may think prudent not to divide

without setting them aside as reserve. The meaning of this clause is that the company has

the right to create any reserve or reserves before recommending any dividend.

Clause 88: according to this clause a company may pay dividend in proportion to the amount paid up

on each share. If unequal amounts have been paid up on some shares, the dividend may be unequal

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among different shareholders. However in the absence of such a clause in the articles of a company,

members will be entitled to dividend in proportion to the nominal value of the shares and not in

proportion to the amount paid in respect of each share.

Clause 89: the board may deduct from any dividend payable to any member, all sums of money if any

presently payable by him to the company on account of calls or otherwise in relation to shares of the

company.

Clause 90:

1. Any dividend, interest or other money payable in cash in respect of shares may be paid by

cheque or warrant sent through the post directly to the registered address of the holders

and in the case of joint holders, to the registered address of that one of the joint holders

who is first named on the register of members, or such person and to such address as the

holders or joint holders may in writing direct.

2. Every such cheque or warrant shall be made payable to the order of the person to whom it

is sent.

Clause 91:

Any one of two or more joint holders of a hare may give effectual receipts for any dividends bonuses

or other money payable in respect of such share.

Clause 92: notice of any dividend that may have been declared shall be given to the persons entitled

to share therein, the manner mentioned in the act.

Clause 93: no dividend shall bear interest against the company.

2. Provisions of the Company’s Act.

Out of current profits: depreciation must be provided by the company, before declaring any

dividend out of the current profits. It is also important that in respect of financial year ending after 28th

December 1960, the arrears of depreciation must also be provided for before declaration or payment

of dividend.

Company’s amendment act 1974 says that the company should also transfer the prescribed percentage

of profits (that is not exceeding 10%) to its reserves before declaring dividends. The company can

also transfer a higher percentage of its profits in accordance with the rules framed by the central govt.,

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in this regard. However, no amount needs to be transferred to the reserves where the rate of dividend

is 10% or less.

Out of past Reserves: section 205 A(3) of the companies act, provides that in the event of inadequacy

or absence of profits in any year, dividend may be declared by the company for that year out of the

accumulated profits earned by the company in the previous year and transferred to reserves, if the

following conditions are satisfied:

1. The rate of dividend declared by the company shall not exceed the average rate at which

dividend was declared by it in 5years immediate.

2. The balance of the reserves which may remain after declaring such dividend shall not fall

below 15% of its paid up share capital.

Amount provided by the Central Government.

A company may also declare dividend out of the amount provided by the central govt., or a state

govt., for he payment of dividends in pursuance of a guarantee thereof.

Provisions for Depreciation.

The position as to depreciation which is compulsorily required to be provided before declaration or

payment of dividend for any financial year may be summed up as follows:

1. For declaration of payment of dividend in respect of the current financial year,

depreciation must be provided.

2. In respect of financial year ending after 28th December 1960, the arrears of depreciation

must be provided before declaration or payment of dividend.

3. Under section 205(1) (c), the central govt., may if it thinks necessary to do so in public

interests, exempt any company from the requirement of providing depreciation before

declaring of paying dividend for that year.

Past Losses:

Under section 205(1) (b) of the companies act if a company has incurred a loss in any financial year

or years after the companies amendment act 1960, then either the amount of loss or the amount equal

to the amount of depreciation whichever is less shall be set off against the profits of the company

before dividends can be declared. That is, that amount of depreciation forming part of past losses

shall be allowed to set off against the future profits first.

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3. Provisions of the Income Tax Act:

Section 104 to 109 of the Income Tax Act provides that in the case of a company in which public are

not substantially interested, has to distribute a specified amount of dividend as prescribed by the

income tax act. The company would have to pay additional income tax on the undistributed part of its

income if the actual dividends fall short of the amount so prescribed.

Provisions of the banking regulation act also affect divisible profits section 17 of the act provides that

a banking company incorporated in India must transfer 20% of its annual profits to a reserve fund

before payment of dividend. However, the bank may obtain exemption from the central govt., in this

regard.

4. Principles of Accountancy.

Divisible profits are calculated as surplus of income over expenditure for a given period. For this

purpose all transactions are distinguished as capital and revenue, and such a distinction is necessary

from the accountancy point of view. But a modified basis is now adopted to calculate divisible profits,

that are the differences between assets and liabilities plus capital at the commencement of the year

(i.e. net worth at the beginning0is found out. If assets are more, there is surplus, otherwise there will

be deficiency. Similarly the deficiency or surplus at the end of the year is calculated after considering

the increase of decrease of the capital etc. if there is surplus it is profit and if its is deficiency there is

loss. This is now well recognized principle for determining profits.

According to the principles of accountancy it is not proper to distribute capital profits as dividends

and it is also not advisable to distribute the profits of the current year without providing for the losses

of the previous year. Principles of accountancy also advocate that proper reserve should be created

among the shareholders by way of dividends.

5. Legal Decisions:

The provisions regarding declaring dividends is made clear with certain legal decision, they are:

Distribution of capital profits and legal decisions:

Capital profits are not profits in the normal course of business. If a company sells a part of the property at

a cost higher than the original cost of such assets the profits thus earned is capital profit. Similarly,

premium received on issue of shares, profits made on the re-sale of forfeited shares etc are examples of

capital profits, and thus it is clear that capital profits do not arise in the course of business. As per the

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company law, such profits should not be distributed amongst the shareholders as dividends. But the below

mentioned case decisions provides that under certain circumstances, capital profits can also be distributed

among the shareholders of the company.

Based on the tow legal decisions regarding the distribution of capital profits, it can be concluded that

capital profits cant be distributed as dividends, unless:

a. All the other assets have been revalued.

b. Such profits had been actually realized.

c. That the Articles of Association of the company had permitted such a distribution and

d. Working capitals of the company should also be sufficient for the company to carry out the

business because it is always good from the financial point of view of the company.

Auditor’s duties with regard to payment of Dividend.

1. The auditor should examine the Memorandum and Articles of Association of the company to

determine the rights of different classes of shareholders to whom dividend has been paid.

2. Dividend can only be distributed out of profits and capital of eh shareholders cannot be used

for the purpose.

3. The auditor should ascertain whether profits set aside for the purpose of dividend have been

computed in accordance with the requirements of section 205 of the companies act.

4. The auditor should ascertain whether the rate of dividend has been recommended properly in

the meeting of the board of directors.

5. The auditor should examine the list of shareholders with the register of shareholders to see

that the total amount of dividend payable agrees with the dividend account.

6. The amount of unclaimed dividend should be verified with the dividend account bank

passbook and dividend warrants if any returned undelivered.

7. The auditor should check whether the income tax has been deducted at source.

8. The auditor should see that the dividend has been paid within the terms of clause 88 of Table

A i.e in proportion to the amount paid for shares, if the same is incorporated in the articles of

the company.

9. In case of issue of bonus share it should be ascertained that whether the articles of eh

company authorized it.

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10. It should be seen that the depreciation in respect of fixed assets and also floating assets has

been provided before computation of divisible profit.

11. It should be seen that security available to the creditors of the company is in no way affected

by the distribution of dividends.

SECRET RESERVES.

Some time a company creates a reserve, which is not shown in the balance sheet. Such a reserve is called

secret reserve. It has been defined as “any reserve that is not apparent in the face of the balance sheet/”

this is also called Hidden Reserve or Internal Reserve or Inner Reserve.

Objections to creating secret reserves:

1. The balance sheet prepared at the end of the year will not show a true and fair view of the

state of affairs of the company as is required under the companies act.

2. The creation of secret reserve causes loss to the shareholders who are the real owners as they

do not get their due share of profit.

3. Secret reserves might be used by dishonest directors for improper purposes i.e., to cover up

losses upon ultra vires transactions or for indulging in speculation I the shares of the

company or fraudulent activities. All such activities may turn out to be ruinous to the

company.

4. When secret reserves are created by under valuing an asset the balance sheet will show the

value of this asset at a lower figure than its real value, then the company cannot claim from

the insurance company the full value of that asset if it is destroyed by fire. It would be a loss

to the company.

5. According to the companies act creation of secret reserves is prohibited. Only banking

companies, insurance companies and finance companies can create secret reserves.

Auditor’s duty.

The position of the auditor in connection with the secret reserves is very clear. He will have to disclose to

the shareholders if the company has created secret reserves. If he fails to do so, he will expose himself to

risk. At the same time he can’t certify the balance sheet of a limited company as true and fair which is

very important part of his statutory duties.

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In case of financial companies such as banking companies and insurance companies where the creation of

secret reserves is not prohibited legally, he should try to find out the necessity of creating such a reserve.

He should discuss the whole matter with the board of directors and should also satisfy himself about the

method and procedure of creating such a reserve. If he finds that the intention of the directors is honest

and the amount is also reasonable then he should not qualify his report. He should also study the articles

of association to ascertain the legal implication of creating such a reserve. In short, he must review the

whole situation very carefully and must ascertain the object of their creation. If he is fully satisfied he

should not object to such a creation otherwise he should disclose the facts in his report.

AUDIT OF EDUCATIONAL INSTITUTIONS.

(Schools and Colleges or Universities)

Generally educational institutions are run by the registered societies or the public trusts registered under

the relevant act. The audit objective of such institutions is to determine whether financial statements give

true and fair view or the auditor may be asked to report on certain other aspects like whether the

institution has complied with requirements as to accounting and financial records.

PRELIMINARY:

The auditor should study the following aspects:

1. Whether his letter of appointment is in order as well as any additional work assigned to him.

2. Legal status of the institution like the society or a trust or a statutory body under some law.

3. Study important provisions relating to accounts and audit under the relevant law.

4. Study code of state govt., and regard to the ground-in-aid. In case of colleges, University

Grant Commission also provides grants subject to certain conditions. The auditor should

study various conditions and procedures for such grants.

5. Examine charter, Trust Deed, or Regulations and not the provisions particularly relating to

accounts and audit.

6. In case of important decisions like delegation of financial powers, transactions regarding

fixed assets and investments etc minutes book of various meetings of the Board of Trustees

or Governing Body or managing Committee or finance committee should be examined.

7. The auditor should obtain the various lists of books of accounts registers and other records as

well as the persons authorized to sanction and execute financial decisions.

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8. Last year’s audit report should be examined with regard to various observations on

qualifications.

INTERNAL CONTROL SYSTEM

It includes division of duties and their rotation, authorization procedures, adequate record maintenance,

responsibility for safeguarding of assets etc. independent checks should be applied by using proper

systems and procedures. The auditor should assess various aspects of internal control systems.

1. Are various assets like fixed assets, consumable stores and cash verified at the regular

interval of time and reconciled with the recorded balances.

2. Whether proper system is followed for sale and purchase of assets and investments of the

institutions like proper sanctions from the appropriate authority, obtaining quotations for

fixed assets, maintain proper registers and records etc.

3. Whether bank reconciliation statements are prepared regularly and difference in cash book

and pass book investigated?

4. Whether there is adequate internal check and internal audit system?

5. Whether the fee structures of changes therein have been approved by the proper authority?

Some time grant-in-aid is received by the institution, in such cases the fee structure has to be

in accordance with the conditions prescribed by grant-in-aid issuing authority.

6. Whether rules regarding concession in fees and other charges are followed, like concession

allowed only after proper authorization?

7. Whether fines or charges are waived or reduced on the basis of proper sanction?

8. They system regarding receiving fees from students, issuing fee receipts, serial numbering of

receipts, preserving counterfoils should be verified.

9. The person receiving fees should not have any control over the cash book.

10. The fees received daily should be deposited in the bank and no payments should be made

from such receipts.

11. All fees received should be entered in the fee register daily.

12. There should be a proper system of receiving donations. All such receipts should be by

cheque only, if not crossed, these should be crossed immediately on the receipt thereof. When

the donations are received in kind there should be the proper system of receiving such

donations and safe custody thereof. Receipts should be issued for all donations.

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13. There should be proper procedure for the purpose of various items like sanction and authority

for purchases, inviting quotations, approval of purchase order etc.

14. Whether a list of approved suppliers is kept ready for gods which are to be purchased

frequently like sports materials, books stationery and laboratory equipments.

15. Whether system of making payment for purchases has been established.

16. There should be an adequate system for recording purchases like the register of assets and

accounting records.

On the basis of strength of internal control system, the auditor will determine audit procedures to be

applied.

AUDIT OF INCOME AND EXPENDITURE.

1. The auditor should verify the counterfoil of fee receipts issued with entered made into the

fees register. The details of fees and charges should also be examined like tuition fees,

admission fees, like the fees, examination fess, sports fees etc. the fees charged should be as

per fees structure sanctioned by the appropriate authorities.

2. Entries made the cash book should be verified with the fees register. Any concessions have

been granted these should be verified as per the rules.

3. The statement of reconciliation of fees received and total fees receivable should be verifies.

4. In case of hotel accommodation, the charges received for accommodation, mess, fines etc

should be examined. The counterfoils of receipt book should be compared with hostel

charges register and cash book.

5. For donations received the receipt book should be compared with the cash book entries. The

donations received should be accounted for under an appropriate head like specific purpose

(building fund etc) or Corpus Fund or General Purpose.

6. Grants in aid have to be accounted for properly under the head capital receipts and revenue

receipts depending on the purpose for which it has been received.

7. It should be verified that grants received has been utilized for the purpose it was allowed.

8. Rent received for the facilities let out temporarily should be verifies from receipt book, cash

book, sanction by authorized person, rates charged as per rules.

9. Income from investments in approved educational institutions is not taxable. The auditor

should examine it tax deducted at source, refund thereof has been claimed and received.

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10. The interest/dividend received on investment during the year should be verified from

investment register as well as cash book. Any interest due but not received has been duly

recognized.

11. In regard to payment of salaries and allowances, it should be verified that payments on as per

terms and conditions of appointments, computation of gross amount and deductions here

from. (Income tax, provident fund, life insurance premium, loan installment etc). The

payments of net amount should be verified from bank statement.

12. The amount of income tax and provident fund deducted from salaries and employees own

contribution to provident fund is to be verified as being deposited with the appropriate

authorities from receipts challan/ acknowledgments.

13. The auditor should verify payments made out of the grants by comparing minutes of

governing body, vouchers, cash book entries and utilization certificates. The grants must be

utilized as per terms and condition specified by the state govt., UGC. Any grant which

remains unutilized must have been returned back to the authority.

14. The payments of scholarships should be verified by comparing terms and conditions

stipulated, vouchers, cash book entries acknowledgment from students.

15. Expenditure on hostel facilities should be examined like purchases of food grains, other

provisions, stocks, repairs, water charges, electricity charges, maintenance etc.

AUDIT OF ASSETS AND LIABILITIES.

1. Fixed assets purchase should be verified. If state govt., has allowed grant for he acquisition of

fixed assets, the auditor should examine the terms and conditions of grants being complied

with.

2. The auditor should examine that separate account of fixed assets are maintained when these

on acquired out of specific grants.

3. Depreciation should be properly charged on all the fixed assets. The rate of depreciation is

decided by the management on the basis of useful life of fixed assets. Sometimes it may be

decided to charge depreciation as per the provision of Companies Act.

