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AUDITING
UNIT 4
VERIFICATION AND VALUATION OF ASSETS AND LIABILITIES
Verification Meaning Verification means the act of assuring the correctness of value of assets and liabilities in the organization. It refers to the examination of proof of title and their existence or confirmation of assets and liabilities on the date of Balance Sheet. It usually indicates verification of assets of any organization, which can be done by examination of values, ownership, existence, possession of any assets and also ensures that the assets are free from any charge. In simple words, verification means, ‘proving the truth or confirmation’. Definition Spicer and Pegler define Verification as, “An inquiry into the value, ownership and title, existence and possession and the presence of any charge on the asset”. J. R. Batliboi defines it as, “The auditor must satisfy himself that assets really existed at the date of the Balance Sheet and were free from any charge and that they have been properly valued”. The Institute of Chartered Accountants of India defines verification as, “It aims at establishing (a) existence, (b) ownership, (c) possession, (d) freedom from encumbrances, (e) proper recording, (f) proper valuation”. Objectives The objectives of verification are as follows:
- To show the correct value of assets and liabilities.
- To know whether the Balance Sheet exhibits a true and fair view of the state of affairs of the business.
- To find out the ownership, possession and title of the assets appearing in the Balance Sheet.
- To find out whether assets are in existence.
- To detect frauds and errors, if any while recording assets in the books of the concern.
- To find out whether there is an adequate internal control regarding acquisition, utilization and disposal of assets.
- To verify the arithmetic accuracy of the accounts.
- To ensure that the assets have been properly recorded. Auditor’s Duty Regarding Verification The auditor of a business is required to report in concrete terms that the Balance Sheet exhibits a true and fair view of the state of its affairs. In other words, he has to examine and ascertain the correctness of the money value of assets and liabilities appearing in the Balance Sheet and this examination is known as verification of assets and liabilities. Therefore, an auditor has to keep in mind the following points while verifying the assets: · Ensuring the existence of assets. · Acquiring the assets for business. · Legal ownership and possession of the assets. · Ensuring the proper valuation of assets. · Ensuring that the assets are free from any charge Valuation Meaning Valuation means finding out correct value of the assets on a particular date. It is an act of determining the value of assets and critical examination of these values on the basis of normally accepted accounting standard. Valuation of assets is to be made by the authorized officer and the duty of auditor is to see whether they have been properly valued or not. For ensuring the proper valuation, auditor should obtain the certificates of professionals, approved values and other competent persons. Valuation is the primary duty of company officials. Auditor can rely upon the valuation of concerned officer but it must be clearly stated in the report because an auditor is not a technical person. Without valuation, verification of assets is not possible. If the valuation of assets is not correct, both the financial statements such as Balance Sheet and Profit and Loss Account cannot be correct. Hence, the auditor must take utmost care while valuing the assets to show true and fair view of the state of affairs of the financial position of the concern.
incurred in connection with the acquisition of an asset. It is a very simple method of valuing assets.
- Market Value Method Valuation of assets can be made on the basis of market price of such assets. But if same nature of assets is not available in the market, it is very difficult to determine the value of such assets. So, there are two methods related to it. They are: i. Replacement Value Method It represents the value at which a given asset can be replaced. This method of valuation of assets can be done only in the case of replacement of the same asset. ii. Net Realizable Value It refers to the price in which such asset can be sold in the market. But expenditure incurred at the sale of such asset should be deducted.
- Standard Cost Method Some of the business organizations fix the standard cost on the basis of their past experience. On the basis of standard cost, they make valuation of assets and present in the Balance Sheet.
- Book Value This is the value at which an asset appears in the books of accounts. It is usually the cost less depreciation written off so far.
- Going concern or Historical Value or Conventional Value or Token Value It is equivalent to the cost less a reasonable amount of depreciation written off. No notice is taken of any fluctuation in the price of the assets. Reason for this is that these assets are acquired for use in the business and not for resale.
