2012

Government Audit

BES 2012 Batch notes Prof.CA.Nitant Trilokekar 3/10/2012

Table of Contents
Government Audit ........................................................................................................... 4 Q. What is Government Audit ...................................................................................... 4 Q. What is C&AG ......................................................................................................... 5 Q. What is the jurisdiction of the C&AG ....................................................................... 8 Audit of Government Companies (Commercial Audit).............................................. 8 Audit Board Setup in Commercial Audit ................................................................... 8 Nature of Audit ......................................................................................................... 9 Regularity Audit (Compliance).................................................................................. 9 Performance Audit ................................................................................................... 9 Regularity Audit (Financial) ...................................................................................... 9 Action on Audit Reports ........................................................................................... 9 Public Accounts Committee ................................................................................... 10 Committee on Public Undertakings ........................................................................ 10 CAG's Role ............................................................................................................ 11 Local Bodies Audit ................................................................................................. 11 UNION AUDIT REPORTS ..................................................................................... 11 How is the independence of the C&AG ensured? ..................................................... 12 Appointment ........................................................................................................... 12 Removal from office ............................................................................................... 12 Q. Role of C&AG in PSU today (D type question) .................................................. 13 Internal Audit ................................................................................................................. 15 International standard setting bodies and/or auditors' associations ....................... 15 Role in internal control ........................................................................................... 16 Role in risk management ....................................................................................... 16 Role in corporate governance ................................................................................ 17 Nature of the internal audit activity ......................................................................... 18 Internal audit reports .............................................................................................. 18 Difference between internal and external audit ...................................................... 19 Management Audit ........................................................................................................ 21 Q: What is Management Audit? ............................................................................. 21 2

Management Audit Explanation ............................................................................. 21 Q: What is Corporate Governance ......................................................................... 22 Management Audit Checklist ................................................................................. 23 Q: How does one go about drafting a Management Audit checklist? (D type question) ................................................................................................................ 23 Q: Can you illustrate with a Financial Management Checklist? .............................. 24 Q: Give a Management Checklist?......................................................................... 26 Some corporate scams leading to demand for Corporate Governance ........................ 28 Enron Scam ............................................................................................................... 28 WorldCom Scam........................................................................................................ 29 Bankruptcy ............................................................................................................. 30 Post-bankruptcy ..................................................................................................... 30

Control in Special Sectors:- Scrap control-Control of R&D-Project ControlAdministrative Cost Control-Audit-Efficiency Audit- Internal Audit-Government Cost Audit-Management Audit. Financial reporting to management under conditions of price level change. Objectives and methodology.

Government Audit
Q. What is Government Audit
The Indian Audit and Accounts Department, functioning under the Comptroller and Auditor General, derives its authority and the powers for performance of its duties on his hebalf under the provisions of Section of 21 of the CAG's DPC Act, 1971. Under the directions given by the Comptroller and Auditor General of India, the Accountants General and other offices and establishments of the Indian Audit and Accounts Department perform such duties and functions as are imposed on or undertaken by the CAG under the provisions of the Constitution of India, or of any law made by Parliament. Major auditorial functions of Pr.Accountant General (Civil Audit) 1. Audit of expenditure conducted under Section 13 of the Act, includes

Audit against provision of funds

This audit is aimed at ascertaining whether the moneys shown in the Accounts as spent were legally available for and applicable to the service or purpose to which they had been applied or charged.

Regularity Audit

The objective of this audit is to see whether the expenditure conforms to the authority which governs it.

Propriety Audit

Propriety Audit is directed towards examining the propriety of executive action beyond the formality of expenditure to its wisdom, faithfulness and economy.

Efficiency-cum-performance or value for money Audit

It is a comprehensive appraisal of the progress and efficiency of the execution of development and other programmes and schemes wherein an assessment is made as to whether these are executed economically and whether they are producing the results expected of them.

Systems Audit

The concept of the Systems Audit is that if an an in-depth analysis of the mechanics of the system reveals that it is designed with appropriate controls, checks and balances to safeguard errors, frauds, etc. Audit can reasonably assume without the necessity of a detailed examination of the individual transactions, that the results produced by the system would be fairly accurate. 2. Audit of Grants and Loans to various Bodies and Authorities under Sections 14 and 15 of the Act This Audit is undertaken on the accounts of authorities and bodies receiving financial assistance in the form of grants and or loans from Government of India or a State or Union Territory, subject to certain conditions specified in those sections. 3. Audit under Section 20 This section deals with audit of bodies or authorities which have not been entrusted to the CAG by or under any law made by Parliament, he shall, if requested so to do by the President or the Governor of a State or the Administrator of a Union territory having a Legislative Assembly, as the case may be, undertake the audit of the accounts of such body or authority on such terms and conditions as may be agreed upon between him and the concerned Government.

Q. What is C&AG
Comptroller and Auditor General of India (C&AG) is an important authority created by the Constitution of India. It is mainly responsible for controlling the financial system of the country at the Union as well as the State levels. He has to see to it that the diverse authorities act in regard to all financial matters in accordance with the Constitution and the laws and rules framed there under. Public audit ensures parliamentary control over expenditures voted by the legislature and renders public authorities accountable for the public moneys raised and spent by them to implement policies and programmes approved by the legislature. Accountability and transparency, the two cardinal principles of good governance in a democratic set-up, depend for their observance, to a large extent, on how well the public audit function is discharged. It is for this reason that the C&AG has been given 5

special status by the Constitution in articles 148 to 152. It is his responsibility to ensure that money is spent and revenue rises not only in accordance with the law, but also with due regard to economy, efficiency and effectiveness. The C&AG is the constitutional authority entrusted with the high responsibility of maintaining probity in the use of public funds.

Article 148 of the Constitution of India provides for a Comptroller and Auditor-General of India who shall be appointed by the Indian President by warrant under his hand and seal. His term of office is six years or up to the age of 65 years. Independence of the office of C&AG To ensure the independence of this office from the executive government of the day, it has been provided that the Comptroller and Auditor General shall not be removed from his office except on grounds of proved misbehaviour or incapacity, on an address passed by each of the two Houses of Parliament by two thirds majority of those present and voting and a majority of the total membership of each House being presented to the President in the same manner as applicable to the judges of the Supreme Court of India under article 124(4). Also, the Comptroller and Auditor General has been made ineligible for any other office under the Government of India or any State Government. His salary etc. is left to be determined by Indian Parliament by law. The salary, etc. of Comptroller and Auditor General have been equated with the judges of the Supreme Court of India. The service conditions of those serving in the Audit and Accounts Department and the administrative powers of the Comptroller and Auditor General are to be laid down by the President by rules framed after consultation with the Comptroller and Auditor General. The administrative expenses of the office of the Comptroller and Auditor General are to be charged upon the Consolidated Fund of India. Functions of C&AG As the most important instrument of accountability, the Comptroller and Auditor General has a dual role to perform- as an agency on behalf of the Legislature to ensure that the executive complies with the various laws passed by the Legislature in letter and spirit, and secondly, on behalf of the Executive to ensure compliance by subordinate authorities with the rules and orders issued by it. He is empowered to make rules for carrying out the provisions relating to the maintenance of accounts; make regulations for carrying out the provisions relating to the scope and extent of audit, including lying down for the guidance of the Government departments the general principles of 6

