Sikkim Manipal University 3rd Semester Fall 2010

MBA – III SEM

Internal Audit & Control – MF0004

SET - 2

Q. 1. Explain the meaning of flow chart. Explain different types of flow chart
Answer:

Definition:-

The flowchart is a means of visually presenting the flow of data through an

information processing systems, the operations performed within the system and the
sequence in which they are performed. In this lesson, we shall concern ourselves with
the program flowchart, which describes what operations (and in what sequence) are
required to solve a given problem. The program flowchart can be likened to the blueprint
of a building. As we know a designer draws a blueprint before starting construction on a
building. Similarly, a programmer prefers to draw a flowchart prior to writing a computer
program. As in the case of the drawing of a blueprint, the flowchart is drawn according to
defined rules and using standard flowchart symbols prescribed by the American National
Standard Institute, Inc.

Meaning:-

a) A flowchart is a diagrammatic representation that illustrates the sequence of

operations to be performed to get the solution of a problem. Flowcharts are
generally drawn in the early stages of formulating computer solutions. Flowcharts
facilitate communication between programmers and business people. These
flowcharts play a vital role in the programming of a problem and are quite helpful
in understanding the logic of complicated and lengthy problems. Once the
flowchart is drawn, it becomes easy to write the program in any high level
language. Often we see how flowcharts are helpful in explaining the program to
others. Hence, it is correct to say that a flowchart is a must for the better
documentation of a complex program.

b) A flowchart is a graphic representation of how a process works, showing, at a

minimum, the sequence of steps. Several types of flowcharts exist: the most
simple (high level), a detailed version (detailed), and one that also indicates the
people involved in the steps

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Flow Chart Symbols:-

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Examples:-

A simple flowchart for computing factorial N (10!).

A flowchart for computing factorial N (10!) where N! = (1*2*3*4*5*6*7*8*9*10), see

image. This flowchart represents a "loop and a half" — a situation discussed in
introductory programming textbooks that requires either a duplication of a component (to
be both inside and outside the loop) or the component to be put inside a branch in the
loop. (Note: Some textbooks recommend against this "loop and a half" since it is
considered bad structure, instead a 'priming read' should be used and the loop should
return back to the original question and not above it

When to use flow chart:- A flowchart helps to clarify how things are currently working
and how they could be improved. It also assists in finding the key elements of a process,
while drawing clear lines between where one process ends and the next one starts.
Developing a flowchart stimulates communication among participants and establishes a
common understanding about the process. Flowcharts also uncover steps that are
redundant or misplaced. In addition, flowcharts are used to identify appropriate team
members, to identify who provides inputs or resources to whom, to establish important
areas for monitoring or data collection, to identify areas for improvement or increased
efficiency, and to generate hypotheses about causes. Flowcharts can be used to
examine processes for the flow of patients, information, materials, clinical care, or
combinations of these processes. It is recommended that flowcharts be created through

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group discussion, as individuals rarely know the entire process and the communication
contributes to improvement.

Types of flowcharts:-

Sterneckert (2003) suggested that flowcharts can be modeled from the perspective of
different user groups (such as managers, system analysts and clerks) and that there are
four general types:

• Document flowcharts, showing controls over a document-flow through a system

A document flowchart traces the movement of a document, such as internal
memos, payroll information and interoffice mail, through a system. The chart is
columns that are divided by vertical lines. Each column represents a section,
employee, department or unit in a company. The flowchart shows how a
document passes from one part of the company to another. Usually, document
flowcharts contain minimal detail, just the route the document takes from one
place to another.

• Data flowcharts, showing controls over a data flows in a system

A data flowchart illustrates how data pass through a system. Symbols connote
operations involved in the flow of data and the storage, input and output materials
needed to keep the flow going. This is a good way to track where data originates
and where it ends up. Data flowcharts are more concerned with the movement of
the data than how the data is processed.