4. The auditor should physically verify investments. The documents related to sale and purchase

of investments should be examined. As per the Indian Public Trust Act in case of public

trusts, investments can be made only in specified securities. All such requirement for the

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acquisition of investment should be complied with. The correspondence with the donor

should be examined when investments are received as a donation.

5. The security deposits received from the students should be examined. The refund of security

deposit should be examined from the acknowledgment received from the students.

6. The financial statement should be examined form the view point that separate statement of

accounts for provident fund, building fund, sports fund etc.

7. The stock of stationery equipments and furniture should be carefully verified.

8. The staff provident fund should be verified and it should be seen that it is invested as per

rules.

9. All the assets and liabilities should be properly exhibited in the balance sheet.

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SUMMARY OF AUDITING AND ASSURANCE STANDARDS

AAS = Accounting Assurance Standards.

AAS 1: Basic principles governing an Audit:

Govern the auditor’s professional responsibilities, which should be complied with for all audits.

Compliance with the basic principles requires the application of auditing procedures and reporting

practices appropriate to the particular circumstances.

The standard enunciates the following principles as integral part of any audit carried out by a member of

the ICAI. They are: Integrity, Objectivity and Independence, Confidentiality, Skills and Competence,

Work Performed by Others, Documentation, Audit Evidence, Accounting System and Internal Control,

Audit Conclusions and Reporting,

AAS 2: Objective and scope of the audit of financial statements

Objective of an audit of financial statements is to enable an auditor to express an opinion. Responsibility

for the preparation of financial statements is that of the management of the enterprise.

The scope of an audit will be determined by the terms of the engagement, the requirements of relevant

legislation and the pronouncements of the Institute.

1. The terms of engagement cannot restrict the scope of an audit in relation to matters which are

prescribed by legislation or by the pronouncements of the Institute.

2. The audit should cover all relevant aspects of the enterprise; ensure sufficiency and reliability of the

information contained in the underlying accounting records/source data and proper disclosure.

3. It recognizes the test nature of audit, exercise of judgment in deciding extent and nature of audit

procedures, and judgment nature of audit opinion.

4. Constraints on the scope of the audit should form part of his report, and a qualified/disclaimer of

opinion be considered.

AAS 3: Audit documentation

Requires an auditor to prepare sufficient and appropriate audit documentation that provides a record of

the basis for the auditor’s report and to demonstrate that the audit was performed in accordance with

AASs and applicable legal and regulatory requirements

Audit documentation implies record of audit procedures performed, relevant audit evidence obtained, and

conclusions the auditor reached.

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It includes working papers (on paper or on electronic media), audit programmes, analyses, issues

memoranda, letters of confirmation and representation, checklists, extracts of important documents,

correspondence concerning significant matters, and schedules of work the auditor performed.

The nature of the Audit Documentation should be such that, an experienced auditor, having no connection

with the audit should be able understand nature, timing, extent and results of the audit procedures, the

audit evidence obtained, conclusions reached on significant matters, etc..

If the auditor has identified audit evidence that contradicts or is inconsistent with the auditor’s final

conclusion regarding a significant matter, the auditor should document how the auditor addressed the

contradiction or inconsistency in forming the final conclusion.

Nature, timing and extent of audit procedures performed should include:

Who performed the audit work and the date of such work; and who reviewed specific audit

documentation and the date of such review. Documentation of nature, timing and extent of audit

procedures performed, should contain the identifying characteristics of the specific items tested. Reasons

for Departure from a basic principle or essential procedure in an AAS to achieve audit objective more

effectively.

In case of change of documentation subsequent to the date of audit report, it should record new audit

procedures carried out, new conclusions reached, when and by whom such changes were made, and

reviewed, the specific reasons for the changes; and the effect, if any, of the changes on the auditor’s

conclusions. Assembling of the audit file be finally completed not more than 90 days after the date of the

auditor’s report

Any changes to the documentation after file assembling should be recorded.

The auditor should have set procedures to maintain its confidentiality, safe custody, protect its integrity,

enable its accessibility and retrievability; and enable its retention for a period sufficient to meet the needs

of the firm, and legal and professional requirements.

Scanning of original documentation allowed for practical reasons so far as its identical in all respects as it

would have been in a physical form.

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AAS 4: The auditor’s responsibility to consider fraud and error in an audit of financial statements

Audit planning must involve risk of material misstatements due to fraud and errors.

"Error" refers to an unintentional misstatement in the financial statements, including the omission of an

amount or a disclosure.

"Fraud" refers to an intentional act by one or more individuals among management, those charged with

governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal

advantage. Fraud misstatements may include fraudulent financial reporting and misstatements resulting

from misappropriation of assets. Refer the annexure to the AAS for circumstances indicating possibility

of fraud.

Primary responsibility for prevention and detection of fraud and errors rests with the management. Audit

cannot guarantee an absolute assurance about absence of material misstatements due to fraud and errors.

Auditor must plan and perform an audit with an attitude of professional skepticism.

When planning the audit, the auditor should make inquiries of management about management’s

assessment of misstatements resulting from fraud and error and internal controls placed to address such

risk and any known fraud or error detected/suspected/investigated by management.

The auditor must consider factors stated in AAS 6, AAS 29 and AAS 13 while analyzing a misstatement

to be indicative of fraud. He must document the procedures carried out and finding thereof.

A misstatement resulting from fraud/suspected fraud/error should be communicated to

management/regulatory authorities as appropriate.

If the auditor unable to continue performing the audit as a result of a misstatement then he must follow

guidance in the AAS.

AAS 5: Audit evidence

Auditor should evaluate whether he has obtained sufficient appropriate audit evidence before drawing

conclusions.

Judgment as to what is sufficient appropriate audit evidence should be evaluated by considerations such

as risk of misstatement, internal controls, materiality, trends and ratios, and so on.

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Audit evidence from compliance procedures reasonably assure the auditor in respect of existence,

effectiveness and continuity of controls.

Audit evidence from compliance procedures reasonably assures the auditor in respect of Existence –

Valuation of assets/liability, Occurrence - Completeness – Measurement of transaction, appropriate

presentation and disclosure of items.

Reliability of audit evidence depends on its source – internal or external, and on its nature – visual,

documentary or oral. Consistency amongst the sources and nature will give increased assurance.

Evidence can be obtained by performing compliance and substantive procedures through Inspection,

Observation, Computation and Analytical review.

AAS 6 : Risk assessments and internal control

Obtain an understanding of the accounting and internal control systems to plan audit, assess audit risk and

design procedures to ensure it is reduced to an acceptably low level.

"Audit risk" means the risk that the auditor gives an inappropriate audit opinion when the financial

statements are materially misstated. It has 3 components: inherent risk, control risk and detection risk.

"Inherent risk" is the susceptibility of an account balance or class of transactions to misstatement that

could be material, either individually or when aggregated with misstatements in other balances or classes,

assuming that there were no related internal controls.

"Control risk" is the risk that a misstatement that could occur in an account balance or class of

transactions and that could be material, either individually or when aggregated with misstatements in

other balances or classes, will not be prevented or detected and corrected on a timely basis by the

accounting and internal control systems.

"Detection risk" is the risk that an auditor’s substantive procedures will not detect a misstatement that

exists in an account balance or class of transactions that could be material, either individually or when

aggregated with misstatements in other balances or classes.

Auditor should assess inherent risk at the level of financial statements.

The auditor should make a assessment of control risk, at the assertion level, for each material account

balance or class of transactions. It means evaluating effectiveness of accounting and internal control

systems in preventing or detecting and correcting material misstatements.

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The auditor should also evaluate the control environment, control procedures, and assessment of control

risk and test controls. He must make adopt suitable nature, timing and extent of substantive procedures.

There is an inverse relationship between detection risk and the combined level of inherent and control

risks. Regardless of risks assessed the auditor must adopt suitable nature, timing and extent of substantive

procedures for material account balances and classes of transactions.

For each of the above assessment/evaluations of risks and other items the auditor must document his

conclusions and evidence for reaching them.

Auditor should communicate with management, at an appropriate level, of material weaknesses in the

design or operation of the accounting and internal control systems, which have come to his attention.

Auditor’s assessment of control risk is:

Auditor’s assessment of inherent risk

AAS 8: Audit planning

Plans should be made to cover at least

(a) acquiring knowledge of the client’s accounting systems, policies and internal control procedures;

(b) establishing the expected degree of reliance to be placed on internal control;

(c) determining and programming the nature, timing, and extent of the audit procedures to be performed;

and

(d) co-coordinating the work to be performed.

Planning should be continuous throughout the engagement. It must involve overall plan for the expected

scope and conduct of the audit and nature, timing and extent of audit procedures.

Audit plan should strive to accomplish that appropriate attention is devoted to important areas of the

audit; ensure that potential problems are promptly identified; ensure that the work is completed

expeditiously; utilize the assistants properly; and co-ordinate the work done by other auditors and experts.

Matters to be considered in developing the audit plan given in Para 11 of the AAS.

Auditor should document his overall plan based on size and complexity of the audit. A time budget, in

which hours are budgeted for the various audit areas or procedures, can be effective planning tool.

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Planning should consider factors such as complexity of the audit, the environment in which the entity

operates, previous experience with the client, discussions with client and knowledge of the client’s

business.

A written audit programme should be made setting forth procedures needed to implement the audit plan.

It may contain audit objectives for each area and should have sufficient details to serve as a set of

instructions to the assistants involved and as a means to control.

AAS 13: Audit materiality

Information is material if its misstatement (omission or erroneous statement) could influence the

economic decisions of users taken on the basis of the financial information.

Materiality depends on the size and nature of the item, judged in the circumstances of its misstatement.

The assessment of what is material is a matter of professional judgment. Materiality can be considered at

individual account balances, classes of transaction, legal and regulatory requirements, cumulative impact

of small misstatements.

Materiality should be considered while determining the nature, timing and extent of audit procedures,

evaluating the effect of misstatements and degree of audit risk.

If the aggregate of the uncorrected misstatements that the auditor has identified approaches the materiality

level, or if auditor determines that the aggregate of uncorrected misstatements causes the financial

information to be materially misstated, he should consider requesting the management to adjust the

financial information or extending his audit procedures.

AAS 14: Analytical procedures

"Analytical procedures" means the analysis of significant ratios and trends including the resulting

investigation of fluctuations and relationships that are inconsistent with other relevant information or

which deviate from predicted amounts.

Auditor should apply analytical procedures at the planning (in understanding business and potential risks)

and overall review stages of the audit.

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Analytical procedures include comparisons of the entity’s financial information with comparable

information – for prior periods, of budgets or forecasts, estimation of depreciation charge for the year etc.,

and similar industry data.

Analytical procedures also include consideration of relationships among elements of financial information

that would be expected to conform to a predictable pattern, such as gross margin percentages and between

financial information and relevant non-financial information, such as payroll costs to number of

employees.

In case analytical procedure is used as substantive test then auditor must consider reliability, relevance

and source of information, changes required to be made to make the information comparable.

When analytical procedures identify significant fluctuations or relationships that are inconsistent with

other relevant information or that deviate from predicted amounts, the auditor should investigate and

obtain adequate explanations and appropriate corroborative evidence.

AAS 16: Going concern

Appropriateness of the going concern assumption underlying the preparation of the financial statements

should be considered while planning, performing and reviewing results of audit.

Auditor must critically evaluate financial, operating and other indicators that question the going concern

assumption. (Refer AAS Para 6)

When going concern assumption is in question, the auditor should gather audit evidence to attempt to

resolve, the question regarding the entity’s ability to continue in operation for the foreseeable future and

document that same.

Where going concern assumption is appropriate because of mitigating factors, the auditor should consider

whether management’s plans or other factors need to be disclosed in the financial statements.

Where the going concern question is not satisfactorily resolved, the financial statements should disclose

adequately:

The principal conditions that raise substantial doubt about the entity’s ability to continue in operation for

the foreseeable future.

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State that there is significant uncertainty that the entity will be able to continue as a going concern and,

therefore, may be unable to realize its assets and discharge its liabilities in the normal course of business;

and State that the financial statements do not include any adjustments relating to the recoverability and

classification of recorded asset amounts, or to amounts and classification of liabilities that may be

necessary if the entity is unable to continue as a going concern.

Where disclosure is inadequate the auditor should express a qualified or adverse opinion, as appropriate.

Where disclosure is adequate audit report should highlight the going concern problem by drawing

attention to the note giving disclosure.

AAS 20: Knowledge of the business

Auditor should have or obtain knowledge of the business to enable him to identify and understand the

events, transactions and practices that, in his judgment, may have a significant effect on the financial

statements or on the examination or audit report.

Knowledge of business, which is a continuous and cumulative process, should be used by the auditor in

assessing inherent and control risks planning and performing the audit effectively and efficiently, in

determining the nature, timing and extent of audit procedures, evaluating audit evidence and providing

better service to the client.

For continuing engagements, the auditor would update and re-evaluate information gathered previously,

including information in the prior year’s working papers. He must document all his finding.

Auditor should ensure that his staff also is communicated with this knowledge. Refer the AAS appendix

for matters for a illustrative list of matters to consider.

AAS 21: Consolidation of laws and regulations in an audit of financial statements

The Standard deals with Auditor’s consideration of compliance with laws and regulations and the audit

procedures where non-compliance is observed. Management is responsible for ensuring that entity’s

operations are as per the relevant laws and regulations; i.e., Responsibility for prevention and detection

rests with management.

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Auditor must obtain:

A general understanding of the legal and regulatory framework applicable to the entity and the procedures

adopted by entity to comply with such framework. A written representation from management that

management has disclosed all known or possible non-compliances of laws and regulations.

Sufficient appropriate audit evidences of the compliances with laws and regulations affecting

determination of material amounts and disclosures in financial statements.

Appropriate planning and performing of such audit tests are required to identify non-compliance with

applicable laws and regulations. Sufficient evidences should be obtained of such non-compliances and

they be considered while preparing financial statements.

AAS 23: Audit considerations relating to entities using Service organizations

The Standard is prescribed for an auditor whose client uses service organizations. Service organizations

undertake activities such as information processing, maintenance of accounting records, facilities

management etc.

Auditor of the client should determine the significance of activities of service organizations and their

relevance to the audit. Instances of factors to be to be considered are the nature of services, terms of

contract, material financial statements affected by use of service organizations and their inherent risks,

client accounting and internal control interactions with those of service organizations, financial strength

and capabilities of service organizations etc.

Auditor of the client who is using a service organization auditor’s ("other auditor") report should consider

the nature, scope of and content of his report. The service organization’s auditor report shall be any one of

the following: Type A or Type B reports.

Type A Reports are on suitability of design that provides an understanding of the service organization’s

accounting and internal control systems and the service organizations auditors’ opinion on the same. Such

report would not be used as a basis for reducing the assessment of control risk

Type B Reports are on suitability of design and operating effectiveness that covers besides matters stated

in Part A, the details of tests of controls identified and performed by the other auditor and their related

results. The client auditor uses such reports as evidences to support a lower control risk assessment.

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The service organization’s auditor may be engaged to perform substantive procedures that are of use to

the client’s auditor.

AAS 26: Terms of audit engagement

The Standard deals with agreeing to terms of engagement and the auditor’s response to changes in the

terms of an engagement to one that gives a lower level of assurance.

