We will start by discussing the types of ledger accounts and proceed to their verification and also the verification of other accounts.
Personal Ledger Accounts
All personal accounts are opened under this category. In big organizations where the number of transactions is quite high, a personal ledger may further be split up into two more ledgers −
- Purchase ledger
- Sales ledger
Purchase ledger is verified from the following −
- Creditor balances of last year
- Cash Book and Bank Book
- Purchase register
- Purchase return book
- Bills payable book
- Journal and other relevant books
An Auditor should carefully verify the following −
- Posting of all vouchers in ledger account should be done without any omission.
- Verification of all opening balances should be properly checked with last year’s balance sheet.
- If the creditor balance shows debit balance it may be due to advance payment made to him, the Auditor should confirm whether the material against advance is received or not.
- Periodical statements of creditor should be reconciled.
- Examination of internal control system.
Sales ledger will be verified from the following −
- Debtors’ balances of last year
- Cash book and bank book
- Sales register
- Sales return book
- Bills Receivable book
- Journal and other relevant books
Auditor should carefully verify the following −
- Posting of all vouchers in ledger account from cash and bank book, sales register, bills receivable register, sales return register and journal should be verified.
- Verification of opening balances, castings, balances carried forward should be carefully examined.
- Credit balance of the debtors’ account may represent the advance received against the supply of goods; the Auditor should examine and confirm whether any material is supplied against it or not.
- Periodical reconciliation of account from debtors should be done without any fail.
- Provision for doubtful debts and bad debts should be done.
- Review and examination of credit policy should be made from time to time.
- Checking of posting in ledger account from subsidiary book.
- Checking of calculations.
- Reviewing truthfulness of debtor balances in customer account.
- Reviewing of Internal Control System.
Impersonal Ledger Accounts
All the nominal account, real account and capital account fall under impersonal ledger accounts. Income and expenditure account (nominal accounts) transferred to profit and loss account.
Capital account, real accounts, debtors and creditors account are transferred to balance sheet. Following steps are involved in the audit of impersonal ledger account −
- Opening balances should be verified from last year’s Balance Sheet.
- Timely posting of balances of subsidiary books (Sales Book, Purchase Book, Sales Return Book, Purchase Return Book) to ledger accounts.
- Checking of totals and castings.
- Checking of balances transferred to trial balances, debit and credit side of trial balance should be tallied.
- Checking of adequacy of internal control system in organization.
It is necessary to include some expenses and income in current year though passing adjustment entries to show the correct profit or loss of the company. Therefore it is must for an Auditor to check each and every outstanding entries. Following are outstanding assets −
These expenses are paid in advance for next coming year(s), hence should not be debited to profit and loss account of current year to arrive at true financial results.
For example; Insurance of Fixed assets is normally paid on annual basis and if we paid insurance premium in the month of October for one year, then insurance for this current year will be calculated from October to March and from April to September it will be treated as prepaid insurance. Prepaid insurance will be shown as prepaid expenses under the head of current assets in the balance sheet.
Auditor should vouch every nominal account to confirm whether correct amount of expenses is debited to profit and loss account or not. Other examples of prepaid expenses are −
- Rent Rates and Taxes
- Annual maintenance Contract, etc
Following are the examples of Income Receivable −
- Interest accrued but not due or received
- Taxation claims
- Declared dividend by company yet to receive
All the above income should be included in the Profit & Loss account of the year to arrive at a correct figure.
Deferred Revenue Expenditure
The examples of deferred revenue expenditure have been described below −
Preliminary expenditure is incurred at the time of incorporation of a new company. These expenses are of heavy amount and are incurred mainly for promotional reasons. Nature of these expenses are capital but not actually represent any asset, hence should be written off from profit and loss account over a period of 3 to 10 years in equal installments.
Advertising and Sales Promotion
These expenses are incurred at the time of establishing new business or at the time of introduction of any new product in the market. These expenses are shown as assets in Balance sheet and should be written off in profit and Loss account over a numbers of accounting periods.
Expenses of heavy repairs of fixed assets shall not be debited to profit and loss account of year in which these expenses incurred but it should be spread to number of years like other deferred revenue expenses. Heavy amount of expenses is incurred on repair of Plant & Machinery due to increased production capacity of the plant or to maintain current production capacity of machine which is very old and need some heavy overhauling or repairing to increase it life.
Other examples of deferred revenue expenses are −
- Discount allowed on debentures
- Experimental expenditure
- Research & development expenses
- Development expenses on mines
There are some expenses and liabilities that come up in due course of business; these are due for payment but not paid till the end of accounting period in question. The Auditor should see all those expenses and liabilities and all these expenses should be included in profit and loss of the current year to arrive at the true profit or loss of the firm.
Following are the main examples of outstanding expenses and liabilities −
Audit fees are debited to profit and loss account of the same year for which audit is conducted. No doubt main audit work start after the close of financial year and finalization of financial statements are done in next financial year but it is a widely accepted practice to do so. It is also argued that audit fee should be debited to the profit and loss account in the next year in which the audit work is actually performed. In the first case, audit fees will be debited and the audit fees payable will be credited.
In case where the purchased goods are received in the current financial year and invoices for the same are received in next year, purchase should be debited and outstanding liabilities should be credited.
Rent on factory premises, office building, godown, etc. is payable on monthly basis. The Auditor should confirm that any unpaid amount of rent for the last month of the financial year or any other month of financial year in question should be added to rent of the current year and the rent payable should be shown as current liabilities.
Commission on Sale
Commission on sale is payable to agent, director or salesmen on the basis of sales. Auditor should check the following −
- Sale agreement
- Rate of commission
- Calculation of commission
- Agent account to know advance payment to agent, commission due and commission payable.
- Applicability of TDS on it and to check whether TDS is deducted at due rate before making payment or not. Whether TDS is deposited in time or not.
- After adjusting all the above, if there is any amount that is payable to the agent, it will be shown in current liabilities as commission payable and if any excess amount is paid that will be shown as current asset representing the amount recoverable from the agent.
The Auditor should carefully examine the interest on loan from bank, loan from outsider parties, unsecured loan, financial institutions, term loan and interest on debentures. He should see that the provision for interest payable should be duly provided in the books of accounts according to the applicable rate of interest.
Salary and wages
Salary and wages for the last month of the accounting year is normally paid in the next financial year. The Auditor should confirm that the salary and wages for last month should be debited to salary and wages account and credited to salary & wages payable account.
Cartage and Freight
Transporters normally provide bills for transportation charges after closing of financial year. It is a duty of an Auditor to take these expenses in the current financial year creating liabilities for the same.
Contingent liability may be payable in future or may not be payable in future it depends on the event. For example, if any person filed a suit against company, possibilities are there, it may be in favor of company or it may be against the company, in case it will decide against the company, company has to pay such amount of suit as the court decides. Therefore, contingent liabilities are said to be possible liabilities.
In case of above, no actual provision is made in the books of account but as a footnote of Balance sheet, it is compulsory to show the probable amount of liabilities.
Contingent assets are not shown as footnote of the balance sheet. Following are the examples of Contingent Assets −
- Claim for the refund of the Income Tax, Sales Tax, Excise Duty, etc.
- Uncalled share capital of the company.
- Claim for infringement of a copy right.