• System flowcharts, showing controls at a physical or resource level

A system flowchart shows how an entire system works by demonstrating how
data flows and what decisions are made to control this event. Symbols that
connote decisions, processes, inputs and outputs and data flow are the most
important elements of a system flowchart. These differ from data flowcharts
because they show decisions, which are more detailed. System flowcharts are
used in fields such instances as aircraft control, central heating and automatic
washing machines.

• Program flowchart, showing the controls in a program within a system

A program flowchart demonstrates how a program works within a system. These
flowcharts show any and all user-interaction pathways by using boxes and
arrows. These arrows and boxes form hierarchical menus. Program charts can be
large and complex. However, they are useful for mapping an entire program. One
example of program flowchart is storyboarding for a film. With all intentions
mapped, people can see exactly how a program functions.

Notice that every type of flowchart focuses on some kind of control, rather than on the
particular flow itself.

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However there are several of these classifications. For example Andrew Veronis (1978)
named three basic types of flowcharts:

• The system flowchart,

• The general flowchart, and

• The detailed flowchart.

That same year Marilyn Bohl (1978) stated "in practice, two kinds of flowcharts are used
in solution planning”:

• System flowcharts and

• Program flowcharts.

More recently Mark A. Fryman (2001) stated that there are more differences:

• Decision flowcharts,

• Logic flowcharts,

• Systems flowcharts,

• Product flowcharts, and

• Process flowcharts are just a few of the different types of flowcharts that are used
in business and government.

High-Level Flowchart:-
A high-level (also called first-level or top-down) flowchart shows the major steps
in a process. It illustrates a "birds-eye view" of a process, such as the example in the
figure entitled High-Level Flowchart of Prenatal Care. It can also include the
intermediate outputs of each step (the product or service produced), and the sub-steps
involved. Such a flowchart offers a basic picture of the process and identifies the
changes taking place within the process. It is significantly useful for identifying
appropriate team members (those who are involved in the process) and for developing
indicators for monitoring the process because of its focus on intermediate outputs.

Most processes can be adequately portrayed in four or five boxes that represent the
major steps or activities of the process. In fact, it is a good idea to use only a few boxes,
because doing so forces one to consider the most important steps. Other steps are
usually sub-steps of the more important ones.

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Detailed Flowchart :-
The detailed flowchart provides a detailed picture of a process by mapping all of the
steps and activities that occur in the process. This type of flowchart indicates the steps
or activities of a process and includes such things as decision points, waiting periods,
tasks that frequently must be redone (rework), and feedback loops. This type of
flowchart is useful for examining areas of the process in detail and for looking for
problems or areas of inefficiency. For example, the Detailed Flowchart of Patient
Registration reveals the delays that result when the record clerk and clinical officer are
not available to assist clients.

Deployment or Matrix Flowchart:-

A deployment flowchart maps out the process in terms of who is doing the steps. It is in
the form of a matrix, showing the various participants and the flow of steps among these
participants. It is chiefly useful in identifying who is providing inputs or services to whom,
as well as areas where different people may be needlessly doing the same task. See the
Deployment of Matrix Flowchart.

Merits of flow charts:-

• Easy to recollect.

• Summarizes the internal controls at one place and provides a bird’s eye view.

• Communication is easier through the use of flow charts.

Demerits of flow charts:-

• No final description is possible as internal controls change due to changes in the

environment.

• Preparing a flow chart is a complex job.

• Preparing a flow chart is a time- consuming job.

Q.2. What are the mandatory standards of ICAI.

Answer: Types of Standards issued by ICAI Auditing and Assurance Standards issued
by the ICAI include the following Standards:

• Auditing and Assurance Standards(AAS)

• Statements on Auditing

• General Clarifications on AAS

• Guidance Notes

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• Technical Guides

Each of them has different scope and authority attached to them.