Government accounting and the broad principles in regard to audit of receipts and expenditure; requisitioning of all records of the auditee departments/organisations; access the computer systems of the auditees and to download and use electronic data either in site or off site; review the development of computer systems of auditees and suggest/enforce controls; the appointment of external auditors engaged by the auditees for meeting any statutory requirements but only with reference to Government companies; to supervise and regulate external auditors` work under the Indian Companies Act; dispense with, when circumstances so warrant, any part of detailed audit of any accounts or class of transactions and to apply such limited check in relation to such accounts or transactions as he may determine.

While fulfilling his constitutional obligations, the Comptroller and Auditor General of India conducts the following types of audit: Financial Audit, Compliance Audit, Performance Audit and EDP Audit. Further, the Comptroller and Auditor General of India undertake Special Audit at the request of the Government.

Thus it can be seen how the Comptroller and Auditor General of India enhances the accountability of the Parliament and State Legislatures of India by carrying out audits n the public sector organisations.

Q. What is the jurisdiction of the C&AG

Audit Jurisdiction The organisations subject to the audit of the Comptroller and Auditor General of India are:

All the Union and State Government departments and offices including the Indian Railways and Posts and Telecommunications. About 1200 public commercial enterprises controlled by the Union and State governments, i.e. government companies and corporations. Around 400 non-commercial autonomous bodies and authorities owned or controlled by the Union or the States. Over 4400 authorities and bodies substantially financed from Union or State revenues

Audit of Government Companies (Commercial Audit) There is a special arrangement for the audit of companies where the equity participation by Government is 51 percent or more. The auditors of government companies are appointed or re-appointed by C&AG in terms of provisions of section 619(2) of the Companies Act., 1956 in view of Companies Amendment Act,2000, who gives the auditors directions on the manner in which the audit should be conducted by them. He is also empowered to comment upon the audit reports of the primary auditors. In addition, he conducts a supplementary audit of such companies and reports the results of his audit to Parliament and State Legislatures. Audit Board Setup in Commercial Audit A unique feature of the audit conducted by the Indian Audit and Accounts Department is the constitution of Audit Boards for conducting comprehensive audit appraisals of the working of Public Sector Enterprises engaged in diverse sectors of the economy. These Audit Boards associate with them experts in disciplines relevant to the appraisals. They discuss their findings and conclusions with the managements of the enterprises and their controlling ministries and departments of government to ascertain their view points before finalisation. The results of such comprehensive appraisals are incorporated by the Comptroller and Auditor General in his reports

Nature of Audit While fulfilling his Constitutional obligations, the Comptroller & Auditor General examines various aspects of Government expenditure. The audit done by C&A G is broadly classified into Regularity Audit and Performance Audit. Regularity Audit (Compliance)

Audit against provision of funds to ascertain whether the moneys shown as expenditure in the Accounts were authorised for the purpose for which they were spent. Audit against rules and regulation to see that the expenditure incurred was in conformity with the laws, rules and regulations framed to regulate the procedure for expending public money. Audit of sanctions to expenditure to see that every item of expenditure was done with the approval of the competent authority in the Government for expending the public money. Propriety Audit which extends beyond scrutinising the mere formality of expenditure to it wisdom and economy and to bring to light cases of improper expenditure or waste of public money. While conducting the audit of receipts of the Central and State Governments, the Comptroller & Auditor General satisfies himself that the rules and procedures ensure that assessment, collection and allocation of revenue are done in accordance with the law and there is no leakage of revenue which legally should come to Government.

Performance Audit Performance audit to see that Government programmes have achieved the desired objectives at lowest cost and given the intended benefits. For a complete list of Performance Appraisals since 1983 Regularity Audit (Financial) In regularity (financial) audit and in other types of audit when applicable, auditors should analyse the financial statements to establish whether acceptable accounting standards for financial reporting and disclosure are complied with. Analysis of financial statements should be performed to such a degree that a rational basis is obtained to express an opinion on financial statements. Action on Audit Reports The scrutiny of the Annual Accounts and the Audit Reports thereon by the Parliament as a whole would be an arduous task, considering their diverse and specialised nature, 9

besides imposing excessive demands on the limited time available to the Parliament for discussion of issues of national importance. Therefore the Parliament and the State Legislatures have, for this purpose, constituted specialized Committees like the Public Accounts Committee (PAC) and the Committee on Public Undertakings (COPU), to which these audit Reports and Annual Accounts automatically stand referred. Public Accounts Committee The Public Accounts Committee satisfies itself:a.that the moneys (shown in the accounts) were disbursed legally on the service or purpose to which they were applied. b.that the expenditure was authorised. c.that re-appropriation (i.e. distribution of funds. It is also the duty of the PAC to examine the statement of accounts of autonomous and semi-autonomous bodies, the audit of which is conducted by the Comptroller & Auditor General either under the directions of the President or by a Statute of Parliament. Committee on Public Undertakings The Committee on Public Undertakings exercises the same financial control on the public sector undertakings as the Public Accounts Committee exercises over the functioning of the Government Departments. The functions of the Committee are:a.to examine the reports and accounts of public undertakings. b.to examine the reports of the Comptroller & Auditor General on public undertakings. c.to examine the efficiency of public undertakings and to see whether they are being managed in accordance with sound business principles and prudent commercial practices. The examination of public enterprises by the Committee takes the form of comprehensive appraisal or evaluation of performance of the undertaking. It involves a thorough examination,including evaluation of the policies, programmes and financial working of the undertaking. The objective of the Financial Committees, in doing so, is not to focus only on the individual irregularity, but on the defects in the system which led to such irregularity, and the need for correction of such systems and procedures.