Auditor and Client must agree on the terms of engagement that is recorded in a contract or any other

suitable form of contract. To avoid misunderstandings the engagement letter must be sent to client before

the commencement of the engagement.

Audit engagement letter must be clear and precise and must include the scope of assignment, declaration

that the audit process are subjected to peer review, the objectives of financial statements, communicating

matters of conflicts of interest, and the responsibilities of the management.

Management responsibilities are the selection and implementation of accounting standards and their

departures, records maintenance, efficient internal controls for safeguarding assets and prevention of

frauds and other irregularities

The changes in terms of engagement letter must be agreed between the client and auditor. If in a situation

the auditor is not in agreement with suggested changes than he should withdraw from the engagement.

Subsequently on withdrawal, the auditor will need to consider whether there is any contractual obligation

or otherwise to report the circumstances necessitating his withdrawal to parties like the board of directors

or shareholders.

AAS 27: Communication of audit matters with those charged with governance

This Standard deals with establishing standards on communications of audit matters arising from the audit

of financial statements between the auditor and those charged with governance of an entity. The Standard

does not provide guidance on communication by the auditors to outside agencies like the external

regulator or supervising agencies.

The Standard also includes guidance on confidentiality requirements, laws and regulations.

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"Governance" refers to the role of persons who are entrusted with the supervision, control and direction of

an entity. Auditors to determine the relevant persons who are charged with Governance and with whom

audit matters of Governance are required to be communicated.

The structure of Governance may be different for very entity. Example in case of companies the board,

audit committee, corporate governance committee; in case of trusts the trustees or the management etc.

The communications of matters of Governance are required to be reported on a timely basis. This may be

either orally or in writing. In case of oral communications, the auditor must document such facts and

responses of the entity in his working papers.

Instances of Matters of Governance of Interest are limitations in the scope of audit, changes in accounting

polices which are having a material effect, modification in the auditor’s report, continuity of the entity as

a going concern, disclosures of significant risks and exposures in financial statements, any other matters

agreed in the audit engagement letter.

Auditors are not required to design procedures for specific purposes of identifying the matters of

Governance.

AAS 29: Auditing in a computer information systems environment

This AAS sets the standards on procedures to be followed when an audit is conducted in a computer

information systems (CIS) environment.

Auditor to have sufficient knowledge of the computer information systems to plan, direct, supervise,

control and review the work performed.

In planning audit in a CIS environment, the auditor should obtain an understanding of the significance

and complexity of the CIS activities and the availability of the data for use in the audit.

When the CIS are significant, the auditor should also obtain an understanding of the CIS environment and

how it may influence the assessment of inherent and control risks.

He must evaluate risks and controls in the light of the following – Lack of transaction trails, Uniform

processing of transactions, Lack of segregation of functions, Potential for errors and irregularities,

Initiation or execution of transactions, Dependence of other controls over computer processing, Potential

for increased management supervision, Potential for the use of computer-assisted audit techniques.

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Auditor should consider whether CIS:

Ensure that authorized, correct and complete data is made available for processing;

Provide for timely detection and correction of errors;

ensure that in case of interruption in the working of the CIS environment due to power, mechanical or

processing failures, the system restarts without distorting the completion of the entries and records;

Ensure the accuracy and completeness of output;

Provide adequate data security against fire and other calamities, wrong processing, frauds etc.;

Prevent unauthorized amendments to the programmes and

Provide for safe custody of source code of application software and data files.

Auditor should document his audit plan and also assessment of risks as per AAS 6 and design audit

procedures to reduce the audit risk.

Notes:

Only selected AAS are covered here considering their pervasive importance and applicability.

All AAS should be read with reference to the "Preface to the Statements on Standard Auditing Practices".

AAS are mandatory with respect to all attest engagements carried out by the members. Any audit not

done in accordance with the AAS, the auditor draws attention to material departures there from in his

report.

Points covered in one AAS but are otherwise covered in detail in another AAS are ignored in the first one.

Detailed definitions should be read from the AAS.

Subjects of AAS that are covered by an AS are not produced here.

For a detailed illustrative check lists on AAS and AS refer the Society’s publication Audit Checklists for

Companies.

AAS 33: Engagements to review financial statements

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This Standard provides guidance to the auditor’s professional responsibilities, the formats and contents

for a review of financial statements.

Auditor needs to comply with the code of ethics prescribed by the Institute of Chartered Accountants of

India.

The procedures for a review shall be governed by the requirements of this Standard, the relevant laws and

regulations governing the entity and where appropriate the terms of the review engagement and its

reporting requirements.

The auditor must plan the work for an effective review by way of obtaining or updating knowledge of the

client businesses, accounting and operating systems etc. Important matters of review should be

documented including making inquiries on matters subsequent the balance sheet dates that may require

adjustment or disclosures in the financial statements.

Review reports wherever possible to quantify the matters that impair the true and fair view with either

express a negative assurances or adverse statements on the financial statements. Limitation of scope must

be specified by way of qualification or negative assurances when such limitations are significant in

nature. The date of review report must not be a date when the financial statements are signed or approved

by the management. Review reports must include performing procedures relating to events occurring up

to date of signing of the report.

CHAPTER FOUR

FINANCIAL REGULATIONS

Financial statement

Summary report that shows how a firm has used the funds entrusted to it by

its stockholders (shareholders) and lenders, and what is its current financial position.

The three basic financial statements are the

(1) balance sheet, which shows firm's assets, liabilities, and net worth on a stated date;

(2) income statement (also calledprofit & loss account), which shows how the net income of the

firm is arrived at over a stated period,

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(3) cash flow statement, which shows the inflows and outflows of cash caused by the

firm's activities during a stated period. Also called business financials.

What are the required financial statements?

The required financial statements for U.S. business corporations are:

1. Statement of income. This financial statement is also known as the statement of operations,

statement of earnings, or income statement. It reports the corporation's revenues, expenses,

gains and losses (except for items stipulated as other comprehensive income) for a period of

time such as a year, quarter, 13 months, etc.

2. Statement of comprehensive income. This financial statement begins with the bottom line of

the income statement and then lists the items considered to be other comprehensive income.

Some of these items involve currency translation, hedging, available-for-sale securities, and

pensions.

3. Balance sheet. This statement of financial position reports a corporation's assets, liabilities

and stockholders' equity as of the final instant of the date shown in its heading (December 31,

January 31, June 30, etc.)

4. Statement of cash flows. This statement reports the major causes for the change in cash and

cash equivalents during the accounting period. The cash flows are presented as operating,

investing, or financing activities.

5. Statement of stockholders' equity. This financial statement is often presented as the

statement ofshareholders' equity, statement of equity, statement of changes in stockholders'

equity, etc. It reports all of the changes in stockholders' equity which occurred during the

accounting period.

The five annual financial statements must be accompanied with notes to the financial statements.

These notes are needed in order to disclose additional information about items that are reported

or are not reported in the financial statements.

4.1. The "Local Government Financial Regulations" (1998)

4.2. Budgeting techniques and monitoring budgetary performance

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4.3.Estimating the needs, purchasing, receiving, stocking and distributing medicines, vaccines

and other consumables

CHAPTER FIVE : STORES AND STOCK MANAGEMENT,

STOREKEEPING, STOCK CONTROL AND STORES MANAGEMENT

Introduction

- Why Stocks are Held Virtually every enterprise finds it necessary to hold ‘stocks’ (or

‘inventory’) of various items and materials. That is because it would be practically impossible to

operate with only one of each item to be sold or used in manufacture or used in office work. A

‘reserve’ or a ‘fund’ or ‘inventory’ of each item or material used or sold frequently is therefore

‘maintained’, so that as items or materials are sold or used they can be replaced or replenished

from the stocks ‘held in reserve’.

Let us take a footwear shop as an example to make these matters quite clear to you:

- There will be a variety of different shoes, boots, etc, on display

- both in the shop’s windows and inside the shop itself. It would be very inconvenient and time-

consuming for a shop assistant to have to remove the footwear from the display each time a

customer wished to try on a pair. And, in any case, only one size and colour of each style or type

of shoe, boot, sandal, etc., is likely to be on display at any one time. Instead, when a customer

expresses interest in a particular style, a shop assistant will ask the size he or she usually wears

and the colour preferred, and will then try to find the right size and colour from the pairs of

footwear held in reserve. In many cases pairs of popular items in the most commonly asked for

sizes will be kept inside the shop itself, on shelves or in cabinets. But other pairs will be kept in

another room - or perhaps in more than one room - to which the shop assistant can go to find the

footwear concerned; that room is the ‘store room’ or ‘stock room’. When a pair of shoes or other

footwear is sold from those inside the shop, it must be possible to replace that pair quickly,

whenever possible, by another pair held in the store or stock room. No business could operate

efficiently if every time it sold an item or used up an item in manufacture, it had to order a

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replacement from the supplier or manufacturer! Of course, from time to time, items can ‘run out

of stock’ but, as you will learn during this Program, efficient stock control will reduce or

eliminate such happenings, and ensure that replacements are received in good time, and are

available when required to replace those items sold or used.

Why Stores are Needed In some countries the word “store” is used to refer to a retail outlet -

such as a “general store” or a “department store” - from which goods are sold, mainly to

individuals, who are commonly called “consumers”. However, in this Program on Stores

Management & Stock (Inventory) Control, we define a “Store” (with a capital ‘S’) as: An area

set aside into which all the items and materials required for production and/or for

sale/distribution are received, where they are housed for safekeeping, and from which they will

be issued as required

In only a tiny minority of cases are sales made directly from Stores, and even in such cases those

sales are merely a “subsidiary” activity, and are not the primary functions of the Stores, as given

in our definition. The various items and materials received into, housed in and issued from Stores

are commonly referred to collectively as being ‘stock’ (or ‘inventory’) hence the use of the term

‘stock control’.

At this stage, the following serve as a few examples to “introduce” the need for Stores to you:

- • Retail shops such as the footwear shop (or store),

- need Stores to house reserves of goods for sale to customers and from which to replace those

sold. •

Wholesale businesses (often called simply ‘wholesalers’) purchase goods in large quantities from

the producers or manufacturers of them, so they need Stores in which to hold the goods until they

are required for supply in smaller quantities to retailers. •

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A manufacturing concern, for example a footwear factory, must hold stocks of all the

items (materials and components): leather, plastic, heels, buckles, nails, glue, etc, which are

used in making the different types of shoes, etc. •

An office is likely to need stocks of printed and plain paper, envelopes, pins, clips and other

items. • Even an enterprise which provides a service, like a garage for example, must hold

stocks: of spare parts for vehicles, consumables like oil, and, of course, tools for use by its

mechanics. In many cases the “Store” might be quite small, perhaps no more than a stock

cupboard in a small service concern, such as an estate agency, or a small office. Other

enterprises, however, require huge Stores to hold the vast stocks of items, of many different

kinds and sizes, which they must have available if they are to be able to run efficiently and

successfully.

In between the two extremes, there is an enormous range of different enterprises with Stores of

different sizes. Whatever the situation, you will find that the Stores of most enterprises fall

within the definition we have given you. A Store might be a department or section of an

enterprise, and be its ‘Stores Department’; often that name is shortened simply to ‘Stores’ (with a

final letter ‘s’). For example, a person might work “in the Stores”. The Importance of Efficient

Stores Management In an enterprise with a small quantity of stock, one person might be placed

in charge of it, if the owner/manager does not look after it himself. Where the volume of stock is

too large to be handled on a part-time basis, one or more storekeepers will be required.

Enterprises with large quantities of stock must employ trained stores personnel (storekeepers,

clerks, etc) under the control of a Stores Manager (who might go by the designation of Head or

Chief Storekeeper, Stock Controller, Stores Administrator, or a similar title). is impossible to

state at what stage a Stores Manager will be appointed by a particular enterprise, as

circumstances and sizes vary so greatly. But whatever its size and the volume of its stocks, the

success of the enterprise can depend to a large extent on the efficient management of its Store

and stocks. Let us now examine why that is so. ( All the possessions of an enterprise - that is,

what it owns - are called its ‘assets’.

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Frequently the value of the stocks of goods and/or materials held in its Store is as great as - if not

greater than - the total value of all its other possessions - e.g. land and/or buildings, plant,

machinery, motor vehicles, equipment, etc., and, of course, money and investments - added

together! ( The items and/or materials in the Store cost money; if, through bad Stores

Management, there are too many held in the Store or if the wrong items or materials are being

held, money will be “tied up” - money which might be required to buy other, needed items

and/or materials or to pay the many expenses involved in running the enterprise. ( Conversely, if

poor stores management has led to shortages of needed items and materials, there will be hold-

ups and interruptions in production, or losses of production and/or losses of sales to customers

and, indeed, losses of the customers themselves, and losses of profits which can in turn lead to

job losses and - in extreme cases - to the collapse of the enterprise. ( If items in the Store are lost,

stolen or damaged in any way, the enterprise loses money. ( And it costs money to run the Store -

on building maintenance and/or rent, on salaries of stores personnel, on containers and

equipment, on heating or cooling, on lighting and power, etc. - and the enterprise must receive a

“return” from its expenditure, in terms of efficiency, particularly as its Stores is “nonproductive”

(Stocks The range of items and materials - stocks - which might be held in Stores is huge. The

variety and quantity of items and materials held in the Store of a particular enterprise will depend

on its size and on its range of activities.

Broadly speaking, the various activities of different enterprises can be divided according to the

three main groups of enterprises:- ) Industrial Enterprises Into this group fall enterprises like

mines, which extract raw materials such as oil, coal, iron, etc., which are in general sold to other

enterprises for use as power or for use in manufacture. Agriculture and fishing are also classified

as extractive. Other enterprises in this category are classified as processing or refining because

they “process” the raw materials and, in so doing, alter their original form into more useful or

saleable forms. Still other industrial enterprises are involved in using the raw or processed

materials in the manufacture - in factories or in workshops - of the wide range of products

available on the market today, or in producing components which will form part of the final

products of other manufacturers. In addition, there are industrial enterprises involved in

construction and allied fields.

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Trading Enterprises

The range of enterprises in this group is very wide, but the common activity is the buying and

selling of the raw materials, components and products produced by the industrial enterprises.

Enterprises involved in trading range from small one-man shops and kiosks to huge

supermarkets, departmental stores, hypermarkets and shopping centers. Some trading enterprises

are involved in wholesaling; they purchase products from their producers in large quantities, and

then sell them in smaller quantities to retailers, who in turn sell them, generally in even smaller

quantities, to their customers, who might or might not be the final consumers. Some larger

trading concerns might eliminate wholesalers - often called “middlemen” - by buying direct from

the producers. ) Service Enterprises Frequently the services provided involve the performance of

some work, only the results of which might be seen; examples include banking, finance,

transport, maintenance of machinery, etc., and the provision of insurance cover. Besides those

already mentioned, services are provided by such diverse businesses as hotels, restaurants, estate

agents, computer bureaux, travel agents, tailors, electricians, hair dressers and barbers, and many

more. (Note that certain services are provided by persons who do not consider themselves to be

“in business”, e.g. accountants, doctors, lawyers, dentists, auditors, etc.