Authority Attached to Standards Authority attached to AAS, Statements on Auditing and

General Clarifications on AAS Auditing and Assurance Standards, Statements on
Auditing and General Clarifications on AAS are mandatory in nature. AAS codify the
existing best practices in the area of auditing. AASs are critical for the proper discharge
of functions as auditor. Statements on Audit are issued for compliance by Members.
General Clarifications to AAS are also issued in matters where doubts exist.
Accordingly, while discharging their attest function, it will be the duty of the members of
the ICAI to ensure that these are followed in the audit of financial information covered by
their audit reports.

The nature of these Standards requires members to exercise professional judgment in

applying them, for example, a member may judge it necessary to depart from an
essential procedure laid down in these Standards to achieve more effectively the
objective of the engagement.

If, for any reason, a member has not been able to perform an audit in accordance with
such Standards, his report should draw attention to the material departures there from.
Authority Attached to Guidance Notes.

Guidance Notes are designed primarily to provide guidance to members on matters

which may arise in the course of their professional work and on which they may desire
assistance in resolving issues which may pose difficulty.

Guidance Notes are recommendatory in nature. A member should ordinarily follow

recommendations in a Guidance Note except where he is satisfied that in the
circumstances of the case, it may not be necessary to do so.

If the recommendations in a Guidance Note have not been followed, the member should
consider whether keeping in view the circumstances of the case, a disclosure in his
report is necessary. Technical Guides, Studies and Other Papers Published by ASB
AASB may also publish Technical Guides, Studies and Other papers. Technical Guides
are ordinarily aimed at imparting broad knowledge about a particular aspect or an
industry to the members. Studies and other papers are aimed at promoting discussion or
debate or creating awareness on issues relating to quality control, auditing, assurance
and related service, affecting the profession.

They do not establish any basic principles or essential procedures to be followed in

audit, assurance or related services engagements.

CAS 1: Classifications of Costs.

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CAS 2: Capacity Determination.

CAS 3: Overheads.

CAS 4: Cost of Production for Captive Consumption.

CAS 5: Determination of Average (Equalized) Cost of Transportation.

CAS 6: Material Cost

shall be mandatory with effect from period commencing on or after 1st April 2010 for
being applied for the preparation and certification of General Purpose Cost Accounting
Statements. Since there is no statutory requirement for the application of such Cost
Accounting Standards for the preparation and certification of Cost Accounting
Statements, in case the cost accountant is of the opinion that the aforesaid standards
have not been complied with for the preparation of the Cost Statements, it shall be his
duty to make a suitable disclosure/qualification in his audit report/certificate”

List of Accounting Standards:-

01 AS 1 Disclosure of Accounting Principles

02 AS 2 Valuation of Inventories
03 AS 3 Cash Flow Statements
Contingencies and Events Occurring After the
04 AS 4
Balance Sheet Date
Net Profit or Loss for the Period, Prior Period
05 AS 5
Items and Changes in Accounting Policies
06 AS 6 Depreciation Accounting
07 AS 7 Accounting for Construction contracts
08 AS 8 Accounting for Research and Development
09 AS 9 Revenue Recognition
10 AS 10 Accounting for Fixed Assets
AS 11 The Effects Of Changes In Foreign Exchange
11
(Revised 2003) Rates
12 AS 12 Accounting for Government Grants
13 AS 13 Accounting for Investments
14 AS 14 Accounting for Amalgamations
AS 15
15 Employee Benefits
(Revised 2005)

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16 AS 16 Borrowing Costs
17 AS 17 Segment Reporting
18 AS 18 Related Party Disclosures
19 AS 19 Leases
20 AS 20 Earnings Per Share
21 AS 21 Consolidated Financial Statements
22 AS 22 Accounting for taxes on income
Accounting for Investments in Associates in
23 AS 23
Consolidated Financial Statements
24 AS 24 Discontinuing Operations
25 AS 25 Interim Financial Reporting
26 AS 26 Intangible Assets
27 AS 27 Financial Reporting of Interests in Joint Ventures
28 AS 28 Impairment of Assets
Provisions, Contingent Liabilities and Contingent
29 AS 29
Assets

(AS 1) Disclosure of Accounting Policies:-

This Standard requires that proper disclosure of Accounting Policies followed in

the preparation of financial statements should be made in the financial statement itself.
This would facilitate more meaningful comparison of financial statements by users.
While discussing the principle of “Full, Fair and Adequate disclosure “earlier, we have
noted that the user should be provided the accounting information in complete form
which is fair and adequate for his decision making. This Standard makes this concept or
principle to be compulsorily followed by Companies.