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CAG's Role The Comptroller & Auditor General of India plays a key role in the functioning of the financial committees of Parliament and the State Legislatures. He has come to be recognised as a 'friend, philosopher and guide' of the Committee. His Reports generally form the basis of the Committees' working, although they are not precluded from examining issues not brought out in his Reports. He scrutinises the notes which the Ministries submit to the Committees and helps the Committees to check the correctness submit to the Committees and helps the Committees to check the correctness of facts and figures in their draft reports. The Financial Committees present their Report to the Parliament/ State Legislature with their observations and recommendations. The various Ministries / Department of the Government are required to inform the Committees of the action taken by them on the recommendations of the Committees (which are generally accepted) and the Committees present Action Taken Reports to Parliament / Legislature. In respect of those cases in Audit Reports, which could not be discussed in detail by the Committees, written answers are obtained from the Department / Ministry concerned and are sometimes incorporated in the Reports presented to the Parliament / State Legislature. This ensures that the audit Reports are not taken lightly by the Government, even if the entire report is not deliberated upon by the Committee. Local Bodies Audit With the introduction of the third tier of government in the pursuance of the 73rd Ammendement of the UNION AUDIT REPORTS The Union Audit Reports of the Comptroller and Auditor General of India, contain the findings of transaction audit and performance audit in the areas of:

Civil Audit Audit of Autonomous Bodies Defense Services Railways Receipts of the Government Central Commercial

The Audit of the CAG is bifurcated into two streams namely Performance Audit and Regularity (Compliance) Audit. 11

While audit of the Civil Departments, Railways and Defense are conducted as per the direct mandate in the constitution and relevant provisions of the DPC Act, the Commercial Audit is conducted under the provisions of Company Act. Autonomous Bodies are audited as per the mandate in the act establishing the body. The reports of the CAG are deliberated upon by the Public Accounts Committee (PAC) of the parliament, save the commercial reports which are examined by the Committee on Public Undertakings (COPU).

How is the independence of the C&AG ensured?

The Comptroller and Auditor General (CAG) of India is an authority, established by the Constitution of India, who audits all receipts and expenditure of the Government of India and the state governments, including those of bodies and authorities substantially financed by the government. The CAG is also the external auditor of government-owned companies. The reports of the CAG are taken into consideration by the Public Accounts Committees, which are special committees in the Parliament of India and the state legislatures . The CAG of India is also the head of the Indian Audit and Accounts Department, which has over 58,000 employees across the country. The current CAG of India is Vinod Rai, who was appointed on 7 January 2008. He is the 11th CAG of India. Appointment The Constitution of India [Art.148] provides for an independent office to the CAG of India. He/she is the head of Indian Audit and Accounts Department. His/her duty is to uphold the constitution of India and laws of the Parliament in the field of financial administration. The Comptroller and Auditor-General of India is appointed by the President of India[1] following a recommendation by the Prime Minister. On appointment, he/she has to make an oath of affirmation before the President of India. Removal from office The CAG cannot be removed from office other than through a procedure of impeachment similar to what is applicable to a Judge of the Supreme Court of India. 12

Q. Role of C&AG in PSU today (D type question) Where autonomous bodies are created under a specific act, the statute setting them provides for the audit arrangement. There are a number of corporations, particularly in financial sector such as nationalised banks , IDBI, IFCI, LIC which have been kept outside the ambit of C&AG's audit . This is possibly on the ground that government audit is not suitable and hamstrungs their commercial operations. Audit of public enterprises by C&AG has always remained a controversial issue. In the 50's when PSU's were being set-up first time, there were attempts to bar C&AG's jurisdiction but the then C&AG resisted and the matter was resolved by amending the Companies Act and providing for supplementary audit of government companies by C&AG. Subsequently in the 70's, as a result of recommendation of Administrative Reforms Commission, an Audit Board system was introduced to provide commercial type audit for PSU's. In the wake of current privatisation programme, government is making policy pronouncements that government portion of equity will be brought down to a level of 49 or 26 percent. This is ostensibly being done to free them from government control including audit as they would no longer fall within the definition of government company. Will this not tantamount to evasion of public accountability as by retaining sizable shareholding government could still exercise policy control over these companies but will not be answerable to Parliament?

There is an opposite view that government control and agencies such as CBI, CVC, and CAG hampers decision making and risk taking necessary for a commercial organisation and largely responsible for their poor performance. Public enterprise managers and experts argue that in an era of globalisation and liberalisation where competition is the new mantra government companies have to be provided the same level field as their compeers in private sector if they have to survive the market forces. They should therefore be given autonomy and supplementary audit by CAG be done away with.

In U.K nationalised industries were kept outside C&AG's audit from the beginning. However, British practice was more of an exception. France and Italy which have large public enterprises including banks fall within the jurisdiction of state audit. In USA under the Corporation Control Act, financial transactions of wholly owned corporations are audited by General Accounting Office.

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2012 Internal Audit

BES 2012 Batch notes Prof.CA.Nitant Trilokekar 3/10/2012

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Internal Audit
Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. Internal auditing is a catalyst for improving an organizations effectiveness and efficiency by providing insight and recommendations based on analyses and assessments of data and business processes. With commitment to integrity and accountability, internal auditing provides value to governing bodies and senior management as an objective source of independent advice. Professionals called internal auditors are employed by organizations to perform the internal auditing activity. The scope of internal auditing within an organization is broad and may involve topics such as the efficacy of operations, the reliability of financial reporting, deterring and investigating fraud, safeguarding assets, and compliance with laws and regulations. Internal auditing frequently involves measuring compliance with the entity's policies and procedures. However, internal auditors are not responsible for the execution of company activities; they advise management and the Board of Directors (or similar oversight body) regarding how to better execute their responsibilities. As a result of their broad scope of involvement, internal auditors may have a variety of higher educational and professional backgrounds. Publicly-traded corporations typically have an internal auditing department, led by a Chief Audit Executive ("CAE") who generally reports to the Audit Committee of the Board of Directors, with administrative reporting to the Chief Executive Officer. The Internal Auditing profession evolved steadily with the progress of management science after World War II. It is conceptually similar in many ways to financial auditing by public accounting firms, quality assurance and banking compliance activities. Much of the theory underlying internal auditing is derived from management consulting and public accounting professions. With the implementation in the United States of the Sarbanes-Oxley Act of 2002, the profession's growth accelerated, as many internal auditors possess the skills required to help companies meet the requirements of the law. International standard setting bodies and/or auditors' associations The Institute of Internal Auditors ("IIA") has established Standards for the Professional Practice of Internal Auditing and has over 150,000 members 15

representing 165 countries, including approximately 65,000 Certified Internal Auditors. The IFAC's IAASB is the independent standard setting body which issue external auditing, review, other assurance related services and quality control standards to be applied by the global external auditing profession. Some standards target the internal auditing practices, cf. the International Standards on Auditing 40X and 610. The IRCA International Register of Certificated Auditors, formed in 1984, is a division of the Chartered Quality Institute. Based in the UK it claims 14,750 members in 150 countries. COSO
The Committee of Sponsoring Organizations of the Treadway Commission (COSO) is a voluntary private-sector organization, established in the United States, dedicated to providing thought leadership to executive management and governance entities on critical aspects of organizational governance, business ethics, internal control, enterprise risk management, fraud, and financial reporting. COSO has established a common internal control model against which companies and organizations may assess their control systems.