They refer to themselves as being in “the professions”, although their services are rarely

provided without charge!). There are also enterprises which provide specialized services which

are called utilities. These include enterprises - often fully or partly state-owned and run - which

provide supplies of electricity, water and gas, as well as sewerage, post and telecommunications,

and similar services, often on a national or on a regional scale. )

Multi-activity Enterprises There are, of course, some enterprises which fall into more than one of

the three major groups. For example, a business might operate a factory, and then sell the

products of its factory from its own shop(s) - and is thus involved in both industrial and trading

activities. Another enterprise might sell, say, office machines and also provide a maintenance

service for those machines, and so is involved in both trading and service-providing activities.

Stock items in the Store of an enterprise could include any or all of:- raw materials components

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(parts) spare parts partly finished work (sub-assemblies, work in progress) materials for

maintenance consumables tools, jigs and gauges finished products (of the enterprise or purchased

from others) ready for sale

packaging materials

scrap and by-products of production damaged, substandard or obsolete items and others. Some

items and materials might be solid, others might be liquid, and yet others might be gaseous. We

shall refer to all things held in Stores as ‘items’ or ‘stock items’ or ‘materials’ or ‘stocks’. What

is involved in Storekeeping The term storekeeping covers the actual handling of the items or

materials received into, held in and issued from the Store. The work involves: ‘ receiving items

and materials, including the inspection of them; ‘ storing the various stock items in the most

appropriate fashion, binning and/or racking them by the best methods, and placing them in such

a way that any item or material in the Store can be located quickly and easily when it is required;

‘ ensuring the safety of all items and materials whilst in the Store - that is, protecting them from

pilfering, theft, damage and deterioration; ‘ ensuring, when necessary, that items issued from the

Store are so packed that they will not be damaged or caused to deteriorate whilst in transit to

their destinations.

What is Involved in Stock Control (also known as ‘Inventory Control’) What we refer to

as stock control comprises mainly the clerical and administrative functions of stores work.

It involves:

+ ensuring that the right types and qualities of items needed for production, sale and distribution,

are always available when required;

+ ensuring that stock is issued in the correct sequence, that is, “first in first out”, so that “older”

stock is not allowed to deteriorate by being kept too long in the Store, for instance because it has

been hidden from view by more recently received stock;

+ maintaining records showing the “movement” of items into and out of the Store, controlling

and monitoring those movements and maintaining full records of the items in the Store;

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+ ensuring that the correct “stock levels” of the various items are set and are maintained, that

orders and reorders are made (or requested to be made) in good time, and that what is ordered is

received;

+ checking, counting or otherwise measuring stock to ensure that records are accurate and that no

losses are occurring due to pilfering, theft, damage or poor storage;

+ pricing and valuing the items in the Store.

What is Involved in Stores Management

Stores management is concerned with ensuring that all the activities involved in storekeeping

and stock control are carried out efficiently and economically by those employed in the Store. In

many cases it will also encompass the recruitment, selection, induction and the training of stores

personnel, and much more.

The work of any manager comprises two different aspects:

’ The ‘technical’ aspect, which is concerned with the work to be performed in the

section, department or enterprise concerned.

’ The ‘human’ aspect, which is concerned directly with the people who are employed to

perform that work. The ‘technical’ work of different managers might vary considerably;

thus, the technical (and we use the word in the widest sense of its meaning) work of a

factory manager will be very different from the technical work of a sales manager or a

stores manager or an office manager, etc.

Even the technical work of two stores managers working for two different enterprises might

differ in many areas. However, the ‘human’ aspect of the work of all managers must be

similar because it involves managing the activities of other people. The management of

people is an art; men and women are unpredictable and each person has his or her own

different and complex character. The management of human beings requires the provision of

leadership for a group of people and more; they require training, advice and guidance,

supervision and control, and their work must be so organised and co-ordinated that they work

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together as a team to achieve a stated objective - which in the case of stores management is

the efficient running of the Store of an enterprise.

In this Program we look at the technical and the human aspects of a Stores Manager’s job,

and give you an insight into the true meaning of management. The Stores Function You will

have noted that earlier we stated that the Stores Department has a nonproductive function.

We can now explain what we meant. Departments of an enterprise such as its Sales

Department and/or its Production Department are directly involved in the primary or

revenue-earning functions of that enterprise. Their functions - or activities - are designed to

bring money into the enterprise as the result of producing and/or selling goods or services.

For example, if an enterprise has a Production Department, its function is to make or

manufacture goods or other items which will be sold to bring in money. The whole function

of the Sales Department of an enterprise is to sell goods or other items (whether produced

internally or purchased for resale from other enterprises) and/or services, in return for which

customers will pay money to the enterprise.

In contrast, the Stores Department of an enterprise does NOT make or - in general - sell

goods or services to customers. Its function is to: Provide a SERVICE to the rest of the

enterprise of which it is part. The SERVICE provided by the Stores Department is

ESSENTIAL to all other parts of the enterprise, because it is basically intended: To ensure

that all other sections or departments of the enterprise are furnished, when required, with the

correct items, in the correct quantities and of the correct qualities. As we explained earlier,

the standard of the service provided by the Stores Department will affect the efficiency and

profitability of the entire enterprise of which it is a part.

Obviously, the Stores Department cannot be expected to provide the best service unless it

receives adequate information from other departments. Furthermore, it must work closely in

co-operation and co-ordination with those other departments. The departments with which

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the Stores will have contact will, of course, depend on the activities in which an enterprise is

engaged. However, we now look briefly at some of the major departments with which close

contact by Stores Departments might be necessary. The Production Department As the Stores

Department must ensure that all items, materials and tools, as well as spare parts for

machinery, are always available for continuous, uninterrupted production, it requires

adequate warning about expected future needs, in terms of types, quantities, qualities (and

possibly even colours). Stores might also have responsibility for quality control and for

inspection (although these might be the responsibility of a separate department which, again,

must work closely with the Stores).

The Stores Department will be responsible for holding finished products, as well as

substandard products, items damaged during production, scrap and by-products of

production. The Sales Department Close liaison is necessary between the Sales and Stores

Departments. There is no value in the Stores holding stocks of items which the Sales

Department cannot sell, or in the Sales Department securing customers for items which

Stores does not have in stock, or will not have in stock at the times required by customers.

The Stores Department requires adequate information, based on forecasts of future sales and

trends, to assist in planning orders, setting stock levels, allocating storage space, etc. Stores

might also have to take back into stock items sold but rejected (for one reason or another) by

customers or items supplied, for instance, to a shop but not sold. In many cases orders made

by customers will be filled direct by the Stores Department. Fig.1/2. The relationship

between the Stores and Sales Departments The Purchasing Department In smaller enterprises

responsibility for purchasing might rest with the Stores Department, and in many large

enterprises the Purchasing and Stores Departments might be linked in a ‘Supply Division’.

Obviously in cases where there are two separate departments, there must be a very close, co-

ordinated relationship between them. Stores must keep Purchasing up to date with

information about stock levels, whilst Stores relies on Purchasing to buy all the items and

materials needed by the enterprise for its operations. The Maintenance or Engineering

Department This department relies on Stores to have available all the spare parts, tools,

equipment and materials required for maintenance. In return it must supply full information

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to Stores of all long-term and short-term maintenance plans and the items which will be

needed.

The Accounts Department

This department requires information from Stores about the value of stock held, about any

damages or losses, about the receipt of items for which payment has to be made, and about

stock issued for various operations, processes or contracts, etc. The position of a particular

Stores Manager in the hierarchy of management can vary considerably, depending on the size

of an enterprise and of the importance to it of its Stores. In some enterprises the Stores

Manager might be no more than a supervisor or a junior manager; in others he might be a

senior executive, possibly even an executive director - a member of the board of directors.

Nevertheless, no matter what his status might be, the Stores Manager will have important

managerial duties to perform. This Program of necessity concentrates on the ‘technical’

aspect of his work, but we must first introduce you to important matters which are likely to

fall within the ‘human’ aspect of the work of most Stores Managers. We advise you to pursue

these matters, and others, in greater depth by studying our excellent Program on ‘Modern

Management/ Administration’, full information about which will gladly be sent to you on

request. Note: Purely for simplicity we refer to a Stores Manager as being male. However,

you should read the word “he” as being “he or she”, and the word “his” as being “his or her”.

No disrespect is intended to our many female Trainees who make successful careers in Stores

Management.

THE PRINCIPLES OF MANAGEMENT

Modern management is an art. Just as the basic material with which an artist works might be

his paints, and the potter’s basic material is his clay, so does the manager have his much

more complex basic material

- human beings, men and women. (It is worth remembering always that the first syllable of

management is man).

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Management is thus the art of managing the activities of other people. This is no

exaggeration, and a manager’s measure of success, or otherwise, depends upon his skill in

dealing effectively with other people.

What then is management?

What is its purpose - what does it seek to achieve?

To put it simply we can say that management as an activity is involved with ensuring that a

group of people work together in the most effective and efficient manner to achieve a stated

goal, in the best and most economical way.

Management is a job, but a job which is that much more difficult because it involves dealing

not with inanimate objects, services or theories but with unpredictable men and women, each

of whom has a different and complex character. Management involves the provision of

leadership for a group of people, together with the training, advice and guidance, supervision

and control necessary for each individual in the group to perform his or her work in the best

way.

And if the stated goal or objective is to be achieved, the work of each person in the group

must be so organised and co-ordinated that they work together as a team

Having used the words “goal” and “team”, we shall examine further the objectives of

management using an example with which you are likely to be familiar - a football (soccer)

team. Such a team comprises eleven people; they do not simply walk on to the football pitch,

stand wherever they feel like and start kicking the ball in any directions at random - if they

did so, they would stand little chance of beating the opposing side! No! Under the direction

of the team captain, who will be one of the eleven players, and the team manager (who might

not be one of the players and who might remain off the pitch) each team member takes up a

predetermined position; where possible the position which, from previous observation, he has

been found to be most suitable. From prior training, each player has been encouraged to

improve his playing skills, and each will know what his role is in the team - as an attacker or

a defender, for example - and will know the rules of the game. Whenever possible, the team

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will try to play the game to a plan or method laid down in advance by the team manager, and

the efforts of the players on the field will be controlled and co-ordinated by the captain, who

will give additional instructions and take on-the-spot decisions as necessary. Because the

eleven players are a team and are NOT just eleven individuals playing separately with the

same ball, they will pass the ball to team-mates, will try to create opportunities for them and

they will play together to achieve their objective - which in their case is to score goals against

their opponents. By giving guidance and encouragement, the captain and the team manager

will motivate all the team members to do their very best to win.

Now let us relate this example to a business, bearing in mind that many professional

football teams are run on business lines:

- + The team manager will be the owner of the business or a section or departmental manager

(e.g. a Stores Manager), who might not actually perform the work, but who must possess

considerable knowledge of that work.

+ The equivalent of the captain will be a supervisor, foreman or an assistant manager who

although subordinate (that is, junior) to the manager will work closely with him.

+ The other players would be the members of staff of the enterprise or the section or

department of it.

+ The objective of the business or the section or department of it might be the production of

an item or the sale of an item or - in the case of the Stores Department - the provision of an

efficient service. The manager and the supervisor must ensure that the members of staff are

so organized and controlled that they work together as a team to achieve the stated

objective:- • each individual must know what he is to do, when and how; • where possible

he will be given the work to do which he is most suited to perform, and he will be trained to

perform that work; • the work of the members of staff will be planned in advance and

organised so that one person is not idle whilst another is overloaded; • their efforts will be

co-ordinated so that there will be no hold-ups or delays and so that, if necessary, work flows

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smoothly from one person to the next; • and, of course, the manager and supervisor must be

available and willing to advise, guide and encourage the employees.

We can take the example further by thinking of each team in the professional Football

Association or League as a department of a business, each having its own manager and

supervisor (the team manager and captain, respectively). The governing body - Committee or

Council - of the Association/ League, which exercises control over all the teams involved,

defines the policy and lays down the rules of the game, is equivalent to the top managerial

strata of a business, for example the Board of Directors of a company. Indeed, many large

enterprises are organised in a very similar fashion. Although a manager’s team of staff might

not actually confront an opposing - competitive - team on a playing field, as in our football

example, it is often vital that his staff “beat” a similar group employed by a competitive

enterprise - not by scoring goals against them, but by producing a better product or by

producing the product more economically or by providing a more efficient service. Most

businesses have competitors producing or providing similar goods or services; in most cases

a business can survive only by keeping abreast of the competition, and can only expand (for

the benefit of its owners and employees alike) by doing better than its competitors. Only the

successful manager can weld his staff into an efficient and co-ordinated team capable of

achieving its objective in the best and most economical way. You should therefore by now

appreciate just how important are proficient managers and effective management to any

enterprise.

The Functions of Management

What we called earlier the “human aspect” of any manager’s job can be divided broadly into

five functions or types of activities, which are:- Planning: This entails deciding how the

predetermined objectives of the enterprise, or a department of it, should be achieved in the

most efficient and economic way in accordance with policy. Organizing: This involves

putting the “theory” (the plans) into “practice”, so arranging the work to be performed that

the objectives will be achieved as laid down in the plans. Co-coordinating: This is very

closely related to organizing, and ensures that although different staff might perform

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different work, all their efforts mesh smoothly together and are directed at achieving the

common objectives. Motivating: This involves providing leadership for subordinates, and

also requires the ability to inspire them to give of their best in achieving the objectives - as

well as in their own best interests - by creating a good morale or working spirit amongst all

those employed. Controlling: This comprises supervising the people employed, checking

their work and the machinery and equipment used, to ensure that the end products are the

desired.

It also includes the recording of performances to provide a guide for future similar activities.

We examine the functions of management in greater detail shortly, and show how they

interrelate and what they entail in practice. However, as they are all concerned with

achieving objectives, let us first consider what these might be and who decides what they are

to be. Objectives in Business Basically, objectives are the goals which an enterprise aims to

achieve; in fact their attainment is the principal reason for the existence of that enterprise.

Before any enterprise is started or established a person or a group of people has to decide

what that business is going to do, for example:- Is it going to manufacture something - if so

what? Is it going to buy and sell - if so what? Is it going to provide a service - if so what? In

some cases the answer is fairly straightforward, for example a person might decide to open a

bookshop, or an experienced painter/decorator might decide to set up on his own instead of

working for others.

However, in other cases considerable thought and research might be necessary before

deciding to produce or to provide something not already available or which is likely to be

able to compete successfully with similar products or services already available. In the

private sector, the specific objectives of a business are combined with the objective of profit;

that is, the result of achieving the specific objectives of the business must be that its owners

gain money. Business Policies Together with the decision on the objectives of an enterprise

is the necessity to decide in broad terms how and where the objectives are to be achieved,

that is, to lay down the basic policies of the enterprise. If the objective of a particular

enterprise is to sell, then it must be decided how sales will be made (for example, for cash

and/or on credit) and where sales will be made; from shop(s) or by mail-order or through

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travelling or door-to-door salesmen, etc., and, of course, where the premises of the enterprise

will be located. Interpretation and Implementation of Policies Once the initial objectives and

basic policies of an enterprise have been decided upon, the interpretation and implementation

of the policies and the achievement of the objectives are the responsibilities of the

management team. In other words, they have to set in motion the various activities which

will actually gain those objective IN PRACTICE. That involves two important

considerations:-

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Firstly the policies must be interpreted. This means that the policies must be examined

carefully, and “broken down” to see clearly what activities and tasks will be have to be

undertaken.