- Scrap Value This method shows the value realized from sale of an asset as scrap. In other words, it refers to the value, which may be obtained from the assets if it is sold as scrap. Auditor’s Duty as Regards Valuation In a legal case against Kingston Cotton Mills Co: It was held that “although it is no part of an Auditor's’ duty to value the assets and liabilities, yet he must exercise
reasonable skill and care in scrutinizing the basis of valuation. He should test the accuracy of the values put by the officers of the business. In any case, the auditor cannot guarantee the accuracy of the valuation”. It is not an auditor's duty to determine the values of various assets. It has been judicially held that he is not a valuer or a technical man to estimate the value of an asset. But he is definitely concerned with values set against the assets. He has to certify that the profit and loss account shows true profit or loss for the year and Balance Sheet shows a true and fair view of the state of affairs of the company at the close of the year. Therefore, he should exercise reasonable care and skill, analyse all the figures critically, inquire into the basis of valuation from the technical experts and satisfy himself that the different classes of assets have been valued in accordance with the generally accepted assumptions and accounting principles. If the market value of the assets is available i.e., in the case of share investment then he should verify the market value with the stock exchange quotations. If there is any change in the mode of the valuation of an asset, he should seek proper explanation for it. If he is satisfied with the method of valuation of the assets, he is free from his liability. Importance of Verification and Valuation of Assets Assets and liabilities are very important aspects of every business concerns. To show the exact financial position of the concern, one of the main works of an auditor is to verify the assets and liabilities. An auditor should satisfy himself about the actual existence of assets and liabilities appearing in the Balance Sheet is correct. If Balance Sheet incorporates incorrect assets, both Profit and Loss account and Balance Sheet will not present a true and fair view. So, verification and valuation of assets is very important for business and their importance is highlighted below.
- Assures Safe Investment to Shareholders Verification and valuation provide actual information about assets and liabilities to the shareholders which assure safety of their investment.
- Easy for Sale At the time of sale of the company, it can be sold at the price which is enlisted in the Balance Sheet, but the assets whose valuation is not made need valuation before selling the company.
- Easy to Get Loan Companies disclose the Balance Sheet proved by auditor for public knowledge which increases the trust of the company. Hence, companies can easily obtain loan from financial Institutions.
- Easy to Get Compensation Whenever the loss occurs due to any incident, insurance company provides compensation on the basis of valuation of assets. So, the company can easily get compensation.
Differences Between Verification and Valuation Classification of Assets Fixed Assets Fixed assets are utilized to create incomes. Investments Investments are expected to fetch income from external agencies. Wasting assets Wasting assets are of a fixed nature but depleted or consumed gradually. Fictitious Assets Assets, which have no market values, are known as fictitious assets. They are shown in the Balance Sheet on the asset side of it under the head “Miscellaneous Expenditure”. Current Assets. Current assets are those which are utilized or converted into cash within one year period.
- He should also see that a separate account for building and land on which it is constructed is maintained. It is necessary because depreciation is provided for building and not for the land. (B) Leasehold Property Leasehold is an accounting term for an asset being leased. The asset is typically property such as a building or space in a building. · The property which is on lease (rent). · The property (plot/flat/villa/mall/ factories) which is leased by the landlord for a certain period of time to the lessee (tenant /leaseholder/renter/ occupant/dweller). · The (tenants) have been given the right to use during that specified time by the landlord. · The ownership of the property returns to the landlord when the lease comes to an end. Auditor’s Duty
- The auditor should verify this by inspecting the lease agreement or contract to find out value and duration. He should see that the terms and conditions of lease are properly complied with.
- In case property has been mortgaged, the auditor should obtain a certificate from the mortgagee regarding the possession of title deed
- Where the leasehold property has been sub-let, the counter part of the tenant’s agreement should also be examined.
- The auditor should physically inspect the properties.
- The auditor should also note that proper provision has been made for depreciation of lease problem and for any possible claims arising there under. 2. Plant and Machinery A plant is an asset with a useful life of more than one year that is used in producing revenues in a business’s operations. Plant is recorded at cost and depreciation is reported during their useful life. Auditor's Duty
- When the machines are purchased in the current accounting period, the invoices and the agreement with the vendors should be verified.
- The auditor should ` examine the plant register in which particulars about the cost, records about sales, provision for depreciation, etc., are available.
- He should prepare a list of each machine from the plant register and should get the list certified by the works manager as he is not a technical person and therefore, he has to depend upon the advice of the works manager regarding their valuation, etc.
- He should see that plant and machinery account is shown in the Balance Sheet at cost less depreciation after making proper adjustment for purchases and sales during the year under audit.
- In case any plant and machinery has been scrapped, destroyed or sold, he should ascertain that the profit or loss arising thereon has been correctly determined. 3. Furniture, Fixtures and Fittings They are items of movable equipment that are used to furnish an office. Examples are chairs, desks, shelves, book cases, filing and other similar items. Auditor's Duty
- Verify Invoices: When assets have been acquired during the current accounting period, the auditor should examine the purchase invoice of the dealers.