Role in internal control Internal auditing activity is primarily directed at improving internal control. Under the COSO Framework, internal control is broadly defined as a process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following internal control categories: Effectiveness and efficiency of operations. Reliability of financial reporting. Compliance with laws and regulations.

Management is responsible for internal control. Managers establish policies and processes to help the organization achieve specific objectives in each of these categories. Internal auditors perform audits to evaluate whether the policies and processes are designed and operating effectively and provide recommendations for improvement.

In the United States, internal auditors may assist management with compliance with the Sarbanes-Oxley Act (SOX). Role in risk management Internal auditing professional standards require the function to monitor and evaluate the effectiveness of the organization's Risk management processes. Risk management relates to how an organization sets objectives, then identifies, analyzes, and responds to those risks that could potentially impact its ability to realize its objectives. Under the COSO enterprise risk management (ERM) Framework, risks fall under strategic, operational, financial reporting, and legal/regulatory categories. Management 16

performs risk assessment activities as part of the ordinary course of business in each of these categories. Examples include: strategic planning, marketing planning, capital planning, budgeting, hedging, incentive payout structure, and credit/lending practices. Sarbanes-Oxley regulations also require extensive risk assessment of financial reporting processes. Corporate legal counsel often prepares comprehensive assessments of the current and potential litigation a company faces. Internal auditors may evaluate each of these activities, or focus on the processes used by management to report and monitor the risks identified. For example, internal auditors can advise management regarding the reporting of forward-looking operating measures to the Board, to help identify emerging risks. In larger organizations, major strategic initiatives are implemented to achieve objectives and drive changes. As a member of senior management, the Chief Audit Executive (CAE) may participate in status updates on these major initiatives. This places the CAE in the position to report on many of the major risks the organization faces to the Audit Committee, or ensure management's reporting is effective for that purpose. Internal auditors may help companies establish and maintain Enterprise Risk Management processes. Internal auditors also play an important role in helping companies execute a SOX 404 top-down risk assessment. In these latter two areas, internal auditors typically are part of the risk assessment team in an advisory role. Role in corporate governance Internal auditing activity as it relates to corporate governance is generally informal, accomplished primarily through participation in meetings and discussions with members of the Board of Directors. Corporate governance is a combination of processes and organizational structures implemented by the Board of Directors to inform, direct, manage, and monitor the organization's resources, strategies and policies towards the achievement of the organizations objectives. The internal auditor is often considered one of the "four pillars" of corporate governance, the other pillars being the Board of Directors, management, and the external auditor. A primary focus area of internal auditing as it relates to corporate governance is helping the Audit Committee of the Board of Directors (or equivalent) perform its responsibilities effectively. This may include reporting critical internal control problems, informing the Committee privately on the capabilities of key managers, suggesting questions or topics for the Audit Committee's meeting agendas, and coordinating carefully with the external auditor and management to ensure the Committee receives effective information.

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Nature of the internal audit activity Based on a risk assessment of the organization, internal auditors, management and oversight Boards determine where to focus internal auditing efforts (the focus prioritization is part of the annual/multi-year audit planning; usually, the audit plan is proposed by the Chief Internal Audit (sometimes with several options or alternatives) to the approval of the Audit Committee or Board of Directors). Internal auditing activity is generally conducted as one or more discrete assignments. A typical internal audit assignment involves the following steps: 1. Establish and communicate the scope and objectives for the audit to appropriate management. 2. Develop an understanding of the business area under review. This includes objectives, measurements, and key transaction types. This involves review of documents and interviews. Flowcharts and narratives may be created if necessary. 3. Describe the key risks facing the business activities within the scope of the audit. 4. Identify control procedures used to ensure each key risk and transaction type is properly controlled and monitored. 5. Develop and execute a risk-based sampling and testing approach to determine whether the most important controls are operating as intended. 6. Report problems identified and negotiate action plans with management to address the problems. 7. Follow-up on reported findings at appropriate intervals. Internal audit departments maintain a follow-up database for this purpose. Audit assignment length varies based on the complexity of the activity being audited and Internal Audit resources available. Many of the above steps are iterative and may not all occur in the sequence indicated. By analyzing and recommending business improvements in critical areas, auditors help the organization meet its objectives. In addition to assessing business processes, specialists called Information Technology (IT) Auditors review information technology controls. Internal audit reports Internal auditors typically issue reports at the end of each audit that summarize their findings, recommendations, and any responses or action plans from management. An audit report may have an executive summary; a body that includes the specific issues or findings identified and related recommendations or action plans; and appendix information such as detailed graphs and charts or process information. Each audit 18

finding within the body of the report may contain five elements, sometimes called the "5 C's": 1. Condition: What is the particular problem identified? 2. Criteria: What is the standard that was not met? The standard may be a company policy or other benchmark. 3. Cause: Why did the problem occur? 4. Consequence: What is the risk/negative outcome (or opportunity foregone) because of the finding? 5. Corrective action: What should management do about the finding? What have they agreed to do and by when? The recommendations in an internal audit report are designed to help the organization achieve its goals, which may relate to operations, financial reporting or legal/regulatory compliance. They may relate to effectiveness (i.e., whether goals were met or compliance with standards was achieved) or efficiency (i.e., whether the outputs were generated with minimum inputs). Audit findings and recommendations also relate to particular assertions about transactions, such as whether the transactions audited were valid or authorized, completely processed, accurately valued, processed in the correct time period, and properly disclosed in financial or operational reporting, among other elements. Difference between internal and external audit Internal auditors are often confused with external auditors, but there are significant differences between the two groups. Internal auditors look at all the risks facing an organisation and what is being done to manage these risks. External auditors on the other hand look at financial accounts. So internal audits role is broader and might, for example, include auditing the reputational risk that a company could be damaged by using cheap labour in foreign countries. It could also include auditing operational risks such as poor health and safety procedures, or strategic risks such as the board stretching company resources by producing too many products.

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2012 Management Audit

BES 2012 Batch notes Prof.CA.Nitant Trilokekar 3/10/2012

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Management Audit
Q: What is Management Audit? A detailed audit that concentrates on analysis and evaluation of management procedures and the overall performance of an organization. A management audit is undertaken to discover weaknesses and to institute improvements within the organization. Also called operational audit, performance audit. A systematic assessment of methods and policies of an organization's management in the administration and the use of resources, tactical and strategic planning, and employee and organizational improvement. The objectives of a management audit are to (1) establish the current level of effectiveness, (2) suggest improvements, and (3) lay down standards for future performance. Management auditors (employees of the company or independent consultants) do not appraise individual performance, but may critically evaluate the senior executives as a management team. See also performance audit.