Secondly, once it is clearly understood what is to be involved, it can be decided what steps

must be taken to implement the policies; that is, what actions are necessary to put them into

practice.

To put is simply, we can say that: the policies - the “theory” - have to be ‘translated’ into

action. Unless an enterprise is very small, in addition to there being objectives for the

enterprise as a whole, there will also be departmental or section objectives set by the Board,

with policies laid down for the attainment of them.

For example, the basic objective of the Stores Department or section will be to provide an

efficient service to all other departments/sections of the enterprise, and the detailed

objectives will cover all the matters we summarized for you earlier.

The policies which are laid down for the Stores Department will cover such matters as how

the service is to be provided and from where, etc. You should note that unless each

department, Stores included, attains its set objectives, the overall objectives of the enterprise

as a whole might not be achieved). The interpretation of the policy for the Stores

Department, and its implementation to achieve the department’s objectives will be the

responsibility of the Stores Manager. This brings us back to the five functions of

management, which we can now consider in greater detail. Planning and Plans Planning is

the activity concerned with making or formulating plans. Plans can be looked upon as being

routes to objectives. Once objectives have been set, planning is necessary to work out how to

achieve those objectives within the framework of the policy formulated. The board of

directors - top management - is involved mainly with long-term planning or ‘strategic

planning’, which is concerned primarily with deciding what the objectives of an enterprise

should be in two, four, five or even ten years ahead, and its future policies. Such planning is

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concerned mainly with the enterprise as a whole rather than with individual departments or

sections. Senior managers will be involved in ‘tactical planning’, that is, planning how the

overall strategies are to be achieved; devising and operating short-term plans, for up to a year

ahead. Other levels of management are involved mainly in short-term ‘activities’ planning -

sometimes called ‘operational planning’. That involves the day to day running of

departments or sections and individual assignments, for example planning how to fill an

order or how and where to store a consignment of newly delivered items, or deciding what

each member of staff should be doing at any given time. A good deal of the planning which

managers will be called upon to perform involves making routine decisions and with

everyday matters, for example planning the work of a team of stores office staff, which will

be similar week after week.

Flexibility in Planning However, plans must be flexible so that they can quickly and easily

be modified in the light of events. For example, a Stores Manager might have decided how

his office staff will cope whilst another member is on holiday, and has planned the

rearrangement of the work. But the day after the implementation of the new plan, another

member of staff falls ill; so he must modify his plans, and determine how the work can be

rescheduled with two staff away.

Organizing and coordinating are very closely linked, and frequently coordinating is an

essential continuation of organizing. Co-ordination involves: Ensuring that all efforts move

smoothly together in the same direction, that is, towards the common objectives. Co-

ordination is just as essential in top management as it is at junior management and

supervisory levels. For example, the managing director or general manager must ensure that

the efforts and activities of all the different departments of an enterprise are in harmony, and

in co-operation; as we said earlier, there is no point in, for example, the sales department

endeavoring to sell items not yet in stock or in production! Good relations and

communications between departmental managers must be developed and fostered so that

they all work together in concert. At the other end of the scale, a junior manager, supervisor

or foreman must co-ordinate the work of his subordinates so that although different people

might be performing different tasks, work will, when necessary, flow smoothly and

continuously from one person to the next. Motivation and Motivating Motivation is directly

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concerned with the people who work for a particular enterprise, and it involves: Encouraging

them to work well and willingly in the most economic manner in the best interests of the

enterprise, and in their own best interests.

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5.1.avoiding stock outs and monitoring consumption

5.2. Managing time, space, records in health care facilities

5.3. Managing waste disposal and water supplies in hospitals and lower level health units

5.4. Ensuring continuing maintenance of buildings, furniture, equipment and vehicles

CHAPTER SIX : THE PHYSICAL INVENTORY IN HEALTH CARE FACILITIES

CHAPTER SEVEN: PUBLIC PROCUREMENT OF GOODS AND SERVICES

1.1.INTRODUCTION

The establishment, maintenance and improvement of sound public procurement systems are critical

responsibilities of governments throughout the world. Public procurement in modern times is an engine

for economic growth and development as it stimulates domestic, regional and international trade.

Procurement is a crucial factor in good governance. Well-functioning, competitive, transparent and fair

public procurement systems give satisfaction to suppliers and contractors, encouraging them to participate

in procurement opportunities, and yield value for money to the procuring entities and taxpayers that

support them.

Public confidence in government administration generally depends upon the reality and perception that

procurement procedures and actions are responsibly undertaken by public officials, both technical and

political, who are committed to procurement efficiency and integrity with a conviction that public

procurement policies, procedures and practices ensure good governance and value for money.

1.2.DEFINITION AND INTERPRETATION OF KEY TERMS IN PUBLIC

PROCUREMENT

The following are key terms often used in public procurement:

Accounting officer (Chief budget manager): Means an official empowered to approve reports of the

Tender Committee and sign the contract on behalf of the procuring entity. This official must be

empowered by Law to act as a Chief Budget Manager within the public entity in which he is employed.

Addendum: Means any changes, modifications or amendment made in the bidding document by the

procuring entity at any time before the deadline for submitting tenders.

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Procuring entity: Means Central Government authority, Local Government authority, public institution,

commission, Government project, parastatal, agency, or any specialized institution engaged in

procurement process and entering in contract with a successful bidder.

Bid: Means a tender, an offer or a proposal given in response to an invitation to supply goods, works or

services;

Bidder: Means a natural or legal person submitting or seeking to submit a bid;

Bidding documents: Means the tender solicitation documents or other documents for solicitation of bids

on the basis of which bidders are to prepare their bids;

Bid evaluation: Is the review and ranking by an evaluation committee of the bids submitted on a timely

basis to the procuring entity in accordance with the evaluation criteria set forth in detail in the bidding

documents.

Bid Security: means any guarantee by a bank or other relevant financial institution to allow the

prospective bidder to participate in tendering;

Bid submission: The preparation and transmission to the procuring entity of the bids or proposals

prepared by bidders in response to the invitation to bid or request for proposals

Bid validity: Is the time that bidders remains committed to their bids. During the bid validity period, a

bidder may not withdraw or modify her/his bid. The procuring entity is

obliged to award a contract during the bid validity period. A procuring entity may request bidders to

extend their bid validity periods. If a bidder refuses to extend the bid validity period, she/he cannot be

forfeited with bid security.

Contract: Means an agreement between the procuring entity and the successful bidder. This agreement

contains rights and obligations for both the procuring entity and the successful bidder.

Consultant services: Refers to an intellectual activities or activities of an intangible nature. Consultant

services are provided by consultants using their professional skills to study, design, and organize specific

projects, advise clients, conduct training, and transfer knowledge.

Conflict of interest: Is a situation in which a party to a procurement proceeding behaves in a biased

manner in order to obtain undue benefit for itself or its affiliates or acquaintances.

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Corruption Corruption is defined as: impairment of integrity, virtue, or moral principle, depravity, decay,

decomposition, inducement to wrong by improper or unlawful means (as bribery), a departure from the

original or from what is pure or correct”. Procurement officials must reject corrupt practices, which are

contrary to good practice in the procurement profession.

Corrupt practice: includes the offering, giving, receiving, or soliciting, directly or indirectly, of anything

of value to influence the action of a public official in the procurement process or in the execution of a

contract;

Day: Refers to every weekday including holidays unless stated otherwise.

E-procurement: Means the process of procurement using electronic medium such as the internet or other

information and communication technologies;

Framework agreement: Means an agreement between one or more procuring entities and one or more

bidders, the purpose of which is to establish the terms governing procurement contracts to be awarded

during a given period, in particular, with regard to price and where appropriate the quantity envisaged;

Fraudulent practice: Includes a misrepresentation or omission of facts in order to influence a procurement

process or the execution of a contract to the detriment of the procuring entity, and includes collusive

practices among bidders, prior to or after bid

submission, designed to establish bid prices at artificial or non-competitive levels and deprive the

procuring entity of the benefits of free and open competition;

Goods: Are objects of every kind and description, including raw materials, products and equipment,

supplies, automated data processing hardware and software, objects in solid, liquid or gaseous form,

electricity and works and services incidental to the supply of the goods if the value of those incidental

works and services does not exceed that of the goods themselves;

Procuring entity: Means – (a) any entity which uses public funds to procure goods, services and works

including a ministry, department, agency or an organ of any statutory body, public enterprise or

parastatal; and (b) a private entity acting for the state or using public funds, except that any procurement

by a private entity using public funds shall be restricted to those public funds.

Public funds: means – (a) any fiscal resources appropriated to procuring entities through budgetary

processes; (b) aid, grants and credits made available to procuring entities by local and foreign donors (c)

revenues of procuring entities or other extrabudgetary funds;

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Public procurement: Means the acquisition, by any procuring entity, of goods, works or services or any

combination of goods, works or services, by contractual means, in accordance with the Regulations

relating to public procurement;

Public procurement contract: Means a contract or agreement between a procuring entity and a

successful bidder resulting from public procurement procedures;

Competitive bidding means any public procurement procedure that is within the threshold set by the

government.

Threshold: Means standards or limits set by the public procurement law.

Contractor, Consultant or Supplier: Means any physical or legal person under procurement contract with a

procuring entity. Services: Means any services other than consultant services.

Works: Works means all activities related to the realization of building or engineering works upon the

request by the client .It is all works associated with the construction, reconstruction, rehabilitation,

demolition, maintenance or renovation of a building or structure, including –

(a) site preparation, excavation, erection, building, installation of equipment or materials, decoration and

finishing;

(b) services incidental to works comprising drilling, mapping, satellite photography, seismic

investigations and similar

services provided following the public procurement contract, if the value of those services does not

exceed that of the work itself; or (c) building altering, repairing, improving, extending or demolishing any

structure, building or highway, and any drainage, dredging, excavating, grading or similar works on real

property.

Successful bidder: means a bidder whose offer has been accepted after being considered the most

competitive both technically and financially. It also refers to one who has concluded a procurement

contract with a procuring entity without having been subject to tendering proceedings;

Terms of reference: Means the document prepared by the procuring entity defining the requirements for

an assignment and means to be made available, concerns to be taken into account as well as the expected

results.

1.4. PRINCIPLES GOVERNING PUBLIC PROCUREMENT

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The fundamental principles governing public procurement in Rwanda are outlined in article four of law n°

12/2007 of 27/03/2007 on public procurement. In establishing this law, one of the main objectives of the

Government of Rwanda has been to create a market that eliminates barriers to trade in goods and services.

Creating a procurement market means removing any barriers to trade arising from the public procurement

context.

Transparency refers to the principle that is central to a modern public procurement system, that gives to

the public generally, and to the bidders community in particular, information concerning and access to the

law, regulation, policies and practice of procurement by government Procuring Entities PE.

From an economic perspective, “competition” operates as a discovery procedure by allowing different

bidders to communicate the prices at which goods and services are available on the market. Those prices

act as guideposts and reflect the demand and supply conditions at any given moment. They also reflect the

differences in quality and in terms and conditions of sale of the different (non-homogenous) products

available. This is why the advertising provisions are so important, as they guarantee the widest possible

competition, enabling bidders from all over the Community to communicate their prices to a given

procuring entity, thus ensuring the greatest possible choice. Procurement legislation seeks to prevent any

distortions or restrictions of competition within the Community, and any attempts to prevent bidders from

being able to tender will be prohibited. Such attempts can take many forms and can affect the products or

services or the economic operator itself.

This is a principle that is often used to describe the technical efficiency of the procedure

itself, i.e. whether the planning has been appropriate and carried out on time; whether the various

responsibilities have been engaged; whether sufficient time has been given to all bidders to prepare

suitable tenders; whether the procurement is made in a timely manner. At a more “economic” level, the

principle can also be used to identify whether the correct or best contracting strategies have been used to

minimize waste and benefit from economies of scale. At a policy level, the principle may be used to

analyze the allocative efficiency of transactions and of the system as a whole to determine whether this

can be optimized further.

Efficiency

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Efficiency to speed up procurement functions is of high essence so as to avoid bogging down

implementation of public programs at the expense of transparency. This means that through standardized

procedures and consistent application of best selection practices minimize delays to the procurement

be treated in the same way or that different situations not be treated in the same way. It does not depend

on nationality (as with the principle of non-discrimination) but is based on the idea of fairness to

individuals. Thus treating two bidders from the same country differently could be unequal treatment but,

since they are of the same nationality, there would be no discrimination (on grounds of nationality).

Accountability is defined as: “the quality or state of being accountable, especially an obligation or

willingness to accept responsibility or to account for one’s actions”. In accordance with this definition, it

is said that public officials have the obligation and must be willing to accept responsibility for their

actions. Accountability has a literal meaning related to counting and accounting for items of monetary

value, but as a concept its expanded meaning covers ethics and corporate social responsibility.

encourages good governance

Enforcement of internal and external legal regulations

An absence of corrupt practices

Accountability for their actions In this context procuring entities are spending public

money, generally derived from taxation imposed on citizens. It is therefore fundamental

that Procuring Entities are made for the money spent on their behalf.Procuring Entities

must therefore have structures and processes that allow them to ‘account’ for actual

expenditure.

THE CHOICE OF PROCUREMENT METHODS AND CONDITIONS OF THEIR USE

INTRODUCTION

The choice of procurement method is a critical issue to the success of procurement process; the

differences between the methods are significant in terms of formality, level of competition, duration and

complexity for bidders and the procuring entity. The choice should be made with the following factors in

mind, with a view to maximize competition to the greatest extent possible.

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However the main challenge in selecting a procurement method is to consider what method will

maximize competition, given the nature of what is being purchased, and obtain a large participation of

qualified bidders. The risk of choosing a method lacking competition is that premium prices will be paid

without assurance that the best bidder has been selected.

Legal provisions on methods of procurement:. It is important to note that Open Competitive bidding

method is the procurement method by default. The procurement law also clearly indicates the conditions

under which other procurement methods are used(art.45 of Rwanda procurement law).

1.OPEN COMPETITIVE BIDDING

This method should be considered as the preferred method of procurement for procurement of goods,

works, and non-consulting services designed to attract the widest possible participation of eligible and

qualified bidders and suppliers the method is most suited to obtaining value for money in the public

interest Exceptions to the use of open competitive bidding should be carefully considered and based only

on compelling circumstances established in procurement Law N° 12/2007 of 29/03/2007 on Public

Procurement, article 23, which makes open competitive bidding a procurement method by default.

However, the method of procurement that the procuring entity chooses to use for a particular requirement

depends on the nature, size and the urgency with which the works, goods or services to be procured.

The purpose of Open Competitive Bidding (OCB) is to give all eligible and qualified prospective bidders

adequate and timely notification of a procuring entity’s requirements and to give them equal access and a

fair opportunity to compete for contracts for required goods and services. Bidding opportunities must

therefore be advertised in media outlets of wider circulation and all eligible bidders given reasonable

possibilities to participate.

OCB requires formal bidding documents which are fair, non-restrictive, clear and comprehensive. The

bidding documents and technical specifications relating to the requirement should clearly describe the

criteria for evaluation of bids and selection of the successful bidder.

