ZeePedia buy college essays online


Fundamentals of Auditing

<<< Previous BOOKS OF ACCOUNT & FINANCIAL STATEMENTS Next >>>
 
img
Fundamentals of Auditing ­ACC 311
VU
Lesson 09
BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
Books of Account to be Kept by Company [SECTION-230]
A company should keep proper books of account in respect of:
a)
Cash received and expended by the company;
b)
Sales and purchases of goods by the company
c)
All Assets and liabilities of the company; and
d)
In case of a company engaged in production, processing, manufacturing, or mining
activities, a production record as may be required by the Commission through a general or
special order;
Books of account should be preserved for ten years;
Books of account are to be kept at the registered office of the company. If kept at any other place, the
registrar should be informed;
Books of account should give a true and fair view of the state of affairs of the company and should contain
explanation of transactions.
Directors can inspect the books of account during the business hours.
If company fails to comply with the above provisions a director, including chief executive and chief
accountant:
(a)
of listed company is liable to imprisonment for one year and a fine of not less than Rs.
20,000 not more than Rs. 50,000, and a further fine of Rs. 5000 per day during which the
default continues; or
(b)
of other companies is liable to imprisonment for six months and with a fine, which may
extend to Rs. 10,000
Accounting Cycle
 Transaction
 Document
 Voucher
 Books of original entry/journal/day book
 Books of secondary entry/ledger
 Financial statement
Transaction
Source Document
Sale
Invoice Issue
Purchase
Invoice Receive
Sales return
Credit Note Issued
Purchases return
Credit Note Received
Cash received
Receipt/Cash Memo Issue
Cash paid
Receipt/Cash Memo Received
Lease/Hire Purchase Agreement
Voucher
 Receipt voucher
 Payment voucher
 Journal voucher
 Petty cash voucher
Books of Original Entry
 Purchase journal
 Sale journal
 Purchase return journal
 Sales return journal
 Cash book (two/three column)
 Petty cash book
23
img
Fundamentals of Auditing ­ACC 311
VU
 General journal/ transfer journal
Books of Secondary Entry
 Main ledger
 Subsidiary ledger
Financial Statement
 Balance sheet
 Income statement
 Statement of changes in equity
 Cash flow statement
 Notes to the accounts
Recording of Transactions from Source Documents
To enter into a transaction we need approval from our responsible managers. When, after having approval of
a manager, transaction takes place, such transaction should be evidenced by a document. Because, to record a
transaction into the books of account, a bookkeeper needs an evidence of proper approval of transaction
and authorization of documents, therefore, a voucher is prepared on which all of the descriptions of the
transaction are written up and with which all of the evidences of approvals and authorized document are
attached. Such voucher is finally authorized by accounts manager which is then recorded in the books of
accounts by a bookkeeper.
To have a more clear understanding of the above paragraph, lets have a step by step example of purchasing
an air conditioning plant for workshop.
1. Production manager will send a requisition to the general manager for air conditioning the workshop
to improve the working environment.
2. The general manager will approve the requisition (if he gets convinced that workshop is in real need of
air conditioning plant) and will send this approval to the purchase department.
3. The purchase department will call a tender and after having received several quotations the purchase
department will place a purchase order to the vendor quoting lowest rate. (All of the above procedure
is properly documented).
4. The vendor company (supplier) will send an invoice (purchase invoice) to the business along with the
air conditioning plant. Such air conditioning plant will be inspected by the expert and finally the invoice
will be approved for payment.
5. Now all of the documents along with the purchase invoice shall be send to the bookkeeping office
where a voucher will be prepared and will also be approved by the concerned manager for recording
this transaction in the books of accounts.
Source Documents:
Following are the few examples of source documents which
are required to support different types of
transactions.
Sr. No.
Transaction
Source Documents
1
Sales
Sales Invoice issued
2
Purchase
Purchase Invoice received
3
Sales Return
Credit Note issued
4
Purchase Return
Credit Note received
5
Cash received
Cash Memo/receipt issued
6
Cash paid
Cash Memo/receipt received
7
Leases/Hire purchase
Agreements
8
Staff Salaries
Approved Payrolls
9
Electricity, Gas, Water, Tele. Phone
Metered Bills/Invoices.