A management audit can be defined as an audit which analyzes the effectiveness of the management team of a company. The purpose of this is seven-fold: understand current practices, relate these to company financials, suggest new procedures which will improve the efficiency of managers, present a financial gain related to these new procedures, and create benchmarks and projections for the future. A management audit letter is the final piece of material shared with the client; it is a report of the findings. Management Audit Explanation The management audit process can be explained by the auditing of both the management method as a whole as well as key management staff. This is important to establish the effectiveness of both the leaders of the department as well as how it performs as a team. In this way, it can fill the purpose of a staff audit or performance audit, depending on the scope of the company.

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Q: What is Corporate Governance? Corporate governance is "the system by which companies are directed and controlled" (Cadbury Committee, 1992). It involves a set of relationships between a companys management, its board, its shareholders and other stakeholders; it deals with prevention or mitigation of the conflict of interests of stakeholders. Ways of mitigating or preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which have impact on the way a company is controlled. An important theme of corporate governance is the nature and extent of accountability of people in the business, and mechanisms that try to decrease the principalagent problem. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. In contemporary business corporations, the main external stakeholder groups are shareholders, debtholders, trade creditors, suppliers, customers and communities affected by the corporation's activities. Internal stakeholders are the board of directors, executives, and other employees. It guarantees that an enterprise is directed and controlled in a responsible, professional, and transparent manner with the purpose of safeguarding its long-term success. It is intended to increase the confidence of shareholders and capital-market investors. There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large corporations, most of which involved accounting fraud. Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these include Enron Corporation and MCI Inc. (formerly WorldCom). Their demise is associated with the U.S. federal government passing the Sarbanes-Oxley Act in 2002, intending to restore public confidence in corporate governance. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms. Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy).

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Management Audit Checklist Q: How does one go about drafting a Management Audit checklist? (D type question) A management audit checklist is a set of guidelines and methodologies that a company's internal audit department provides to staff members who review corporate processes and procedures. This checklist usually adheres to industry practices, top leadership's recommendations, regulatory criteria and generally accepted auditing standards, or GAAS. An audit checklist also helps internal auditors perform tasks adequately. Learn about Control Environment An internal auditor reviews a company's control environment to learn about factors influencing operating activities. There are two types of factorsexternal and internal. Internal elements may relate to senior leadership's ethical qualities and management style, human resources policies, training guidelines and the company's mission and vision. External factors relate to competitors, economic trends and regulatory initiatives. For instance, an insurance company's internal factors may relate to hiring practices and performance evaluation processes. Its external factors may include rules that the Securities and Exchange Commission (SEC), the Public Company Accounting Oversight Board (PCAOB) and the Financial Industry Regulatory Authority (FINRA) promulgate. Test Internal Controls An auditor tests internal controls to ensure conformity to GAAS as well as SEC and PCAOB rules. A control is a set of guidelines that senior management establishes to prevent operating losses arising from technology systems breakdowns, fraudulent activity, neglect and error. An auditor also tests financial reporting controls to ensure they are adequate, functional and adhere to generally accepted accounting principles, or GAAP. An adequate control provides clear instructions on how to perform duties and report problems to senior leadership. A functional or effective control provides appropriate solutions to internal problems. Rank Controls and Risks An internal auditor ranks risks and controls after testing them. He usually rates such risks as "high," "medium" and "low," based on the loss expectation. Often, a company may hire a specialist, such as a certified public accountant or a certified internal auditor, to aid in assessing and ranking internal risks. An auditor also reviews "risk and control self-assessment" (RCSA) reports that segment managers periodically prepare. An RCSA is a document in which staff members list all risks and controls in a business unit, a department or a segment.

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Issue Final Report An internal auditor usually discusses "high" and "medium" risks with senior management because such risks may cause a firm significant operating losses and material misstatements in financial reports. In accounting parlance, a material misstatement means a significant error that can change an investor's decision if known publicly. Materially misstated financial statements do not conform to GAAP and international financial reporting standards. Top leaders usually ask department heads to provide corrective measures for "high" and "medium" risks. Segment employees usually find mitigating or corrective solutions for "low" risks. Q: Can you illustrate with a Financial Management Checklist? The list below is a set of questions to test the financial strength (Value) of you and your organisation. The checklist is aimed at managers and directors not at their accountants. The questions do not relate only to financial issues but also to issues that have a bearing on the Intangible Assets and hence the future strength of the organisation. The list may also be regarded as an action list for the future. The questions may be marked between 1 10. 1 means no / little: 10 means strongly or excellent. A high mark is the target but questions should be realistically answered. A high mark may also include danger areas for improvement Financial Do you have free assets in your balance sheet which can be used for future lending ? Do you make a profit / surplus ? Do you generate cash consistently without increased lending or share capital? Do you require additional loans each year to survive (negative 1-10) ? Has your business attracted money from outside shareholders / would they invest more ? Have the bank said that they will lend more to you (even if you have said that you do not need it)? Do you have a good relationship with the bank ? If your present bank or shareholders said no to providing more money, are other banks or shareholders prepared to help? Have you produced a business plan which has successfully attracted additional loans or shares? Do you create a budget or internal business plan for control purposes ? If yes are these reports in publishing language or in statutory accounts format ? Do you meet your forecasts in terms of: 24

sales targets ? cash targets ? publication dates ? costs ? Do you understand all the financial reporting supplied to you ? Are you actively involved in designing financial reports and systems with your accountant ? Do you monitor cashflow based on commitments or just on invoices received ?

Financial Understanding Do you and your team appreciate the needs for all team members to have a basic commercial understanding ? How many members of your management team have a sound commercial understanding What is the average payback on new titles What is the average return on a typical title ? What is your Working Capital as a percentage of turnover ? How long in months does it take for a typical print run to sell out (in schools, shops, etc.): 1-6 months; 7-12 months; 13 18 months; 19 months +?

Marketing Are you actively involved in the marketing of your products? Do you know who your ultimate customers are? Do you know them personally? Do you use several distributors or only one? Are your distributors efficient in selling throughout the country / reaching most of the population? Do you carry out regular market research (even though this may be very difficult)? Does your organisation have a strong brand image: o with ministries ? o with distributors ? o with the ultimate consumers ? Do you encourage and receive feedback from your ultimate customers Do your products make a profit for distributors ? retailers ? What percentage of time is spent on promoting and selling products o by you ? o by your organisation ? 25

Team Do you or your board colleagues (and staff) have a record of successful commercial success prior to working for the present organisation? Are you and your team well connected in Commercial circle Cultural circles (1-5 only) Does your Board include a financial specialist? Does your board include a banking or commercial figure (as an advisor / director) Do all the board understand the need to make a profit / surplus and to generate cash? Does all your board members understanding the financial side of business and how to create a financially successful organisation? Do you have all the data that you need internally to run the organisation effectively ? Can you access the necessary information quickly ?