2.National Competitive Bidding (NCB): Means the bidding which focus to nationals and local bidders

or suppliers. NCB must be used when the estimated contract value(s) are below the threshold set for ICB

and above the threshold set for shopping. It is advertised as ICB except that it needs only to be advertised

in a national newspaper of wide circulation. All contractors both foreign and national are eligible to bid,

however no domestic preference is applicable. The minimum period for the availability of documents

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(publication) is 30 days and the document (Bidding document) cannot be sold on the day of Bid

submission. The threshold to be considered National is ABOVE 5 MILLIONS RWF.

3.International Competitive Bidding: Means bidding open to all bidders, including nationals, local and

foreign bidders or foreign suppliers. In most cases, ICB properly administered, and with the allowance for

preferences for domestic bidders for works under prescribed conditions is the most appropriate method.

ICB is the preferred method of procurement as it will provide users a wide range of choices from

competing contractors and potential contractors adequate, fair and equal opportunity for the works being

procured. Its use is mandatory when the estimated contract value(s) exceed the appropriate threshold

stated in the national regulations in the ministerial order No 001/08/10/Min of 16/01/2008, article 13. ICB

is advertised both nationally and internationally and is open to all who need to purchase the bidding

document.

Types of Open Competitive Bidding Methods

Procurement using open competitive bidding (OCB) method can follow either a onestage and two-stage

bidding process.

In one-stage tendering process, the procuring entity prepares a bidding document with, among other

things, detailed functional and technical requirements. In response, bidders submit bids containing their

technical and financial proposals at the same time. The procuring entity then evaluates each of the

bidders’ proposals and awards the contract to the lowest evaluated bidder, according to the method and

criteria specified in the bidding documents.

Article 49 of the Law on Procurement gives explanations of a two-stage tendering.

In a two-stage tendering process, the procuring entity prepares a first stage bidding document with

functional performance specifications, rather than detailed

technical specifications. In response, bidders offer non priced technical proposals (i.e., no financial

proposal is submitted at this time).

The procuring entity then:

• assesses the suppliers’ qualifications

• evaluates the technical proposals;

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Following the first stage evaluation, the procuring entity may prepare addenda to the bidding documents,

including revisions to the technical requirements made in the light of the first stage technical evaluation,

and initiates the second stage bidding process.

During the second stage bidding process, bidders offer amended bids containing their final technical

proposal and a financial proposal. The procuring entity then evaluates the combined proposals (technical

and financial) according to the method specified in the bidding documents.

The advantages of the two-stage process include the ability of the procuring entity, during the first stage,

to interact extensively on technical matters with bidders than is permissible in a one-stage process.

In this way, a procuring entity can learn from the market and adopt its requirements. In addition, a two

stage process allows a procuring entity to, in the first stage, state its requirements in more general

functional terms than the detailed functional and technical requirements necessary to carry out a one-stage

process. By knowing the bidders and their technologies prior to the second stage, this reduces the burden

of preparing detailed functional and technical requirements which are so comprehensive that they can

accommodate the entire universe of potential technical proposals.

Time for preparing bids/tenders- Article 29 of the procurement law stipulates that the time allotted

(agreed) to the preparation of tenders for open competitive bidding must not be less than thirty (30)

calendar days from the time the notice is published through a newspaper.

If the bidding document is amended, when the time remaining before the deadline for submitting tenders

is less than one third (1/3) of the time allotted to the preparation of tenders, the procuring entity extends

the deadline in order to allow the amendment of the tender documents to be taken into account in the

preparation of tenders.

In case of an international tender, the period of its publication in an internationally most widely read

newspaper is between forty five (45) and ninety (90) calendar days from the day on which the newspaper

is issued, depending on interest and importance of the tender. The bidding documents are drafted both in

French and English in case of international tenders (ref: Article 47 of the same law on public

procurement).

OTHER PROCUREMENT METHODS

Restricted Tendering (Ref: Articles 51-52 of the public procurement law).

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Restricted tendering is another variation of formal bidding in which only those issued invitations from

the procuring entity’s restricted list of potential bidders are permitted to submit bids. With these variations

in mind, the procedures to be followed for each of these methods of procurement are essentially the same.

Restricted tendering (also known as limited bidding) is essentially competitive bidding by direct

invitation, without open advertisement. Restricted tendering is an option generally where there is a limited

number of possible potential bidders or where contract values are small or other special circumstances

that may justify departure from competitive bidding.

Where the procuring entity uses restricted bidding as the method of procurement, bids should be solicited

from a list of potential bidders broad enough to ensure competitive prices, including all known bidders if

their number is small. Under restricted tendering two bidders may not be shortlisted from the same

country if international sourcing is done. The shortlisted bidders must be at least three (3) selected in a

fair and nondiscriminatory manner from a list of prequalified bidders.

An invitation to apply for inclusion on the prequalified list must be advertised, at least annually, in at least

one newspaper of the largest nationwide circulation.

Article 16 of the ministerial order No001/08/10/Min defines a threshold for use of restricted tendering by

stating that any procurement contract of which value is LESS THAN FIVE MILLION RWANDA

FRANCS (5.000.000) may be awarded using the restricted tendering method if the time and cost required

to examine and evaluate a large number of bids would be disproportionate to the value of goods, works or

consultancy services to be procured.

Request for Quotations

Request for quotations (sometimes referred to as “shopping”) is a procurement method used for small and

routine purchases. It is also defined as a method of procurement used primarily for procurement of goods

or low value procurement in which the procuring entity evaluates and makes award to the winning bidder

submitting a quotation on the basis of price alone.

Article 53 to 54 of procurement law explains request for quotations as an appropriate method for

procuring readily available off-the-shelf goods or standard commodities in quantities of small value and

in some cases, small simple works. Request for quotations does not require formal bidding documents,

and is carried out by requesting written quotations from several local or foreign suppliers or contractors --

usually at least three -- to ensure competitive prices. Telephone or verbal quotations are not acceptable.

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In evaluating quotations submitted by bidders under request for quotations, price and ability to meet

required delivery requirements are usually the main selection considerations for these simple purchases.

However, the procuring entity may also take into account, things such as the availability and costs of

maintenance services and spare parts over a reasonable period of use. The terms of the accepted offer are

incorporated in the purchase order and/or contract. Article 16 of the ministerial order No 001/08/10/Min

of 16/01/2008 clearly specify that a procuring entity may resort to the request for quotations for the

procurement of goods or construction works readily available on the market and have standard

specifications and their cost is BELOW ONE MILLION RWANDA FRANCS (RW F 1.000.000). Such a

tendering method cannot be used more than once within three months for a tender of the same category.

N.B: procuring entities must not split their tender into separate contracts for the purpose of using request

for quotations. Quotations should be requested from as many bidders as possible and not less than three

(3) — article 53 of the law on public procurement.

Single Source Procurement/Direct Contracting

Single Source (Also known as Direct Procurement or Direct Contracting) is a method of procurement in

which the procuring entity determines not to use competitive procurement on grounds of urgency or some

other legal principle and negotiates a contract with a single qualified bidder. Article 55 of procurement

law affirms that this method can be used and article 56 specify under which conditions it is allowed to be

used.

Direct contracting without competition is the method of procurement open to procuring entities in a

limited number of circumstances. In all cases where direct contracting is proposed, procuring entities

must ensure that it would not be feasible to apply a competitive bidding procedure. The contractors or

suppliers hired by direct contracting must be qualified to perform the works or supply of goods on time,

meeting specifications and fulfilling the special requirements of the sole source contract. They should also

be required to meet any performance security and warrant conditions that would normally apply in a

competitive bidding situation.

Single source method is used when the total cost does not exceed the total amount which is determined by

an order of the Minister in charge of public procurement Article 16 of the ministerial order

No001/08/10/Min of 16/01/2008 indicates the threshold for direct contracting where it states that any

tender whose value does not exceed one hundred thousand Rwanda francs (100.000frw) may be awarded

without tendering.

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In other way, single source is applied when additional works that cannot be technically separated from

initial tender. The value of additional works shall not exceed twenty per cent (20%) of the initial tender

value. The additional works shall be subject to additional contract,

When there is a case of force majeure. The circumstances giving rise to the urgency should not be neither

foreseeable by the procuring entity nor the result of dilatory conduct on its part. The procurement shall

only be in respect of those goods, works or services that are necessary to cater for the emergency

It is applied also for procurement related to items that are available only from a monopolist. Single source

procurement shall not be justified on the grounds that only one bidder has the capacity or the exclusive

right to manufacture or deliver goods, works or services if functionally equivalent goods, works or

services from other bidders would meet the needs of the procuring entity.

Force Account

This method refers to the government’s own workforce, equipment and resources, used to complete a

works project. Refer to the Law N° 12/2007 of 29/03/2007 on Public Procurement article 57.

It may be suitable when: • The quantities of works cannot be defined in advance; • The works are small

and at scattered locations that competent construction firms are unlikely to bid at reasonable prices; • The

works need to be undertaken without interrupting ongoing operations; • The risk of delay is better borne

by the government rather than an individual contractor; • There is a natural disaster or similar emergency

that need immediate attention.

After reviewing all options, the use of force account is decided upon, it should be managed so as to

introduce productivity controls approximating those of commercial contracting.

2 .2.5 Community Participation

In the interest of providing employment to local communities, the PE may decide to execute small

construction works, including maintenance and repair, through local User Committees. The applicable

maximum threshold value, the procuring entity’s obligation to provide design and technical inputs,

responsibilities for supervision and quality control and other related matters shall be specified by the PE

in consultation with the representatives of local User Committees. Refer to article 58 of procurement law

where this method shall be used if it is established that, it will contribute to the economy, create

employment and involvement of the beneficiary community.

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Threshold for using community participation (Article 21 of the regulations): A procurement contract may

be awarded to the beneficiary community if its value does not exceed TWENTY MILLION RWANDA

FRANCS (RWF 20, 000, 000). However, the value of the contract may exceed TWENTY MILLION

FRANCS (FRW 20,000,000) if the contract is for making terraces, anti-erosion trenches or planting trees.

In such a case, the procuring entity shall hire an expert, to support the community in the particular

activity, in accordance with procurement regulations.

NB: Use of procurement methods Competitive bidding is the procurement method by default. This me

ans that procuring entities must strive to the extent possible to use open competitive method r ather than

other methods. Other methods should only be u sed under circumstances laid down in the procurement

law and guideli nes. But the se circumstances should n ot be created by the procuring entity, there should

be circumstances that arise out of the procuring entity’s control. Time limits for bid submission under

other methods (Ar ticle 59 of procurement law) : For restricted tendering, the time limit for the pre

paration of tend ers shall be as provided in a rticle 47 of this Law. Such time limit may be reduced but

shall not be less than twenty one (21) calendar days for an international restricted tender and fourteen (14)

calendar days for the national restricted t ender. The time limit given to the bidders for them to request for

quotations shall be at least three (3) working days. Such time shall be counted from the date of receipt of

the invitation to tender by the bidder.

N.B: There are other kinds of procuremen t methods which are close to types of Contracts Turnkey

contracting

Turnkey is a contract type rather than a method of procurement in itself and can be either ICB or NCB.

Turnkey is a method of contracting by which a works contractor is made responsible for the design,

supply and installation of a complete facility or works. This type of contract will only be used on an

exceptional basis when the facility or works involved are both of high value and high complexity.

. Framework Agreements

A method of procurement in which contractors compete on the basis of qualifications for inclusion on

a list of stand-by eligible contractors who later may submit bids or proposals against a specific order

by the procuring entity for goods or services.

A) Framework Agreements Defined: Framework agreements, sometimes called Indefinite Quantity

Contracts, are twophase procurement instruments, in which the first competitive round generates

sometimes one but often multiple awards to contractors generally able and available to perform specific

tasks yet to be ordered by the procuring entity under the framework arrangement. The second round of

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competition, between one or more of the contractors now in the qualified pool, yields a specific contract

with one of them to supply the particular goods or services required. The second round or phase may or

may not be competitive, depending upon the number of suppliers in the framework arrangement and the

terms of the arrangement.

B) Appropriate Use of Framework Agreements Use of framework agreements is appropriate when the

procuring entity intends to acquire a series of similar goods or services, but before the particularities of

time and place have been identified. One or more procuring entities/end-users may be involved if the

procurement concerns common-use supplies or services. A good example is the engagement of a series of

contractors to provide lodging and logistic services for foreign diplomatic or business visitors. If a

number of firms are able to provide those services, it may be desirable for a government entity to use

Framework Agreements to select, during an initial round of competition, a pool of those contractors, with

established rates and basic contract terms. Then, when the visits are scheduled, a second brief round of

competition is used to choose one of the contractors to handle each specific visit. Procurement for

maintenance and repair contracts is another typical use of such framework arrangements. The first round

will generally include most of the features of the open tendering method of procurement. The second

round will generally resemble request for quotations from the qualified group of contractors. Variations

on this approach are possible, depending on the number of contractors awarded a framework agreement.

C) Competitive Aspects of Framework Agreements Framework agreements are sometimes criticized as

anti-competitive, because the first round of competition, which yields no specific contract, resembles a

pre-qualification and not a full and open round of competitive proposals. It should be noted, however, that

the first round may establish a contract price with reference to the catalogues of the suppliers who receive

awards. If not, the second round will involve price competition but it is only limited to the pre-qualified

suppliers and contractors. Sometimes, in fact, procuring entities will only involve one or two or three

contractors in the second round on the premise that full competition has already taken place in the first

role.

On the other hand, there are significant gains in cost and efficiency in the use of framework agreements

from the perspective of the government. Much of the preliminary work of the procurement process is

accomplished during the first round, at little cost to the government. The second round, focused on

specific tasks or orders, is likely to generate substantially competitive prices. Record keeping in this

method of procurement is particularly important, but complicated because of the two rounds of

competitive action.

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CHAPTER 3: PUBLIC PROCUREMENT

INTRODUCTION

The establishment, maintenance and improvement of sound public procurement systems are critical

responsibilities of governments throughout the world. Public procurement in modern times is an engine

for economic growth and development as it stimulates domestic, regional and international trade.

Procurement is a crucial factor in good governance. Well-functioning, competitive, transparent and fair

public procurement systems give satisfaction to suppliers and contractors, encouraging them to participate

in procurement opportunities, and yield value for money to the procuring entities and taxpayers that

support them.

Public confidence in government administration generally depends upon the reality and perception that

procurement procedures and actions are responsibly undertaken by public officials, both technical and

political, who are committed to procurement efficiency and integrity with a conviction that public

procurement policies, procedures and practices ensure good governance and value for money.

3.1 DEFINITION AND INTERPRETATION OF KEY TERMS IN PUBLIC

PROCUREMENT

The following are key terms often used in public procurement:

Accounting officer (Chief budget manager): Means an official empowered to approve reports of the

Tender Committee and sign the contract on behalf of the procuring entity. This official must be

empowered by Law to act as a Chief Budget Manager within the public entity in which he is employed.

Addendum: Means any changes, modifications or amendment made in the bidding document by the

procuring entity at any time before the deadline for submitting tenders.