Recording in the Books
Approved voucher are recorded in the books of accounts, many businesses now a days use computers for
recording of transactions. However, an understanding of book of accounts is necessary whether
transactions are recorded manually or electronically.
Basically, there are two types of books of accounts which are used to record the business transactions
24
img
Fundamentals of Auditing ­ACC 311
VU
1. Books of original entries.
2. Books of secondary entries.
These are further subdivided according to the needs of the business and/or complexity of the transaction.
Following diagram best describes the different books of accounts which are used in the business for
recording transactions.
BOOKS OF ACCOUNT
Books of Secondary
Entries (Ledger)
Books of Original
Entries (Journal)
To record credit transaction
To record cash transaction
Purchases
Returns
Returns
General
Sales Journal
Cash
Inward
Outward
Journal
Book
Journal
Journal
Journal
For credit
For credit
For sales
For
For all other
For cash
purchases
receipts &
purchases
sales
return
transactions
return
payments
Source Documents
Invoices
Invoices
Credit
Credit Note
Depends upon
Cash
Note
the nature of
Received
Issued
Received
Memos
Issued
Transaction
Main Ledger
Subsidiary Ledger
To extract trial balance and to
prepare financial statements
Debtors
Creditors
Materials
Other
Ledge
Ledger
Ledger
Ledger
To keep memorandum
Figure 3.1
Just after analyzing a transaction or event for its debit and credit effects it is required to record them in a
systematic way. So the books of accounts in which Debit and Credit are initially recorded in a systematic
way are known as books of original entry (BOE). In accounting system of business concern books of
original entries possess a very important position.
25
img
Fundamentals of Auditing ­ACC 311
VU
JOURNAL:
It depends upon the complexity of transactions and size of the business that what books of original entries
are required to record the transactions. For a very little business, having very few cash and credit
transactions, a general purpose journal is sufficient to record each type of transactions.
Journal is the very first book of account in which all of the business transactions and events are recorded. In
this book transactions and events are recorded in a chronological (date) sequence. Both of the accounting
effects (Debit & Credit) are recorded in it in a systematic way. Information recorded in the journal for a
transaction or an event is known as journal entry.
Sketch of a Journal & Journal Entry
Date
Particulars
Post
Debit
Credit
2003
Ref.
(Rs)
(Rs)
Jan. 10
Salaries Account (Debit)
39
50,000
Cash Account (Credit)
10
50,000
Cash
(Staff salaries paid in cash).
Memos
Figure 3.2
From the above illustration we can understand that on 10th January 2003, business paid cash Rs.50,000 as staff
salaries. It is customary that the accounting head analyzed as debit is written firstly in the particulars' column
and its amount is written in the debit column whereas the accounting head analyzed as credit is written under
the debit accounting head but after indenting a little space from the left side, its amount is written in the
credit column. The column of post reference cannot be very well understood without having knowledge of
Ledger, any how, the column post reference shows page numbers of the Ledger in which salaries and cash
accounts are posted. Words written within the parenthesis in the particulars column are known as
"Narration of a transaction or event"; it is an integral part of a journal entry. Narration explains the
accounting treatments to a layman.
Subdivision of Journal:
As discussed earlier in 1.2 that the journal is sub-divided based on complexity of the transactions or size of
business. This happens only when there are a number of cash transactions in a day and also there are so
many transactions for credit purchases and credit sales. This large numbers of transactions create a mess in
bookkeeping office; therefore, separate bookkeeping clerks are given responsibilities for separate types of
transactions along with separate journals. For example,
For cash transactions there is a separate cash office in which only cash transactions are analyzed and
recorded in a book named as cash book.
For purchases there is a purchase journal in which only and only credit transactions for purchases are
recorded. In the same way sales journal for credit transaction of sales is maintained. And if there are a large
number of returns then separate journals for sales return and purchase return are also maintained.
Now that, after having separate journals for credit sales, credit purchases, sales & purchases return and cash
transactions, all of the remaining transactions and events like sale and purchase of assets on credit, loss by
fire etc. shall be recorded in general journal.