This standard lays down that:

• Choice of an accounting concept, principle or policy by a company should be is

based on prudence, materiality and the principle of substance over form.

• All significant accounting policies adopted in preparation of financial statements

are to be disclosed. Significance is to be decided from user’s point of view and
not from the point of Management. What is important to a reader of financial
statement might not be important to Management. Usually the accounting policies
adopted are disclosed by way of ‘Notes to Accounts’ at the end of Financial
Statements.
• Changes in accounting policies are to be disclosed with its effect on financial
statements. For example, if a company changes the method of charging
depreciation on its assets from Straight Line Basis to Written Down Value

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method, the effect of such change on Profits or Assets should be disclosed in the
Notes to financial statements.

• Accounting assumptions, if not followed, disclosure is required. We have studied

that accounting conventions are universally followed. However if they are not
followed by a firm, it should mention the fact by way a Note to financial
statements.

(AS 2) Valuation of Inventories:-

Inventory is stock of goods for sale or consumption in a business. Inventory can be

classified as follows:

• Raw materials

• Finished goods

• Work in progress

• Stores, consumables etc.

Internal control as to inventory is very important as frauds and errors frequently occur in
this area. Misappropriation of goods is common if no control over inventory exist.

Similarly ’stock records’ are subject to manipulation also. Items in stocks at the end of
the year can be valued at more value to show more profit or at less value to show less
profits. Thus fraudulent financial reporting can be resorted to with reference to inventory
valuation.

Hence a Standard is necessary with regard to inventory valuation.

Purpose of this Standard is to:

• Determine what is inventory in case of a business.

• Provide standard as to measurement and classification of inventory .

Such an analysis of inventory would ensure true and fairness of Profit and Loss Account
and Balance Sheet as far as inventory is concerned.

Main stipulations laid down by this standard are:

• Revenue and capital expenditure distinction is to be made while deciding what is

inventory. Goods meant for sale during the regular business are inventory. For
example, a car is inventory for a car dealer but a fixed asset for a doctor as the
latter is not buying and selling the car regularly.

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• Valuation-method as to inventory can be FIFO (First in First out) or Weighted

average and not any other method.

o FIFO method of valuation assumes that goods that have been bought first
are sold first. Thus the closing stock consists of goods that are bought
later. Valuation of closing stock would be at latest prices.

o In Weighted average method , the stocks are issued or valued at the

weighted average cost of purchase till that point.

Thus internal control over purchases, stores etc. should be designed according to
these Standards.

(AS 3) Cash Flow Statements:-

Cash flow statements provide the summary of inflow and outflow of cash in a business.
Cash flow statements are now a part of financial statements, in case of a listed (listed
with stock exchanges) company in India.

Purpose of this standard is to provide more meaningful disclosure and comparison

between two sets of cash flow statements.

This standard stipulates that Cash Flow Statement has to disclose the following
information

• Cash flow from operating activities.

• Operating activities are regular business activities of a company.

• Cash flow from financing activities.

Financing activities involve inflow like raising capital, borrowing loans and similarly
outflow like repayment of loan, redemption of preference shares etc.

• Cash flow from investing activities

- Investing activities involve outflow like purchase of fixed assets or

investments and inflow like sale of fixed assets or investments.

(AS 4) Contingencies and Events Occurring after the Balance Sheet Date:-

Contingent losses are those which may happen only when another event on which
contingent event is dependant occurs or not occurs.