Procuring entity: Means Central Government authority, Local Government authority, public institution,

commission, Government project, parastatal, agency, or any specialized institution engaged in

procurement process and entering in contract with a successful bidder.

Bid: Means a tender, an offer or a proposal given in response to an invitation to supply goods, works or

services;

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Bidder: Means a natural or legal person submitting or seeking to submit a bid;

Bidding documents: Means the tender solicitation documents or other documents for solicitation of bids

on the basis of which bidders are to prepare their bids;

Bid evaluation: Is the review and ranking by an evaluation committee of the bids submitted on a timely

basis to the procuring entity in accordance with the evaluation criteria set forth in detail in the bidding

documents.

Bid Security: means any guarantee by a bank or other relevant financial institution to allow the

prospective bidder to participate in tendering;

Bid submission: The preparation and transmission to the procuring entity of the bids or proposals

prepared by bidders in response to the invitation to bid or request for proposals

Bid validity: Is the time that bidders remains committed to their bids. During the bid validity period, a

bidder may not withdraw or modify her/his bid. The procuring entity is obliged to award a contract

during the bid validity period. A procuring entity may request bidders to extend their bid validity periods.

If a bidder refuses to extend the bid validity period, she/he cannot be forfeited with bid security.

Contract: Means an agreement between the procuring entity and the successful bidder. This agreement

contains rights and obligations for both the procuring entity and the successful bidder.

Consultant services: Refers to an intellectual activities or activities of an intangible nature. Consultant

services are provided by consultants using their professional skills to study, design, and organize specific

projects, advise clients, conduct training, and transfer knowledge.

Conflict of interest: Is a situation in which a party to a procurement proceeding behaves in a biased

manner in order to obtain undue benefit for itself or its affiliates or acquaintances.

Corruption Corruption is defined as: impairment of integrity, virtue, or moral principle, depravity, decay,

decomposition, inducement to wrong by improper or unlawful means (as bribery), a departure from the

original or from what is pure or correct”. Procurement officials must reject corrupt practices, which are

contrary to good practice in the procurement profession.

Corrupt practice: includes the offering, giving, receiving, or soliciting, directly or indirectly, of anything

of value to influence the action of a public official in the procurement process or in the execution of a

contract;

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Day: Refers to every weekday including holidays unless stated otherwise.

E-procurement: Means the process of procurement using electronic medium such as the internet or other

information and communication technologies;

Framework agreement: Means an agreement between one or more procuring entities and one or more

bidders, the purpose of which is to establish the terms governing procurement contracts to be awarded

during a given period, in particular, with regard to price and where appropriate the quantity envisaged;

Fraudulent practice: Includes a misrepresentation or omission of facts in order to influence a

procurement process or the execution of a contract to the detriment of the procuring entity, and includes

collusive practices among bidders, prior to or after bid submission, designed to establish bid prices at

artificial or non-competitive levels and deprive the procuring entity of the benefits of free and open

competition;

Goods: Are objects of every kind and description, including raw materials, products and equipment,

supplies, automated data processing hardware and software, objects in solid, liquid or gaseous form,

electricity and works and services incidental to the supply of the goods if the value of those incidental

works and services does not exceed that of the goods themselves;

Procuring entity: Means – (a) any entity which uses public funds to procure goods, services and works

including a ministry, department, agency or an organ of any statutory body, public enterprise or

parastatal; and (b) a private entity acting for the state or using public funds, except that any procurement

by a private entity using public funds shall be restricted to those public funds.

Public funds: means – (a) any fiscal resources appropriated to procuring entities through budgetary

processes; (b) aid, grants and credits made available to procuring entities by local and foreign donors (c)

revenues of procuring entities or other extrabudgetary funds;

Public procurement: Means the acquisition, by any procuring entity, of goods, works or services or any

combination of goods, works or services, by contractual means, in accordance with the Regulations

relating to public procurement;

Public procurement contract: Means a contract or agreement between a procuring entity and a

successful bidder resulting from public procurement procedures;

Competitive bidding means any public procurement procedure that is within the threshold set by the

government.

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Threshold: Means standards or limits set by the public procurement law.

Contractor, Consultant or Supplier: Means any physical or legal person under procurement contract with a

procuring entity.

Services: Means any services other than consultant services.

Works: Works means all activities related to the realization of building or engineering works upon the

request by the client .It is all works associated with the construction, reconstruction, rehabilitation,

demolition, maintenance or renovation of a building or structure, including – (a) site preparation,

excavation, erection, building, installation of equipment or materials, decoration and finishing; (b)

services incidental to works comprising drilling, mapping, satellite photography, seismic investigations

and similar services provided following the public procurement contract, if the value of those services

does not exceed that of the work itself; or (c) building altering, repairing, improving, extending or

demolishing any structure, building or highway, and any drainage, dredging, excavating, grading or

similar works on real property; (article 20 of public procurement law).

Successful bidder: means a bidder whose offer has been accepted after being considered the most

competitive both technically and financially. It also refers to one who has concluded a procurement

contract with a procuring entity without having been subject to tendering proceedings;

Terms of reference: Means the document prepared by the procuring entity defining the requirements for

an assignment and means to be made available, concerns to be taken into account as well as the expected

results.

3.2 PRINCIPLES GOVERNING PUBLIC PROCUREMENT

The fundamental principles governing public procurement in Rwanda are outlined in

article four of law n° 12/2007 of 27/03/2007 on public procurement. In establishing this

law, one of the main objectives of the Government of Rwanda has been to create a

market that eliminates barriers to trade in goods and services. Creating a procurement

market means removing any barriers to trade arising from the public procurement

context.

Transparency

Transparency refers to the principle that is central to a modern public procurement

system, that gives to the public generally, and to the bidders community in particular,

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information concerning and access to the law, regulation, policies and practice of

procurement by government Procuring Entities PE.

Competition From an economic perspective,

“competition” operates as a discovery procedure by allowing different bidders to

communicate the prices at which goods and services are available on the market. Those

prices act as guideposts and reflect the demand and supply conditions at any given

moment. They also reflect the differences in quality and in terms and conditions of sale of

the different (non-homogenous) products available. This is why the advertising

provisions are so important, as they guarantee the widest possible competition, enabling

bidders from all over the Community to communicate their prices to a given procuring

entity, thus ensuring the greatest possible choice. Procurement legislation seeks to

prevent any distortions or restrictions of competition within the Community, and any

attempts to prevent bidders from being able to tender will be prohibited. Such attempts

can take many forms and can affect the products or services or the economic operator

itself.

This is a principle that is often used to describe the technical efficiency of

the procedure itself, i.e. whether the planning has been appropriate and carried out on

time; whether the various responsibilities have been engaged; whether sufficient time has

been given to all bidders to prepare suitable tenders; whether the procurement is made in

a timely manner. At a more “economic” level, the principle can also be used to identify

whether the correct or best contracting strategies have been used to minimize waste and

benefit from economies of scale. At a policy level, the principle may be used to analyze

the allocative efficiency of transactions and of the system as a whole to determine

whether this can be optimized further.

Efficiency to speed up procurement functions is of high essence so as to avoid bogging

down implementation of public programs at the expense of transparency. This means that

through standardized procedures and consistent application of best selection practices

minimize delays to the procurement process.

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This is the principle of equality of treatment which requires that identical situations be

treated in the same way or that different situations not be treated in the same way. It does

not depend on nationality (as with the principle of non-discrimination) but is based on the

idea of fairness to individuals. Thus treating two bidders from the same country

differently could be unequal treatment but, since they are of the same nationality, there

would be no discrimination (on grounds of nationality).

Accountability is defined as: “the quality or state of being

accountable, especially an obligation or willingness to accept responsibility or to account

for one’s actions”. In accordance with this definition, it is said that public officials have

the obligation and must be willing to accept responsibility for their actions.

Accountability has a literal meaning related to counting and accounting for items of

monetary value, but as a concept its expanded meaning covers ethics and corporate social

responsibility.

Procurement officers and procuring entities need to demonstrate:

Good governance and a structure that encourages good governance

Enforcement of internal and external legal regulations

An absence of corrupt practices

Accountability for their actions In this context procuring entities are spending

public money, generally derived from taxation imposed on citizens.

It is therefore fundamental that Procuring Entities are made for the money spent on their

behalf.Procuring Entities must therefore have structures and processes that allow them to

‘account’ for actual expenditure.

3.3. LEGAL AND REGULATORY FRAMEWORK

The basic objectives of any public procurement legal and regulatory framework, regardless of the

country’s level of development, are to reduce costs and improve efficiency by promoting fair

competition and streamlining procedures, to ensure accountability by increasing transparency in

the process and reduce corruption. The legal and regulatory framework should however be

tailored according to the specific problems and constraints of a country’s legal system and

traditions. The African legal and regulatory framework is designed to address specific country

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problems and constraints while at the other hand being consistent with the international public

procurement standards.

3.4.THE CHOICE OF PROCUREMENT METHODS AND CONDITIONS OF THEIR

USE

INTRODUCTION

The choice of procurement method is a critical issue to the success of procurement process; the

differences between the methods are significant in terms of formality, level of competition,

duration and complexity for bidders and the procuring entity. The choice should be made with the

following factors in mind, with a view to maximize competition to the greatest extent possible.

However the main challenge in selecting a procurement method is to consider what method will

maximize competition, given the nature of what is being purchased, and obtain a large

participation of qualified bidders. The risk of choosing a method lacking competition is that

premium prices will be paid without assurance that the best bidder has been selected.

Legal provisions on methods of procurement:

It is important to note that Open Competitive bidding method is the procurement method by

default. The procurement law also clearly indicates the conditions under which other

procurement methods are used.

3.4.1. OPEN COMPETITIVE BIDDING

This method should be considered as the preferred method of procurement for procurement of

goods, works, and non-consulting services designed to attract the widest possible participation of

eligible and qualified bidders and suppliers the method is most suited to obtaining value for

money in the public interest Exceptions to the use of open competitive bidding should be

carefully considered and based only on compelling circumstances established in procurement

Law N° 12/2007 of 29/03/2007 on Public Procurement, article 23, which makes open competitive

bidding a procurement method by default. However, the method of procurement that the

procuring entity chooses to use for a particular requirement depends on the nature, size and the

urgency with which the works, goods or services to be procured.

The purpose of Open Competitive Bidding (OCB) is to give all eligible and qualified

prospective bidders adequate and timely notification of a procuring entity’s requirements and to

give them equal access and a fair opportunity to compete for contracts for required goods and

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services. Bidding opportunities must therefore be advertised in media outlets of wider circulation

and all eligible bidders given reasonable possibilities to participate.

OCB requires formal bidding documents which are fair, non-restrictive, clear and comprehensive.

The bidding documents and technical specifications relating to the requirement should clearly

describe the criteria for evaluation of bids and selection of the successful bidder.

National Competitive Bidding (NCB): Means the bidding which focus to nationals and local

bidders or suppliers. NCB must be used when the estimated contract value(s) are below the

threshold set for ICB and above the threshold set for shopping. It is advertised as ICB except that

it needs only to be advertised in a national newspaper of wide circulation. All contractors both

foreign and national are eligible to bid, however no domestic preference is applicable. The

minimum period for the availability of documents (publication) is 30 days and the document

(Bidding document) cannot be sold on the day of Bid submission. The threshold to be considered

National is ABOVE 5 MILLIONS RWF, (art. 23 public procurement law).

International Competitive Bidding: Means bidding open to all bidders, including nationals, local

and foreign bidders or foreign suppliers. In most cases, ICB properly administered, and with the

allowance for preferences for domestic bidders for works under prescribed conditions is the most

appropriate method. ICB is the preferred method of procurement as it will provide users a wide

range of choices from competing contractors and potential contractors adequate, fair and equal

opportunity for the works being procured. Its use is mandatory when the estimated contract

value(s) exceed the appropriate threshold stated in the national regulations in the ministerial order

No 001/08/10/Min of 16/01/2008, article 13. ICB is advertised both nationally and internationally

and is open to all who need to purchase the bidding document.

3.4.2. Types of Open Competitive Bidding Methods

Procurement using open competitive bidding (OCB) method can follow either a onestage and

two-stage bidding process.

In one-stage tendering process, the procuring entity prepares a bidding document with, among

other things, detailed functional and technical requirements. In response, bidders submit bids

containing their technical and financial proposals at the same time. The procuring entity then

evaluates each of the bidders’ proposals and awards the contract to the lowest evaluated bidder,

according to the method and criteria specified in the bidding documents.

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Article 49 of the Law on Procurement gives explanations of a two-stage tendering. In a two-stage

tendering process, the procuring entity prepares a first stage bidding document with functional

performance specifications, rather than detailed technical specifications. In response, bidders

offer non priced technical proposals (i.e., no financial proposal is submitted at this time).

The procuring entity then:

• assesses the suppliers’ qualifications

• evaluates the technical proposals;

Following the first stage evaluation, the procuring entity may prepare addenda to the bidding

documents, including revisions to the technical requirements made in the light of the first stage

technical evaluation, and initiates the second stage bidding process. During the second stage

bidding process, bidders offer amended bids containing their final technical proposal and a

financial proposal. The procuring entity then evaluates the combined proposals (technical and

financial) according to the method specified in the bidding documents.

The advantages of the two-stage process include the ability of the procuring entity, during the

first stage, to interact extensively on technical matters with bidders than is permissible in a one-

stage process. In this way, a procuring entity can learn from the market and adopt its

requirements.

In addition, a two stage process allows a procuring entity to, in the first stage, state its

requirements in more general functional terms than the detailed functional and technical

requirements necessary to carry out a one-stage process. By knowing the bidders and their

technologies prior to the second stage, this reduces the burden of preparing detailed functional

and technical requirements which are so comprehensive that they can accommodate the entire

universe of potential technical proposals.

Time for preparing bids/tenders- Article 29 of the procurement law stipulates that the time

allotted (agreed) to the preparation of tenders for open competitive bidding must not be less than

thirty calendar days from the time the notice is published through a newspaper.

If the bidding document is amended, when the time remaining before the deadline for submitting

tenders is less than one third (1/3) of the time allotted to the preparation of tenders, the procuring

entity extends the deadline in order to allow the amendment of the tender documents to be taken

into account in the preparation of tenders.

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In case of an international tender, the period of its publication in an internationally most widely

read newspaper is between forty five (45) and ninety (90) calendar days from the day on which

the newspaper is issued, depending on interest and importance of the tender. The bidding

documents are drafted both in French and English in case of international tenders (ref: Article 47

of the same law on public procurement).

3.4.3. OTHER PROCUREMENT METHODS

2 .2.1 Restricted Tendering (Ref: Articles 51-52 of the public procurement law).

Restricted tendering is another variation of formal bidding in which only those issued

invitations from the procuring entity’s restricted list of potential bidders are permitted to

submit bids. With these variations in mind, the procedures to be followed for each of

these methods of procurement are essentially the same.

Restricted tendering (also known as limited bidding) is essentially competitive bidding by

direct invitation, without open advertisement. Restricted tendering is an option generally

where there is a limited number of possible potential bidders or where contract values are

small or other special circumstances that may justify departure from competitive bidding.