To learn more about subdivision of journal, firstly have a re-look on figure 3.1.
SALES JOURNAL:
Need for Sales Journal
In case of a small business, there is very little number of transactions of credit sales. As we can have an
example of a barber's shop, a tailor, a retailer etc. they mostly sell their services or goods on cash terms. But
as business expands, the sales of it also grow in terms of cash as well as in terms of credit. The cash sales are
now recorded in the cash book as a receipt, and the credit sales are recorded in a separate journal named as
sales journal (sales day book). In sales journal, no other transactions are recorded except the transaction for
sales on credit terms.
Supporting Document:
As shown in the figure 3.1 the source document supporting credit sales is sale invoice. It is made up in
duplicate or triplicate (depending upon the accounting systems developed for the recording of credit sales)
26
img
Fundamentals of Auditing ­ACC 311
VU
one of these copies is sent to the debtor (credit customer) along with the goods/services sold. A standard
format of sales invoice looks like below;
Name of Vendor Co.
Address of Vendor Co.
Sale Invoice No.
Date:
Name & Address of Customer
Purchase Order Ref. No.
Sr. No.
Particulars/Description
Quantity
Rate
Amount
***
Trade discount
(***)
Total
***
Settlement terms. 2/10, n/30
Figure 3.3
Purchase Order Reference No:
When a customer asks a vendor for supply of some goods, such order is evidenced through a purchase
order form. Purchase order form discloses the quantity and quality of goods ordered along with its rates and
discounts both trade and settlement. Each purchase order has its unique number which is put on the sales
invoice for reference.
Trade Discount:
Amount of trade discount is not required to be recorded in the books of accounts. Actually it is the
discount which is agreed before entering into the transaction of sales or purchase, therefore, it is just
formally show on the face of the invoice, otherwise it has no other financial effects.
Settlement Terms:
It is also known as prompt payment terms. These terms are in fact offered to lure the customer for having
more discounts by making payment for the invoice earlier. In this term, for example 2/10, n/30, the first
part 2/10 contemplates that if customer pays cash within 10 days of the invoice, he will be offered a
discount of 2%, the second part of it n/30 contemplates that after 10 days there will be no discount offer
but the customer has to pay the amount of invoice net of trade discount within the thirty days of the date of
invoice.
This term sounds as two ten net thirty (2/10, n/30).
Brain Storming
How this will sound 5/20, n/60 and what do you understand by this term?
Entering the Transaction of Credit Sales in Sale Journal:
In case of credit sales the business is very much interested in the name and addresses of the credit customer
(Debtor), therefore, sales journal is so designed to cover following information;
Date---------------------
Date of invoice
Name of Debtor -------Mentioned in the invoice
Invoice number ------- It helps to trace the other details of invoice.
Post reference ---------Page number of subsidiary ledger (will be discussed later on)
Amount of invoice ---- Net of Trade Discount
27
img
Fundamentals of Auditing ­ACC 311
VU
Sketch of Sales Journal
Date
Name of Debtor
Invoice
Post.
Amount
No.
Ref.
Rs.
You would have noticed in the sales journal, there is only one column for amount. It might have created
confusion in your mind that why we are not having two columns for amount, one for debit and other for
credit, like in journal. Remember, here in sales journal all of the transactions are of same nature (credit sales)
and the purpose of sales journal is just to avoid over working for recording the debits and credits of each
transaction again & again. So, the role of sales journal in an accounting system is to precise all of the credit
transactions of sales for a month or so and give effect of debit to debtors and credit to sales with total
amount of such period.
Purchase Journal:
Need for a Purchase Journal
After knowing the need of sales journal (as discussed in previous section) it will be very easy to understand
that for a large business having frequent transactions of credit purchases it is necessary to maintain a
separate book for recording the transactions of purchases on credit terms. This book is named as purchase
day book. Obviously like a sales journal no cash transactions relating to purchase shall be recorded in this
book.
Supporting Document:
As shown in the diagram the supporting document for transactions of credit purchases is purchase invoice.