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For example, in case of a bank guarantee issued by a bank, only in the event of the
person on whose behalf the Bank Guarantee has been issued defaults , the bank is
liable for payment .

Similarly, some of the events that occur after the Balance Sheet date, though are not
reflected in the financial statements, nevertheless effect the decision-making of any
investor, creditor or any stakeholder.

For example, a major fire occurring after the Balance Sheet date, which destroys entire
factory of a company, is an event that will effect the decision of a potential investor of or
lender to that company. Hence this fact is to be disclosed in financial statements.

This Standard lays down that as a conservative measure contingent losses and events
occurring after Balance Sheet date are to be disclosed by way of a Note in the
Statements. This would help in proper evaluation of financial statements.

The statement also stipulates that contingent gains should not to be accounted as a
conservative measure.

(AS 5) Net Profit or Loss for the period, Prior Period and Extraordinary Items and
Changes in Accounting Policies:-

This Standard lays down that distinction should be made between Ordinary and
Extraordinary items and Prior period item in the financial statements.

For example, if a huge tax payment of earlier year is made this fact is to be separately
mentioned in the financial statements as it is a “prior period item”.

A bank might have spent huge money on Voluntary Retirement Scheme of its
employees. This is not an expense of one year. The bank even though shows such
expense as revenue expenditure, should show it separately as an Extra ordinary
expense.

Similarly, a company if it makes huge profit by selling its land and building cannot club it
with its regular business income. Such extraordinary profit should be separately
mentioned in Profit and Loss Account.

Similarly changes in accounting estimates and accounting policies and their effect on
financial statements are to be distinguished and disclosed in the financial statements. In
this regard we have already studied in AS1.

(AS 6) Depreciation Accounting:-

Depreciation is an estimated amount written from the value of assets and shown
as expense. Manipulation of profit and asset is possible by manipulating such estimate.

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We have seen earlier how providing more or less depreciation can reduce or inflate the
profits.

True and fairness as to assets can be decided by correct measure of Depreciation.

Similarly profit or loss can be decided fairly if correct depreciation is provided.

This Standard stipulates that:

• Depreciation should be provided on fixed assets.

• Depreciation amount should be based on the life of the asset.

• Depreciation method followed should be consistent from year to year.

• Effect of changes in method of depreciation should be disclosed in the financial

statements.

(AS 7) Accounting for Construction contracts:-

Construction contracts are of special types of business as the profit or loss can be
decided only on final completion of the contract. However construction companies might
have to show estimated profits or losses every year in their financial statements.

Purpose of this Standard is to decide when and how the revenue and costs of a
construction contract are to be recognized as the contract may take more than a year to
complete.

The Standard stipulates that companies have to follow “percentage completion method ”
and show profit or loss every year during which construction is undertaken as per the
rules laid down in the Standard.

(AS 8)Accounting for Research and Development:-

This standard was dealing with R& D Expenditure. However the Standard has withdrawn
as new Standard on “intangibles” has been introduced.

(AS 9) Revenue Recognition:-

Purpose of this Standard is to lay down principles to correctly recognize what is the
revenue of an enterprise and to match revenue to cost. Some problem areas addressed
by this Standard are:

• Grounds for classifying a revenue into sale or service or other income, for
example, contract for supply and erection of plant whether service or sale might
have to be decided based on the factors laid down in this standard.

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• Time when the revenue is to be recognized, for example, whether a particular

transaction is complete on delivery or on sending invoice or on getting an order is
to be decided based on the rules laid down in this Standard.

• Treatment of revenue in case of uncertainty of its collection.

(AS 10) Accounting for Fixed Assets:-

The Financial Statement i.e. Balance Sheet has to represent true and fair value of fixed
assets.

For this, distinguishing between revenue and capital expenditure is required. Factors
which pose problem in this regard are:

• Capitalization of borrowing costs:- Interest paid on loans for acquiring assets

which are not put to use.