Where the procuring entity uses restricted bidding as the method of procurement, bids

should be solicited from a list of potential bidders broad enough to ensure competitive

prices, including all known bidders if their number is small. Under restricted tendering

two bidders may not be shortlisted from the same country if international sourcing is

done. The shortlisted bidders must be at least three (3) selected in a fair and

nondiscriminatory manner from a list of prequalified bidders.

An invitation to apply for inclusion on the prequalified list must be advertised, at least

annually, in at least one newspaper of the largest nationwide circulation.

Article 16 of the ministerial order No001/08/10/Min defines a threshold for use of

restricted tendering by stating that any procurement contract of which value is LESS

THAN FIVE MILLION RWANDA FRANCS (5.000.000) may be awarded using the

restricted tendering method if the time and cost required to examine and evaluate a large

number of bids would be disproportionate to the value of goods, works or consultancy

services to be procured.

3.4.4. Request for Quotations

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Request for quotations (sometimes referred to as “shopping”) is a procurement method used for

small and routine purchases. It is also defined as a method of procurement used primarily for

procurement of goods or low value procurement in which the procuring entity evaluates and

makes award to the winning bidder submitting a quotation on the basis of price alone.

Article 53 to 54 of procurement law explains request for quotations as an appropriate

method for procuring readily available off-the-shelf goods or standard commodities in

quantities of small value and in some cases, small simple works. Request for quotations

does not require formal bidding documents, and is carried out by requesting written

quotations from several local or foreign suppliers or contractors -- usually at least three --

to ensure competitive prices. Telephone or verbal quotations are not acceptable.

In evaluating quotations submitted by bidders under request for quotations, price and

ability to meet required delivery requirements are usually the main selection

considerations for these simple purchases. However, the procuring entity may also take

into account, things such as the availability and costs of maintenance services and

spareparts over a reasonable period of use. The terms of the accepted offer are

incorporated in the purchase order and/or contract. Article 16 of the ministerial order No

001/08/10/Min of 16/01/2008 clearly specify that a procuring entity may resort to the

request for quotations for the procurement of goods or construction works readily

available on the market and have standard specifications and their cost is BELOW ONE

MILLION RWANDA FRANCS (RW F 1.000.000). Such a tendering method cannot be

used more than once within three months for a tender of the same category.

N.B: procuring entities must not split their tender into separate contracts for the purpose

of using request for quotations. Quotations should be requested from as many bidders as

possible and not less than three (3) — article 53 of the law on public procurement.

3.4.5. Single Source Procurement/Direct Contracting

Single Source (Also known as Direct Procurement or Direct Contracting) is a method of

procurement in which the procuring entity determines not to use competitive procurement

on grounds of urgency or some other legal principle and negotiates a contract with a

single qualified bidder. Article 55 of procurement law affirms that this method can be

used and article 56 specify under which conditions it is allowed to be used.

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Direct contracting without competition is the method of procurement open to procuring

entities in a limited number of circumstances. In all cases where direct contracting is

proposed, procuring entities must ensure that it would not be feasible to apply a

competitive bidding procedure. The contractors or suppliers hired by direct contracting

must be qualified to perform the works or supply of goods on time, meeting

specifications and fulfilling the special requirements of the sole source contract. They

should also be required to meet any performance security and warrant conditions that

would normally apply in a competitive bidding situation.

Single source method is used when the total cost does not exceed the total amount which

is determined by an order of the Minister in charge of public procurement Article 16 of

the ministerial order No001/08/10/Min of 16/01/2008 indicates the threshold for direct

contracting where it states that any tender whose value does not exceed one hundred

thousand Rwanda francs (100.000frw) may be awarded without tendering.

In other way, single source is applied when additional works that cannot be technically

separated from initial tender. The value of additional works shall not exceed twenty per

cent (20%) of the initial tender value. The additional works shall be subject to additional

contract,

When there is a case of force majeure. The circumstances giving rise to the urgency

should not be neither foreseeable by the procuring entity nor the result of dilatory conduct

on its part. The procurement shall only be in respect of those goods, works or services

that are necessary to cater for the emergency

It is applied also for procurement related to items that are available only from a

monopolist. Single source procurement shall not be justified on the grounds that only one

bidder has the capacity or the exclusive right to manufacture or deliver goods, works or

services if functionally equivalent goods, works or services from other bidders would

meet the needs of the procuring entity.

3.4.6.Force Account

This method refers to the government’s own workforce, equipment and resources, used

to complete a works project. Refer to the Law N° 12/2007 of 29/03/2007 on Public

Procurement article 57

It may be suitable when:

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• The quantities of works cannot be defined in advance;

• The works are small and at scattered locations that competent construction firms are

unlikely to bid at reasonable prices;

• The works need to be undertaken without interrupting ongoing operations;

• The risk of delay is better borne by the government rather than an individual contractor;

• There is a natural disaster or similar emergency that need immediate attention.

After reviewing all options, the use of force account is decided upon, it should be

managed so as to introduce productivity controls approximating those of commercial

contracting.

3.4.7. Community Participation

In the interest of providing employment to local communities, the PE may decide to

execute small construction works, including maintenance and repair, through local User

Committees. The applicable maximum threshold value, the procuring entity’s obligation

to provide design and technical inputs, responsibilities for supervision and quality

control and other related matters shall be specified by the PE in consultation with the

representatives of local User Committees. Refer to article 58 of procurement law where

this method shall be used if it is established that, it will contribute to the economy, create

employment and involvement of the beneficiary community.

Threshold for using community participation (Article 21 of the regulations): A

procurement contract may be awarded to the beneficiary community if its value does not

exceed TWENTY MILLION RWANDA FRANCS (RWF 20, 000, 000). However, the

value of the contract may exceed TWENTY MILLION FRANCS (FRW 20,000,000) if

the contract is for making terraces, anti-erosion trenches or planting trees. In such a case,

the procuring entity shall hire an expert, to support the community in the particular

activity, in accordance with procurement regulations.

NB: Use of procurement methods Competitive bidding is the procurement method by

default. This means that procuring entities must strive to the extent possible to use open

competitive method rather than other methods. Other methods should only be used under

circumstances laid down in the procurement law and guidelines. But the se circumstances

should not be created by the procuring entity, there should be circumstances that arise out

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of the procuring entity’s control. Time limits for bid submission under other methods (Ar

ticle 59 of procurement law) : For restricted tendering, the time limit for the pre paration

of tend ers shall be as provided in a rticle 47 of this Law. Such time limit may be reduced

but shall not be less than twenty one (21) calendar days for an international restricted

tender and fourteen (14) calendar days for the national restricted t ender. The time limit

given to the bidders for them to request for quotations shall be at least three (3) working

days. Such time shall be counted from the date of receipt of the invitation to tender by the

bidder.

N.B: There are other kinds of procuremen t methods which are close to types of Contracts

2.2.6 . Turnkey contracting

Turnkey is a contract type rather than a method of procurement in itself and can be either

ICB or NCB. Turnkey is a method of contracting by which a works contractor is made

responsible for the design, supply and installation of a complete facility or works. This

type of contract will only be used on an exceptional basis when the facility or works

involved are both of high value and high complexity.

3.5. FRAMEWORK AGREEMENTS

A method of procurement in which contractors compete on the basis of qualifications for inclusion on

a list of stand-by eligible contractors who later may submit bids or proposals against a specific order

by the procuring entity for goods or services.

A) Framework Agreements Defined: Framework agreements, sometimes called

Indefinite Quantity Contracts, are twophase procurement instruments, in which the first

competitive round generates sometimes one but often multiple awards to contractors

generally able and available to perform specific tasks yet to be ordered by the procuring

entity under the framework arrangement. The second round of competition, between one

or more of the contractors now in the qualified pool, yields a specific contract with one of

them to supply the particular goods or services required. The second round or phase may

or may not be competitive, depending upon the number of suppliers in the framework

arrangement and the terms of the arrangement.

B) Appropriate Use of Framework Agreements

Use of framework agreements is appropriate when the procuring entity intends to acquire

a series of similar goods or services, but before the particularities of time and place have

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been identified. One or more procuring entities/end-users may be involved if the

procurement concerns common-use supplies or services. A good example is the

engagement of a series of contractors to provide lodging and logistic services for foreign

diplomatic or business visitors. If a number of firms are able to provide those services, it

may be desirable for a government entity to use Framework Agreements to select, during

an initial round of competition, a pool of those contractors, with established rates and

basic contract terms. Then, when the visits are scheduled, a second brief round of

competition is used to choose one of the contractors to handle each specific visit.

Procurement for maintenance and repair contracts is another typical use of such

framework arrangements. The first round will generally include most of the features of

the open tendering method of procurement. The second round will generally resemble

request for quotations from the qualified group of contractors. Variations on this

approach are possible, depending on the number of contractors awarded a framework

agreement.

C) Competitive Aspects of Framework Agreements

Framework agreements are sometimes criticized as anti-competitive, because the first

round of competition, which yields no specific contract, resembles a pre-qualification and

not a full and open round of competitive proposals. It should be noted, however, that the

first round may establish a contract price with reference to the catalogues of the suppliers

who receive awards. If not, the second round will involve price competition but it is only

limited to the pre-qualified suppliers and contractors. Sometimes, in fact, procuring

entities will only involve one or two or three contractors in the second round on the

premise that full competition has already taken place in the first round.

On the other hand, there are significant gains in cost and efficiency in the use of

framework agreements from the perspective of the government. Much of the preliminary

work of the procurement process is accomplished during the first round, at little cost to

the government. The second round, focused on specific tasks or orders, is likely to

generate substantially competitive prices. Record keeping in this method of procurement

is particularly important, but complicated because of the two rounds of competitive

action.

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3.6.PROCUREMENT CYCLE

INTRODUCTION

The procurement process follows steps that are arranged in a determined order, these

steps can be explained here under as procurement cycle comprises three main phases

namely Pre-tendering including:

Needs assessment,

Planning and budgeting,

Pre - planning and the annual procurement plan :definition of requirements,

determining priorities and choice of procedures, Tendering, including the

invitation to tender, evaluation and award; and Post-tendering, including contract

management, order and payment.

3.6.1 . DETERMINING /IDENTIFYING THE NEEDS

This is the very first stage in the actual procurement process where departments/ services

identifies their needs and send them to the procurement officer where they are unified to produce

procurement plan. Here the basic need of the stakeholder(s) is explored, options considered, and

the requirements briefly described as the basis for a plan and a specification. Procurement officers

should not take the initial need for granted, but rather they should engage in a process that

evaluates the needs and considers alternative cost-effective solutions.

Some ‘needs’ may already have been met by a previous and or by a current contract, the

item sought may already be in stock from an alternative economic operator, or a potential

purchase could be aggregated with other forthcoming purchases so as to present a more

attractive supply opportunity to the supply market. Good practice by ensuring that there is

a need that a procurement officer should not simply be a rubber stamp, Auditors will

want to understand that there is a clear need.

3.6.2.PROCUREMENT PLANNING

Procurement Planning Procurement planning is a key function in public sector organizations. Its

objective is to provide the PE with continuity of inputs (procurements) to enable it to achieve

strategic objectives. It refers to the setting of procurement targets and activities by a PE in a

manner that spreads them out in an annual calendar in accordance with the availability of

resources and needs. Within the framework of the annual procurement plan, this is the stage in the

process when the objectives of making procurement are considered in relation to stakeholder

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needs and when a planned approach to the procurement is set out. This process is vital to the

success of the procurement, although it may be executed in parallel with or immediately after the

specification. Where a sample procurement plan is provided. Auditors will want to see a clear

procurement plan signed off by key stakeholders, as it represents a decision to proceed.

Procurement level plan could also involve co-operation with other procuring entities.

3.6.3.Pre - planning and the annual procurement plan

This process will ideally take place during the year, before the procurement needs to be made.

Procurement people will sit down with user departments and key stakeholders and discuss their

procurement requirements and budgets for the next year, giving advice on likely costs based on

their market knowledge and deciding which items to include within a Prior Indicative Notice ,this

process is vital in helping to inform procurement officers about what they may be expected to

purchase during the following year, and it should be part of the annual engagement process

between stakeholders and procurement. Once procurement officers have been given the

information about what they may be expected to purchase during the coming year, they can then

be alerted to what is happening in the relevant supply markets, and that knowledge can be fed into

subsequent processes. Whilst pre-planning is acknowledged as ‘good practice’ everywhere, it is

recognized that in some countries the procurement plan that results from the process described

above can be: The plan that has been, or has to be, adopted by the contracting authority, a

document that has to be published, a document closely linked to budgets and financial plans The

annual plan, which forms the only basis on which procurement can be carried out in the year

concerned localization here ,the annual procurement plan may also

indicate those cases where a contracting authority(PE) intends to collaborate with other

contracting authorities.

Why Procurement Planning Harvey Mackay said, “Failures don’t plan to fail;

they fail to plan.” Planning is a vital part of the procurement officer’s activity. The

amount of planning undertaken is one of the distinguishing characteristics between good

procurement professionals and others.

Procurement planning is defined both as a process used by contracting authorities to plan

contracting or purchasing activity for a specific period, as well as a plan for the purchase

of a specific requirement. To achieve both definitions procurement officers need to be

closely involved with budget managers and user departments.

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A Procurement plan is a requirement under the Rwandan public procurement laws and

regulations. An annual procurement plan is also the first step in the procurement planning

process. Ideally, the relationship that procurement officers have with user and budget

departments should be so close that they are involved at an early stage of the budget

cycle, where departments are identifying their needs in the respective budget year.

The Rwandan financial year begins from July and ends in June. According to the budget

calendar, Budget estimates and the Budget Framework Paper are submitted to Cabinet in

March. This means that by the month of March, procuring entities have a fair view of

their budgetary allocations. The mistake that most procuring entities commit is that they

begin the procurement process in July when the budget financial year begins. Actually

from July, payments for any procurement can be done, but the process of procurement

can begin before the financial year starts.

3.2.4 Process and Timeline Linked to Budget Cycle

Like in Rwanda where the financial year runs from July to June, the process for

planning would work like this:

procurement proposals and make initial list.

begins, some contracts are almost or ready for signature and execution.

Procurement planning

stages 1. Identifying the needs (listing of needs);

2. Determining the priorities;

3. Determining the required budget;

4. Determining the different lots (packaging) ;

5. Determining the procurement methods;

6. Determining the deadlines for starting and the duration of every activity;

7. Determining a general procurement plan;

8. Determining a specific procurement plan.

Advantages of Procurement Planning

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er unit, the finance unit, and the procurement unit

from the earliest notion of there being requirement/need;

n later months;

procuring entity.

Consequences of not undertaking procurement planning

By not undertaking such a planning process:

Stakeholders, the finance department and the procurement team would work in isolation,

unaware of each other’s’ needs.

Requirements received by the procurement team would be surprises, for which no pre-

planning would have been possible.

Procurement officers would miss information on the potential requirements because they

would not know they existed.

Economies of scale would be lost because the requirements of different areas would be

processed separately.

Requirements would not be timed to the year-end of potential economic operators and so

better deals could not be achieved.

Resource scheduling would be difficult. Periodic indicative notices would not be

published as easily.

Co-operation with other contracting authorities would be more difficult as visibility of

future needs would be limited.

There would be no procurement plan linked to the strategic plan of the contracting