It is exactly the same document as we looked into the diagram of previous section. Purchase invoice is in
fact the copy of sales invoice in the hands of customer. It is issued to the purchaser by the
seller/vendor/supplier. So from the stand point of a purchasing business, the business after having received
the invoice will put an internal number on it and will file it as evidence of the transaction and also for the
purpose to remember that amount of this invoice is still outstanding for payment according to the
settlement terms as discussed in section.
Entering the Transaction of Credit Purchases in Purchase Journal:
The basic contents of a purchase journal are exactly the same as discussed in the case of a sales journal with
the exception of one thing that now in the second column there is the name of Creditors instead of
Debtors. Obviously, we remember the person from whom goods are purchased on credit is creditor of the
business.
Sketch of Purchase Journal
Date
Name of creditor
Inv.
Post.
Amount
No.
Ref.
Rs
A purchase journal is a list of all credit purchases in a stipulated time period. All of the credit purchases
recorded in a purchased journal during a period is totaled and then for such total amount debit effect is
given to the purchases account and credit effect is given to the creditors account. You noticed here that the
rules of debit and credit remain same all the time.
Sales Return Journal: (Returns Inward Journal)
Need for Sales Return Journal
As the business expands the number of complaints and returns inwards also increases. Such return inwards
can be recorded in the sales journal as a negative entry if these are very little in number. But because of its
reverse nature it is recommended to maintain a separate journal to record sales return. Here one very
28
img
Fundamentals of Auditing ­ACC 311
VU
important concept should be remembered that in sales return journal only the returns against credit sales
(from Debtors) are recorded. Normally, it doesn't happen that return of goods sold against cash are
accepted by a business because certainly against such return the business would have to make refund of
money already received. That's why in coming practice you will not find any such transaction. But obviously if
you have any example of such transaction in your business, it will be recorded in cash book as a payment.
Supporting document:
When a business receives back its sold goods it issues a "credit note" to the debtor returning goods, which
evidences that we have received the returned goods and accept that money for such sales will not be
received in future. A "credit note" issued is an evidence of reduction in sales income and also in the amount
of debtors. It is also said that a "credit note" is a reversal document of an "invoice" which cancels the effect
of it. Like an "invoice", a credit note is also given a number and also possesses a reference of sales invoice against
which such return were made. Rest of the contents of credit note are commonly understood, such as:
Name & Address of the business (Seller)
Name & Address of the customer
Date
Particulars
Quantity
Rate
Amount
Sketch of Credit Note
Name of Vendor Co.
Address of Vendor Co.
Credit Note No:
Date:
Customer's Name
Customer's Address
Ref. Invoice No
Account No:
Item No.
Description
Quantity
Rate
Trade
Net Amount
Discount
Total
Figure 3.6
Purchase return journal: (Returns outward journal)
Need for a Purchase Return Journal?
Purchase return journal has the same story as we just have discussed in previous unit. The only thing to
remember is that it is also known as return outward journal/daybook. Obviously these transactions (for
purchase returns) could also be recorded in the purchase journal as negative entry but same as for sales
return journal it is required to have a separate journal for purchase returns because of its reverse nature to
the purchases. The total of purchase return journal will cause a reduction in the purchases expenses and also
a reduction in the amount of creditors.
Supporting document:
Although purchase returns are evidenced by a copy of credit note received from the seller, which is treated as
a reversal document against purchase invoice. But here we shall also discuss the need of a "Debit Note". A
"debit note" is in fact a request, put to the seller by the purchaser business, for issuance of a credit note. A copy
of debit note is sent to the seller along with the rejected goods, in which all of the particulars of goods
rejected and returned along with the reference of relevant invoice number are entered. Remember, a
business cannot record purchases returns considering a debit note as a supporting document because the
29
img
Fundamentals of Auditing ­ACC 311
VU
effects of purchase invoice are not considered cancelled unless acceptance of rejected goods is received
from the seller in shape of a copy of credit note.
Entering Transactions in Purchases Return Journal:
you will find nothing new in this section except the treatment of total of purchase return journal which is
debited to the creditors account and credited to the purchases return account.