Q: Give a Management Checklist?

The firm may also conduct an audit of the firms inventory planning and monitoring systems. Some of the possible areas to look out for are the following:

Description ON INVENTORY LEVELS 1. Is too much money tied up in your inventory? 2. Do frequent shortages in inventory occur? 3. Does an excessive inventory discrepancy occur? 4. Is there are a lot of obsolete and/or non-moving items on stock? ON INVENTORY INFORMATION / POLICIES 1. Does the company have realistic safety stock levels? 2. Does the company have realistic reorder point levels? 3. Does the company have realistic inventory lead times? 4. Are inventory control policies and procedures adequately documented and communicated to all concerned

Yes

No

Remarks

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departments? INVENTORY MONITORING 1. Are inventory records kept up- to-date for all materials? 2. Are inventory records regularly verified by actual count? 3. Are incoming and outgoing materials / goods properly checked, authorized and logged in/out? 4. Are surplus and scrap items properly recorded and controlled?

(This coverage is too short. Discuss this in class)

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Some corporate scams leading to demand for Corporate Governance

Enron Scam
The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was attributed as the biggest audit failure. Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, through the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron's board of directors and audit committee on high-risk accounting practices, but also pressured Andersen to ignore the issues. Shareholders lost nearly $11 billion when Enron's stock price, which hit a high of US$90 per share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a fire sale price. The deal fell through, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron's $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until WorldCom's bankruptcy the following year. Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron's auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the majority of its customers and had shut down. Employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices. As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, expanded repercussions for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain unbiased and independent of their clients.

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WorldCom Scam
CEO Bernard Ebbers became very wealthy from the rising price of his holdings in WorldCom common stock. However, in the year 2000, the telecommunications industry entered a downturn and WorldComs aggressive growth strategy suffered a serious setback when it was forced by the US Justice Department to abandon its proposed merger with Sprint in mid 2000. By that time, WorldComs stock price was declining and Ebbers came under increasing pressure from banks to cover margin calls on his WorldCom stock that was used to finance his other businesses (timber and yachting, among others).During 2001, Ebbers persuaded WorldComs board of directors to provide him corporate loans and guarantees in excess of $400 million to cover his margin calls. The board hoped that the loans would avert the need for Ebbers to sell substantial amounts of his WorldCom stock, as his doing so would put further downward pressure in the stock's price. However, this strategy ultimately failed and Ebbers was ousted as CEO in April 2002 and replaced by John Sidgmore, former CEO of UUNET Technologies, Inc. Beginning modestly in mid-year 1999 and continuing at an accelerated pace through May 2002, the company (under the direction of Ebbers, Scott Sullivan (CFO), David Myers (Comptroller) and Buford "Buddy" Yates (Director of General Accounting)) used fraudulent accounting methods to mask its declining earnings by painting a false picture of financial growth and profitability to prop up the price of WorldComs stock. The fraud was accomplished primarily in two ways: Booking line costs (interconnection expenses with other telecommunication companies) as capital on the balance sheet instead of expenses. Inflating revenues with bogus accounting entries from "corporate unallocated revenue accounts".

In 2002, a small team of internal auditors at WorldCom worked together, often at night and in secret, to investigate and unearth $3.8 billion in fraud. Shortly thereafter, the companys audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, Myers resigned, Arthur Andersen withdrew its audit opinion for 2001, and the U.S. Securities and Exchange Commission (SEC) launched an investigation into these matters on June 26, 2002 (see accounting scandals). By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion.

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Bankruptcy On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection in the largest such filing in United States history at the time (since overtaken by the collapses of both Lehman Brothers and Washington Mutual in a span of eleven days in September 2008). The WorldCom bankruptcy proceedings were held before U.S. Federal Bankruptcy Judge Arthur J. Gonzalez who simultaneously heard the Enron bankruptcy proceedings which were the second largest bankruptcy case resulting from one of the largest corporate fraud scandals. None of the criminal proceedings against WorldCom and its officers and agents was originated by referral from Gonzalez or the Department of Justice lawyers. On April 14, 2003, WorldCom changed its name to MCI and moved its corporate headquarters from Clinton, Mississippi, to Dulles, Virginia. Under the bankruptcy reorganization agreement, the company paid $750 million to the SEC in cash and stock in the new MCI, which was intended to be paid to wronged investors. In May 2003, the company was given a no-bid contract by the United States Department of Defense to build a cellular telephone network in Iraq. The deal has been criticized by competitors and others who cite the company's lack of experience in the area. The SEC and Worldcom reached a deal in which Worldcom agreed to pay a civil penalty of $2.25 billion. The deal was approved by federal judge Jed Rakoff in July 2003. In a sweeping consent decree, the SEC and Rakoff essentially took control of Worldcom. Rakoff appointed former former SEC chairman Richard C. Breeden to oversee Worldcom's compliance with the SEC agreement. Breeden actively involved himself in the management of the company, and prepared a report for Rakoff, titled Restoring Trust, in which he proposed extensive corporate governance reforms, as part of an effort to "cast the new MCI into what he hoped would become a model of how shareholders should be protected and how companies should be run." Post-bankruptcy The company emerged from Chapter 11 bankruptcy in 2004 with about $5.7 billion in debt and $6 billion in cash. About half of the cash was intended to pay various claims and settlements. Previous bondholders ended up being paid 35.7 cents on the dollar, in bonds and stock in the new MCI company. The previous stockholders' stock was cancelled, making it totally worthless. It had yet to pay many of its creditors, who had waited for two years for a portion of the money owed. Many of the small creditors included former employees, primarily those 30