- Verify Furniture Stock Register: He should verify furniture stock register and ask the management to prepare an inventory to reconcile it with the stock register.
- Verify Schedule of Previous Year: He should compare furniture schedule of previous year with that of current year to ascertain the existence, purchase or sales of asset during the year.
- Disclosure of Profit or Loss on Sale: He should examine that any profit or loss on sale of furniture during the year is properly disclosed in books of accounts. Verification and Valuation of Investments An investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit. Investments include Government securities, shares, debentures, etc. When the number of investments is very large, the auditor should ask for a schedule of investments held by the client containing various particulars like name of the securities, date of purchase, nominal value, cost price, market price, etc., and examine the same. He should ensure that the investment asset has been shown separately in the Balance Sheet.
Auditor's Duty in Valuation
- The auditor should satisfy himself that the investment has been valued in the financial statement in accordance with recognized accounting policies and practices and relevant statutory requirements.
- The auditor should examine whether in computing the cost of investment, expenditure incurred on account of transfer fees, stamp duty, brokerage etc., is included in the cost of investment. Unquoted Investments A company share is said to be “unlisted” or “unquoted” if its stocks that are not listed on a stock exchange and so have no publicly stated price. Here, Investments are difficult to value, for example, shares that have no stock exchange listing i.e. Private Company etc. Auditor's Duty in Verification
- Audition should verify the Memorandum of Association to ensure authority for purchase such investment.
- Where investments are in large numbers, the auditor should obtain the schedule of securities certified by a senior officer of the company.
- Obtain the schedule of investment comprises for information about the name of the securities / investment, date of their acquisition, nominal/ face value, cost price, book value, paid up value market value, rate of interest applicable, dates of interest due, tax deduction, etc., at the date of Balance Sheet. Auditor’s Duty in Valuation
- The Auditor should examine the method adopted by the organization for determining the market value of such securities.
- The Auditor should examine whether the method of valuation of securities by entity is one of the recognized methods of valuation viz., breakup value method, capitalization of yield method, yield to maturity method etc. Verification and Valuation of Other Fixed Assets Verification and valuation of other fixed nature assets are classified into two categories such as wasting assets and fictitious assets. The wasting assets are also known as depleting assets and it has both physical and legal existence. The fictitious asset does not have market value but it has legal
existence. The procedure for verification and valuation of both these assets are discussed below. Wasting Asset It is also known as depleting assets, wasting assets are of a fixed nature but depleted or consumed gradually. The process of earning income causes depletion or exhaustion in the value of the assets. Mines, Oil wells, Quarries are some of the examples of wasting assets. There is a difference between fixed assets and wasting assets.
- The Fixed assets are replaceable, whereas wasting assets is irreplaceable after its useful life is over.
- The value of fixed assets decreases due to normal wear and tear, i.e., depreciates with time and use or due to obsolescence while the value of wasting assets declines as a result of gradual exhaustion or reducing stock. Auditor’s Duty The auditor should confirm in this regard, the value of the wasting assets in the Balance Sheet is reduced by the estimated amount of yearly depletion. In other words, a wasting asset appears in the Balance Sheet as its estimated diminished value. Fictitious Asset The assets which do not have physical existence are called as Fictitious Asset. Examples of fictitious assets are - Preliminary Expenses incurred at the time of formation of the company, Development Expenses, Debenture Discount, Amount spent on special advertisement campaign, Brokerage, Underwriting Commission and deferred revenue expenditure. Auditor's Duties
- Auditor should verify that expenses incurred are properly authorised by a responsible person.
- He should ensure that fictitious assets are treated as deferred revenue expenditure. Deferred Revenue Expenditure means temporary capitalization of revenue expenditure with the ultimate object of spreading the amount over several future years to which benefit of such expenditure will be available.