Sketch of a Purchase Return Journal
Date
Creditor Name
Credit
Post.
Amount
Note No.
Ref.
Figure 3.7
Cash Book:
Cash book is a book of original entries in which all of the cash transactions are recorded very firstly. If we
refer to the figure 3.1, we can notice that the (books of original entry) journal is subdivided for two types of
transactions i.e. credit transactions and cash transactions. As discussed in previous units, all credit
transactions are recorded in different journals. The cash transaction of a concern needs a separate book
named as cash book.
A cash book is divided into two sections, one for cash receipts and the other for cash payments. Each of
the section is formatted for date, particulars, post reference and amount. See below for its proper sketch;
Cash book
Date
Particulars
Post
Amount  Date
Particulars
Post
Amount
Ref.
Ref.
Figure 3.8
Left hand side of a cash book is known as receipt side and right hand side is known as payment side. In a
way, we can say that within a cash book, we prepare two cash journals, one, cash receipt journal and second,
cash payment journal.
Supporting Documents:
For Cash Receipts
All cash receipts are evidenced by a copy of cash memo/receipts retained by the business. These cash
memos/receipt are already serially pre-numbered and for each receipt of cash, the cash office issues an
original copy of the cash memo/receipt to the person making payment and retains a carbon copy or
counterfoil of it within the office which are used to record receipts of cash in the cash book.
For Cash Payments
All cash payments are evidenced by an original copy of cash memo/receipts issued by the recipient
business. These are attached with a cash voucher as evidence that cash was paid to recipient who issued this
cash memo/receipt.
30
img
Fundamentals of Auditing ­ACC 311
VU
31
img
Fundamentals of Auditing ­ACC 311
VU
32
img
Fundamentals of Auditing ­ACC 311
VU
33
img
Fundamentals of Auditing ­ACC 311
VU
34
img
Fundamentals of Auditing ­ACC 311
VU
35
Table of Contents:
  1. AN INTRODUCTION
  2. AUDITORSí REPORT
  3. Advantages and Disadvantages of Auditing
  4. OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS
  5. What is Reasonable Assurance
  6. LEGAL CONSIDERATION REGARDING AUDITING
  7. Appointment, Duties, Rights and Liabilities of Auditor
  8. LIABILITIES OF AN AUDITOR
  9. BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
  10. Contents of Balance Sheet
  11. ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
  12. Business Operations
  13. Risk Assessment Procedures & Sources of Information
  14. Measurement and Review of the Entityís Financial Performance
  15. Definition & Components of Internal Control
  16. Auditing ASSIGNMENT
  17. Benefits of Internal Control to the entity
  18. Flow Charts and Internal Control Questionnaires
  19. Construction of an ICQ
  20. Audit evidence through Audit Procedures
  21. SUBSTANTIVE PROCEDURES
  22. Concept of Audit Evidence
  23. SUFFICIENT APPROPRIATE AUDIT EVIDENCE AND TESTING THE SALES SYSTEM
  24. Control Procedures over Sales and Debtors
  25. Control Procedures over Purchases and Payables
  26. TESTING THE PURCHASES SYSTEM
  27. TESTING THE PAYROLL SYSTEM
  28. TESTING THE CASH SYSTEM
  29. Controls over Banking of Receipts
  30. Control Procedures over Inventory
  31. TESTING THE NON-CURRENT ASSETS
  32. VERIFICATION APPROACH OF AUDIT
  33. VERIFICATION OF ASSETS
  34. LETTER OF REPRESENTATION VERIFICATION OF LIABILITIES
  35. VERIFICATION OF EQUITY
  36. VERIFICATION OF BANK BALANCES
  37. VERIFICATION OF STOCK-IN-TRADE AND STORE & SPARES
  38. AUDIT SAMPLING
  39. STATISTICAL SAMPLING
  40. CONSIDERING THE WORK OF INTERNAL AUDITING
  41. AUDIT PLANNING
  42. PLANNING AN AUDIT OF FINANCIAL STATEMENTS
  43. Audits of Small Entities
  44. AUDITORíS REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIALSTATEMENTS
  45. MODIFIED AUDITORíS REPORT