who were laid off in June 2002 and whose severance and benefits were withheld when WorldCom filed for bankruptcy. On August 7, 2002, the exWorldCom 5100 group was launched. It was composed of former WorldCom employees with a common goal of seeking full payment of severance pay and benefits based on the WorldCom Severance Plan. The "5100" stands for the number of WorldCom employees laid off on June 28, 2002 before WorldCom filed for bankruptcy. On February 14, 2005, Verizon Communications agreed to acquire MCI for $7.6 billion. On March 15, 2005 Bernard Ebbers was found guilty of all charges and convicted of fraud, conspiracy and filing false documents with regulatorsall related to the $11 billion accounting scandal at the telecommunications company he founded. He was sentenced to 25 years in prison. Other former WorldCom officials charged with criminal penalties in relation to the company's financial misstatements include former CFO Scott Sullivan (entered a guilty plea on March 2, 2004 to one count each of securities fraud, conspiracy to commit securities fraud, and filing false statements),former comptroller David Myers (pleaded guilty to securities fraud, conspiracy to commit securities fraud, and filing false statements on September 27, 2002), former (pleaded guilty to conspiracy and fraud charges on October 7, 2002), and former and Troy Normand (both pleading guilty to conspiracy and securities fraud on October 10, 2002). On July 13, 2005 Bernard Ebbers received a sentence that would keep him imprisoned for 25 years. At time of sentencing, Ebbers was 63 years old. On September 26, 2006, Ebbers turned himself in to the Federal Bureau of Prisons prison at Oakdale, Louisiana, the Oakdale Federal Corrections Institution to begin serving his sentence. In March 2005, 16 of WorldCom's 17 former underwriters reached settlements with the investors. Citigroup settled for $2.65 billion on May 10, 2004. In December 2005, the Microsoft corporation announced that MCI will join it by providing Windows Live Messenger customers "Voice Over Internet Protocol" (VOIP) service to make telephone calls. This was MCI's last new productcalled "MCI Web Calling". After the merger, this product was renamed "Verizon Web Calling".

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32

2012 Cost Audit

BES 2012 Batch notes Prof.CA.Nitant Trilokekar 3/10/2012

33

Cost Audit
Definition
An internal audit used for enterprise governance to assess operational efficiencies and resource management. Special attention is given to verification of cost records and adherence to acceptable cost accounting procedures.

Cost Audit is the process of ascertaining whether the production, marketing and sales processes as well as other aspects of a business are managed in the most cost effective way. This is essentially an Internal Audit and is done as a tool for optimising management efficiency. The most important benefit is the location of unseen leaks in revenues or unproductive or under- productive employment of resources It is mandatory if the Business is under scrutiny by a financial institution or regulator on the basis of complaints of mismanagement. It is always desirable to have a Cost audit done periodically, to prevent the situation getting out of control, and to help the management to take prompt action where necessary. Meaning of cost audit (a) It means verification of cost records. (b) Examination of these records to ensure that they adhere to cost accounting principles, plans, objectives and procedures. Appointment As per section 233 B , a cost auditor shall be appointed by the BOD of the company and with the previous approval of CG. Further it has been provided that before appointment of any cost auditor is made by the board a written certificate shall be obtained by the board from that auditor that the appointment if made will be in accordance with the provisions of sub section ( 1B ) of section 224. Qualification of Cost Auditor (a) Holding appointment as statutory auditor under section 224 of the act. (b) He should not be an employee of the company. (c) Should not hold securities of the company.

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Types of cost audit (a) On behalf of management 1. Establishing accuracy of cost data. 2. Determining proper overheads rates. 3. Fixation of contract price. 4. Determing unit cost of production. 5. Improving quality of cost accounting system. (b) On behalf of customer For cost plus contract. (c) On behalf of government For subsidies, etc. It may be conducted to determine fair price. Exemption from cost audit 1. Situation for Exemption (a) Temporary closure of company / product. (b) Negligible ( Too small ) production activity. 2. Fees Companies having Authorizes capital Amount of fees Less than 25 laks 25 Lakhs but less than 5 crore 5 crore or above Rs 500 Rs 1000 Rs 2000

Mandatory cost audit

The Ministry of Corporate Affairs has issued two circulars in May 2011 making cost audit mandatory for some selected industries. All listed companies and companies with net worth exceeding Rs five crores or turnover exceeding Rs 20 crores, operating in any 35

of the following industries, will be covered under mandatory cost audit effective from April 1, 2011: Bulk drugs, Formulations, Fertilisers, Sugar, Industrial alcohol, Electricity, Petroleum and Telecommunication. Similarly, all listed companies and companies with turnover exceeding Rs 100 crores, operating in any of the following industries will be covered under mandatory cost audit effective from April 1, 2011: Cement, Tyres and Tubes, Steel Plant, Steel Tubes and Pipes, Paper and Insecticides. This is a clear departure from the earlier government policy of directing cost audit of certain selected companies covered under Cost Accounting Record Rules issued from time to time by the government.

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2012
Statutory/Financial Audit

BES 2012 Batch notes Prof.CA.Nitant Trilokekar 3/10/2012

37

Statutory/Financial Audit
In simple terms statutory audit in India is equated with Audit under the Companies Act. Every company incorporated under the companies act is required to get its accounts audited by a Chartered Accountant in Practice to ensure true and fair view of the accounts. Further, the auditor has to ensure compliance with various provisions of the Companies Act. Statutory Audit ensures reliability of annual accounts of the company for various consumers of Accounts of the Company like government, shareholders, debtors, creditors, bankers etc. Statutory Auditor is the term referred to the external certified public accountant, i.e. external auditors, in most countries. He is an external service supplier; in charge of certifying the Financial Statements according to specific professional auditing standards. In India, membership of the Institute of Chartered Accountants is a must along with the Certificate of practice.

CA Jayadeep Shah President 2012

The principal objectives of the Statutory Audit is to ensure that the financial statements i.e. the Balance Sheet, Profit & Loss Account and Cash Flow Statement give a true & fair view and are free from any material misstatements. Difference between Internal Audit and Statutory Audit
1. Appointment: The management of the organization makes the appointment of an internal auditor. The statutory auditor is appointed by different authorities. First statutory auditors are appointed by the shareholders in the annual general meeting. 2. Qualification: Qualifications of the statutory auditor are prescribed in the companies act, 1956. Essentially a person should be a practicing chartered accountant to be appointed as a statutory auditor. There are no fixed qualification for the position of an internal auditor. 3. 3. Objects: The main object of the statutory audit is to form an opinion on the financial statement of the organization auditor has to state that whether the financial statements are showing the true and fair view of the affairs of the organization or not. The main object of the internal audit is to detect and prevent the errors and frauds. 4. Scope: The scope of the statutory audit is fixed by the companys act 1956. it can not be changed by mutual consent between the auditor and 38

the management of the audited business unit. The scope of the internal audit is fixed by the mutual consent of the auditor and the management of the unit under audit. 5. Remuneration: Remuneration of the statutory auditor is fixed by the appointing authority, I e in case of first auditors, the auditors the directors fix the Remuneration in case of the subsequent auditors the company in its general meeting fixes the remuneration. In case of internal auditor the management who appoints him fixes his Remuneration. 6. Report: The statutory auditor submits his report to the shareholder of the company in its general meeting. The internal auditor submits his report to the management of the company who is also his appointing authority. 7. Removal: The procedure of removal of the statutory auditor is very complex. Only the company in the general meeting can remove the auditor. It also has to take the permission of the central government. The management of the entity can remove internal auditor.