- The auditor should confirm that the asset is disclosed in the Balance Sheet at the amount of expenditure incurred less amount written off.
business enterprise etc. It also refers to the monetary value of reputation of a business. Since, goodwill is not tangible; it does not call for physical verification. The Goodwill is shown in company’s Balance Sheet under the head Fixed Assets. Goodwill is used for attracting the customers. It attracts more customers and therefore, increases profits in future. It is an intangible real asset and not a fictitious asset. Goodwill is a valuable asset if the concern is profitable. On the other hand, it is, valueless if the concern is in loss. Goodwill is to be verified and valued in the following manner. AUDITOR'S DUTY IN VERIFICATION · Ascertain that the company is justified in creating goodwill in its books of account. · Where goodwill is generated in own business, the auditors should verify the particulars of expenses debited to Goodwill account. · In a partnership firm, the partnership deed should be verified by the auditor. He may also verify the changes made in the goodwill account from time to time based on the provisions made in the partnership deed. AUDITOR'S DUTY IN VALUATION · Auditor should confirm himself that goodwill has not been shown in excess of its cost price. · Examine that the sum paid for goodwill does not exceed the difference between the total purchase consideration and the value of net tangible assets acquired. · He should see that it is valued as per method stated in partnership deed, purchase or agreement. · Goodwill may appear in the Balance Sheet at cost less amounts written off. · The amortization period and method of amortization should be reviewed at the end of each financial year. · An intangible asset should be eliminated in the books of accounts when no future economic benefits are expected from its use.
2. Patents According to the Patent Act 1970, “A patent is an official document that guarantees to the inventor an exclusive right for a term of years to make, use or sell his invention”. AUDITOR'S DUTY IN VERIFICATION While verification and valuation patent right the auditor must bear in his mind the following important points. The auditor should examine the actual certificates issued by the patent office in respect of patents granted. · The auditor should ensure that patents are registered in the name of the client. · Obtain a list showing the description of each patent, registered number, date, patented item, renewal date and number of years to run etc., concerning each patent. · Where patents have been purchased from an individual, auditor should inspect the agreement for the purchase and note the age of various patents. · Auditor should carefully verify that none of the patent rights have lapsed. Care should be taken the lapsed patent are written off. · The original fees paid to purchase the patent right should be capitalised and should be debited to patent account while the subsequent renewal fee should be treated as a revenue expenditure. AUDITOR'S DUTY IN VALUATION Patents must be valued at cost less depreciation. There may be three causes of depreciation, viz: (a) lapse of time, (b) obsolescence, and (c) the patented article going out of fashion. At time a patent might become valueless due to obsolescence or failure to create a demand of the patented article. In such cases the auditor should see that its value is written off before the expiry of the period covered by the patent.
The balances outstanding for a long period is to be probed and reasons for the same are to be found out.
- Comparison of Gross Profit: Percentage of gross profits of the previous years is to be compared with the gross profits of the year under audit. Variation if any, found to be unreasonable or omission of purchase or inclusion of fictitious purchases are to be considered.
- Confirmation from Management The auditor shall obtain from the management a certificate that all liabilities that had accrued till the close of the accounting year are carefully accounted for. 2. Bills Payable Bill refers to bill of exchange. Bills payable means bills accepted for the credit purchases made. The amounts on bills are payable at the due dates. It is a current liability. AUDITOR’S DUTY
- Schedule of Bills Payable: The auditor should get a schedule of bills payable and compare with the Bills Payable Book and Account.
- Verify Unpaid Bills: He should verify unpaid bills and check the subsequent payments with the cash book.
- Vouch Payments: He should vouch the payments made against bills payable.
- Examine Cash and Bank Statements: He should examine cash and bank statements for the bills which are met after the date of Balance Sheet but before the date of audit. Verification of Contingent Liabilities Contingent liabilities are those liabilities, which may or may not arise in the future for payment. The auditor should ensure that all known and unknown liabilities have been accounted in the books of accounts and have been shown in the Balance Sheet. The following are the examples of Contingent Liabilities: · Liabilities on Bills Receivable discounted and not matured. · Liability on account of partly paid calls. · Liability on arrears of dividend on Cumulative Preference Shares.
· Liability under a guarantee. · Liability for penalties under forward contracts · Liability that arises on account of litigation in respect of labour suits, trademarks, copyrights etc. Auditor's Duty in Verifying Contingent Liabilities
- Ensure Creation of Adequate Provision: The auditor should ensure that proper provision has been made for certain liabilities, for example, liability which arise on account of litigation and if he is not satisfied, the fact should be stated in the report.
- Disclosure in Balance Sheet: In respect of certain liabilities for which no provision has been made in the books, for example, Bills Receivable which has been discounted, arrears of accumulated fixed dividend etc. The auditor should verify that such liabilities are disclosed as foot note in the Balance Sheet.
