Auditing and Financial Management

Creditors velocity and debtors velocity are opposing liquidity forces: one increases working capital while the other decreases it. When these velocities are similar in magnitude, they offset each other, resulting in no net effect on overall liquidity position.

Issuing redeemable preference shares increases cash (current asset) without affecting current liabilities, improving the ratio. Selling furniture for cash similarly increases current assets. Cash from debtors merely replaces one current asset (receivables) with another (cash), leaving the ratio unchanged.

Purchasing goods for cash merely converts one current asset to another. Selling goods on credit replaces cash with receivables. Converting debentures to equity affects non-current items. However, acquiring plant on account increases current liabilities without changing current assets, reducing the current ratio.

The Companies Act 2013 replaced the Company Law Board with National Company Law Tribunal (NCLT) as the specialized forum for oppression and mismanagement complaints. NCLT has jurisdiction over corporate disputes previously handled by High Courts or CLB.

Management audit evaluates efficiency and effectiveness of management processes, policies, and decisions - not just accuracy of financial records. It assesses whether resources are used optimally to achieve organizational goals, making it fundamentally an efficiency audit.

The Companies Act requires statutory meeting within 1-6 months of the date company becomes entitled to commence business. This is the date when all statutory requirements are satisfied and business operations can legally begin - not necessarily when actual trading starts.

Internal audit is optional and depends on management decision. Statutory audit of company accounts is mandatory under Companies Act for all companies regardless of size. Management audit is different from internal audit - the former evaluates management efficiency while latter checks internal controls.

Cooperative Societies Act mandates auditors to submit reports directly to the Registrar of Cooperative Societies. The Registrar is the regulatory authority overseeing cooperative societies in each state, making the primary submission to them statutory - not to the managing committee first.

Shelf prospectus allows eligible entities to raise funds in tranches over time without filing fresh prospectus each time. Only public financial institutions (like IDFC, SIDBI, IIFCL) are eligible under Companies Act - regular companies whether manufacturing or foreign cannot use this facility.

Operating Profit Ratio = Operating Profit / Sales × 100. Operating profit excludes non-operating items (income and expenses). Operating profit = Net profit + Non-operating expenses - Non-operating income = 28000 + 800 - 4800 = Rs. 24000. Ratio = 24000/160000 × 100 = 15%.

Educational institutions run by charitable trusts must undergo audit under income tax regulations if they receive exemptions or public funding. Clubs are not commercial establishments. Charitable trust audits require qualified auditors, not any person from the accountancy profession.

Only public companies limited by shares are NOT required to register Articles of Association - they can adopt Table A of Companies Act as default articles. All other company types (unlimited companies, private companies, companies limited by guarantee) must file their own AoA with MoA at incorporation.

Acid Test Ratio (Quick Ratio) = Quick Assets / Current Liabilities. Quick assets = Sundry Debtors + Bills Receivable + Cash at Bank = 15000 + 12500 + 17500 = Rs. 45000. Current liabilities = Creditors + Bills Payable = 25000 + 15000 = Rs. 40000. Ratio = 45000/40000 = 1.125:1. Stock is excluded as it's less liquid.

Vouching director remuneration requires verifying: special resolution approving payment (Article of Association compliance), statement of accounts showing remuneration details, and minutes book recording board decision. Central Government approval is needed only in specific cases (excess remuneration under Section 197), not for all remuneration.

Under 'Secured Loans' in the balance sheet, debentures (being long-term secured instruments) are disclosed first, followed by loans from banks (secured against assets). Loans from subsidiaries come next, with 'Other loans and advances' disclosed last. This order reflects the typical hierarchy of secured borrowing, from most formal to least formal.

Current audit working papers contain the current year's audit-related documents like accounts, audit programs, and minutes. The Memorandum of Association and Articles of Association are constitutional documents that belong in the permanent audit file (continuing file), not the current file. They are retained permanently and referenced across multiple audits.

Liability for negligence (a) occurs when auditors fail to exercise due care, such as allowing dividends paid out of capital (4). Misfeasance (b) means breach of trust or duty (1). Criminal liability (c) arises for untrue statements in prospectus (2) under Companies Act provisions. Liability to third parties (d) is generally excluded - auditors are not liable to third parties for untrue statements in prospectus (3), as this is governed by the principle of privity of contract.

Statement 1 is correct - corporate governance norms require public limited companies to establish audit committees. Statement 2 is correct - audit committee members should be independent non-executive directors not representing the controlling group to ensure objectivity. Statement 3 is incorrect - dealing directly with the audit committee actually enhances auditor independence by insulating auditors from management pressure. The audit committee acts as a bridge between auditors and management.

Statement 1 is incorrect - decision-making processes are management functions, not accounting controls. Accounting controls focus on safeguarding assets and reliability of financial records. Statement 2 is correct - accounting controls include the organizational plan for asset safeguarding. Statement 3 is correct - accounting controls include specific procedures designed to protect assets. The core purpose of accounting controls is asset protection, not decision-making.

Statement 1 is correct - working papers provide a roadmap for future audits by documenting what was done. Statement 2 is incorrect - working papers themselves don't verify accuracy; they document the verification procedures performed. The audit procedures verify accuracy, not the papers. Statement 3 is correct - working papers serve as primary evidence of audit work performed, supporting the auditor's opinion.

The correct sequence begins with the client agreement (3) - establishing the engagement terms. Next is ascertaining the audit scope (1) based on the agreement. Then the auditor gains knowledge about the client's business (2) to understand risks and operations. Finally, instructions and information are obtained from the client (4) to facilitate the audit execution. This logical flow moves from contractual commitment to detailed execution.

Rotation of duties (a) is an internal control technique (1) that prevents fraud by separating responsibilities. Random sampling (b) enables selective verification (3) of transactions rather than 100% checking. Trend analysis (c) is an analytical procedure for overall assessment (4) of financial statement reasonableness. Cash verification (d) requires physical examination (2) through actual counting and reconciliation of cash balances.

Statement 1 is correct - internal control systems encompass quality controls as part of comprehensive control frameworks. Statement 2 is incorrect - internal control is not compulsory for all forms of business organizations; it's recommended but not mandated for every business type. Statement 3 is correct - understanding a client's internal control system helps external auditors design appropriate audit programs by determining control reliance and substantive testing requirements.

The question contains OCR errors in the profit figure. Return on equity = Net Profit after tax / Shareholders' Equity. Equity = Share Capital + Revenue Reserves = Rs. 8,00,000 + Rs. 2,00,000 = Rs. 10,00,000. Using the answer of 40%, we can back-calculate that Net Profit after tax should be Rs. 4,00,000 (40% of Rs. 10,00,000). The text incorrectly states 'Rs. 2,00,000 is Rs. 4,00,000' - the first number appears to be a scanning error.