• Payment for technical know:- How whether these are revenue expenditure or
capital expenditure are to be decided.

• Project delays:- might result in assets not being put to use. What should be the
treatment of expenses related to asset is to be decided.

• Non-monetary consideration paid to acquire an asset:- for example parts of

assets might have been manufactured in the factory itself. What should be the
cost of asset might have to be decided.

• Nature of repairs to assets:- a company might incur heavy repairs to an asset

due to which more benefit might occur out of that asset. Is the repair a revenue or
capital expenditure - is to be decided.

• Foreign Exchange loss or profit while acquiring an asset:- Whether to be

adjusted to the cost of the asset or shown separately in Profit and Loss Account
is to be decided.

This standard provides guidance for all these problematic issues pertaining to different
accounting matters relating to fixed assets. Similarly how Revaluation of fixed assets-is
to be treated in the books is also dealt in this Standard.

The Standard also provides how Assets are to be “presented” in Balance Sheet.

(AS 11) Accounting for the Effects of Changes in Foreign Exchange Rates:-

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The problem with regard to foreign exchange transactions done when business is within
the country as well as outside the country in foreign branches of a company are that -the
exact value at which these are to be represented in Indian currency (Rupees) cannot be
easily arrived at, due to exchange rate fluctuations.

For example, you may have imported machinery at $10000 when the rate was
Rs45/US$ whereas while making payment of this $10000, you have to pay by dollars
say, at Rs. 48 per US $. How the loss of
Rs. 30,000 (Rs. 3×10000) is to be treated in the books is dealt in this Standard.

This standard lays down the rules for treatment of foreign exchange profit or losses in
various types of transactions of an entity.

It also stipulates the manner of presenting in the assets and liabilities held at foreign
branches of an entity.

(AS 12) Accounting for Government Grants:-

The nature of grants from Governments is unique. Sometimes they may be given to
acquire some asset, sometimes as a concession, sometimes as incentive like subsidy.

Further these grants may not be received within the stipulated date though sanctioned.

Hence this standard lays down the guidelines to properly account/disclose different
types of Government Grants.

(AS 13) Accounting for Investments:-

Investments are usually in assets like shares, debentures, fixed deposits etc held by
companies.

Some of these may be held for long term and some may be held for short term. The
value of investment in shares is fluctuating and hence on a Balance Sheet date the
value of such investments may have appreciated or declined.

Purpose of this standard then is to properly reflect nature of investments, their cost and
valuation in financial statements.

The standard stipulates that:

• Classifying investments into current and long term is needed.

• Decrease in value in current investments is to be accounted.

• Only permanent decline in value of Long Term investments is to be accounted.

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• Distinction is to be made between Quoted and unquoted investments.

(AS 14) Accounting for Amalgamations:-

Specific accounting issues relating to amalgamation or merger of two companies are

dealt here. The standard has been introduced to reflect nature of amalgamation and
determination of treatment of goodwill or reserve and such other issues.

(AS 15) Accounting for Retirement Benefits in the Financial Statement of

Employers:-

Retirement benefits are provided to employees by employer. They consist of benefits

like pension, gratuity, provident fund, leave encashment etc. These are paid to
employee only on retirement. However setting aside a sum towards these expenses
every year is prudent step by employer.

This standard also stipulates that such provision is to be made. Companies are required
to properly and systematically account retirement benefits like pension, gratuity in their
books.

Issues discussed here are:

• Manner of funding of retirement schemes-definition of ‘contribution schemes’.

• Actuarial valuation methods that are to be considered in making provision for

these expenses in the books of the employer.

Thus while establishing internal controls for Personnel function these aspects are to be
taken care of by the Management.

(AS 16) on Borrowing Costs:-

Borrowing costs are usually interest paid on funds borrowed. Such funds may have
been used to acquire an asset which has not yet been put to use.