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Sample Statutory Audit Report

AUDITORS REPORT

To, The Members of XYZ (India) LTD.

1.

We have audited the attached Balance Sheet of XXXX YYYY Pvt Ltd.. As at 31st March 2012 and also the Profit and Loss Account for the year ended on that date annexed thereto. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit. We have conducted our audit in accordance with auditing standards generally accepted in India. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As required by the Companies (Auditors Report) Order,2003 and amendments thereto issued by the Central Government of India in terms of Sec 227(4A) of The Companies Act 1956, we annex hereto a statement on the matters specified in the paragraphs 4 and 5 of the said order, to the extent applicable to the Company.

2.

3.

4.

We further report that : (i) We have obtained all the information and explanations which to the best of our knowledge and belief were necessary for the purposes of our audit;

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(ii)

In our opinion, proper books of account as required by law have been kept by the company so far as appears from our examination of those books; The Balance Sheet and Profit and Loss Account dealt with by this report are in agreement with the books of account; In our opinion, the Balance Sheet and Profit and Loss account dealt with by this report comply with the accounting standards referred to in sub-section (3C) of section 211 of the Companies Act, 1956; On the basis of written representations received from the directors, as on 31st March 2008, and taken on record by the Board of Directors, we report that none of the directors is disqualified as on 31st March 2012 from being appointed as a director in terms of clause (g) of sub-section(1) of section 274 of the Companies Act, 1956; In our opinion and to the best of our information and according to the explanations given to us, the said accounts give the information required by the Companies Act, 1956, in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India: (i) in the case of the Balance Sheet of the state of affairs of the Company as at 31st March 2012; and in the case of Profit and Loss Account, of the Profit for the year ended on that date. For Nitant P. Trilokekar & Co. Chartered Accountants Firm No. 126874W

(iii)

(iv)

(v)

(vi)

(ii)

CA. Nitant Trilokekar Mem No.: 37415 Place: Mumbai Date: .

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Annexure to Auditors Report

Annexure referred to in paragraph 2 of the auditors report to the members of XXXX YYYY Pvt Ltd. for the year ended 31st March, 2012 As required by the companies (Auditor Report) Order , 2003 and amendments thereto and according to the information and explanations given to us during the course of the audit and on the basis of such checks of the books and records as were considered appropriate we report that: (i) a) The company has maintained proper record showing full particulars including quantitative details and situations of fixed assets. b) All the assets have been physically verified by the management in accordance with a phased programme of verification, which in our opinion is reasonable, considering the size and the nature of business. The frequency of verification is reasonable and no material discrepancies have been noticed on such physical verification. c) The assets disposed during the year are not significant and therefore do not affect the on going concern assumptions. (ii) a) The inventories have been physically verified by the management during the year at reasonable intervals. b) The procedure of physical verification of the inventories followed by the management is reasonable and adequate in relation to the size of the company and the nature of its business. c) The Company has maintained proper records of inventories and discrepancies noticed on physical verification of inventories as compared to books records were not material. (iii) a) The company has not granted unsecured loan to party covered in the register maintained under section 301 of the Companies Act, 1956.

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b) In view of our comments in Para (iii) (a) above, clauses 4 (iii) (b) (c) and (d) of the said order are not applicable to the company. c) The company has taken unsecured loan from two parties covered in the register maintained under section 301 of the Companies Act, 1956 on all basis. The Maximum amount outstanding during the year was Rs. 420800/- and Rs. 120000 the year ended balance was Rs. 560800/-. d) The other terms and conditions on which the loans have been taken are prima facie, not prejudicial to the interest of the company; e) In view of our comments in para (iii) (c) and (d) above, clause (iii) (g) of the said order is not applicable to the company (iv) There are adequate internal control systems commensurate with the size of the company and the nature of its business with regard to purchase of inventories, fixed assets and for the sale of goods and services. During the course of our audit no major weakness has been observed in the internal control system. (v) a) The transactions made in pursuance of contract or arrangements that need to be entered into the register maintained under section 301 of the Companies Act, 1956 has been recorded in the register. b) The transactions made in pursuance of contract or arrangements that need to be entered into the register maintained under section 301 of the Companies Act, 1956 has been recorded in the register. (vi) The company has not accepted any deposits from the public within the meaning of the sections 58A, 58AA or any other relevant provision of the Act and the rules framed there under any directives report issued by the Reserve Bank of India. No order in relation thereto has been passed by the Company Law Board or National Company Law Tribunal or Reserve Bank of India or any Court or any other Tribunal. (vii) The Company has formal internal audit system commensurate with its size and nature of its business. (viii) The Central Government has not prescribed for maintenance of cost records under section 209 (1) (d) of the Companies Act, 1956 for the company. 43

(ix) a) According to the records of the company, the undisputed statutory dues including Provident Fund, Employees State Insurance, Income Tax, Sales Tax, Wealth Tax, Service Tax, Custom Duty and Excise Duty, Cess have regularly deposited with the appropriate authorities. There are no undisputed amount payable in respect of such statutory which have remained outstanding as at 31st March, 2012 for a period more then six months from the date they became payable. b) There are no amount in respect of any disputed income tax, sales tax, wealth tax, service tax, custom duty, excise duty and cess. (x) The company has accumulated losses of Rs.10.55 lacs at the end of the financial year 2006-07 and it has incurred losses in current financial year of Rs.0.45 lacs. (xi) The Company has no defaulted in repayment of its dues to banks and financial institutions. (xii) The company has not granted any loans or advances on the basis of security by way of pledge of shares, debentures or other securities. (xiii) The provisions of any Special Statute applicable to Chit Fund, Nidhi Fund or Mutual Benefit Fund/Societies are not applicable to the company. (xiv) In our opinion and according to the information and explanations given to us, the company is not a dealer or trader in shares, securities, debentures and other investments. (xv) The company has not given any guarantee for loan taken by others from banks and financial institutions. (xvi) In our opinion, the term loan have been applied for the purpose for which they were raised. (xvii) On an overall examination the Balance Sheet of the company, we report that no fund raised on short term basis have been used for long term investment. (xviii) The company has not issued any equity shares and debentures during the year. 44

(xix)

The company has not raised any money by way of public issue during the year.

(xxi) During the course of our examination of the books and records of the company, carried out in accordance with the generally accepted auditing practices in India, we have neither come across any instance of material fraud on or by the Company, noticed or reported during the year.

For Nitant P. Trilokekar & Co. Chartered Accountants Firm No. 126874W

CA. Nitant Trilokekar Mem No.: 37415 Place: Mumbai Date: .

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