Whether the interest paid in such cases is revenue expenditure or is part of the cost of
the asset has been discussed in this standard. Purpose of this standard is to correctly
account the borrowing costs when they are incurred for buying assets.

Issues dealt here are:

• Definition of qualifying assets which take substantial period to get ready for their
intended use or sale.
• Capitalization or charging to revenue is to be decided as to interest on borrowings
used to acquire such assets.

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• When such capitalization commences or suspends or ceases is discussed here.

(AS 17) Segment Reporting:-

These days all major institutions have many segments of businesses-product-wise or

geographic area-wise. Some segment may be providing profits to the firm while other
may be incurring losses. Segmented information will provide the users better
understanding of business and performance of an entity. This Standard lays down that
such segment-wise profitability is to be provided by Companies.

This standard lays down the manner of defining such segments, arriving at the revenue,
expenditure, asset and liability of each segment.

(AS 18) Related Party Disclosures:-

Transaction done with any party which is related to Management of a company is often
suspected. To have good corporate governance the related-party transactions should
not be misused in any organization. This Standard requires that related-party
transactions are to be disclosed separately as a part of financial statements.

Issues dealt here are-

• Definition of a related party as- “person having control and significant influence”.

• Relative, key management personnel, associates, joint venture are some of the
terms defined in this standard.

• Related party transactions can be of different types.

• Related party relationships are also of many types according to this Standard.

(AS 19) Leases:-

Leases are peculiar transactions where the assets are not recorded in the books of the
user of such assets as Assets, whereas they are recorded in the books of the owner
even through the physical existence of the asset is with the user (lessee).

The purpose of this Standard is to correctly depict the right and position of assets in a
lease.

Issues dealt here are:

• “Financial leases” and “Operative leases” are to be identified first.

• In financial lease lessee has to account the assets and claim depreciation.

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• For taxation purpose lessor may still continue to be owner based on the terms of
lease.

(AS 20) Earnings per Share (EPS):-

The Purpose of this Standard is to provide principles of determination of EPS, as most

of the decision makers like investors rely on EPS when deciding to buy or sell a
share/stock of any company.

Issues dealt are:

• Determining the value of earnings, number of shares of the entity.

• Issues relating to calculation of EPS during amalgamation, in case of partly paid

shares or bonus shares.

• The standard stipulates that the companies have to disclose Diluted EPS in
cases of future conversion of bonds or warrants into shares.

(AS 21) Consolidated Financial Statements:-

These days many companies have subsidiaries and associate concerns. The
performance as group may totally vary in relation to individual performance of the
Company. Hence information on group performance is needed.

Purpose of this Standard is to know the financial position of the entire group and not
only of the concern which is submitting the financial statements. This would help in
correct decision making by the stakeholders like investors or creditors.

(AS 22) Accounting for Taxes on Income:-

Taxes are deferred /postponed due to provisions of Taxation Laws. Firms claim higher
depreciation than shown in the books for tax purpose. Similarly due to facility of ”carry
forward of losses”, the income of an entity may not be taxed up to certain number of
years in future. This leads to wrong information being provided in the financial
statements as to taxes. This standard requires that effects of such deferred taxes are to
be accounted in the books.

(AS 23) Accounting for investments in associates in consolidated financial

statements:-

Many scams like that of Enron have occurred due to non-disclosure of liabilities of the
company as to investments made in associated concerns. Purpose of this standard is to
fairly account the position of investments in associate concerns so that any liability in
this regard is disclosed.

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(AS 24) Discontinuing Operations:-

Purpose of this Standard is to establish principles for reporting information about

discontinuing operations thereby enhance the user’s ability to make projections.

(AS 25) Interim financial reporting:-

Statutory bodies like SEBI stipulate that the companies have to report quarterly
performance. However in the absence of correct standard quarterly financial statements
are misleading as only a review and not audit of these statements are made by the
auditor. Hence the purpose of this standard is to prescribe minimum content of interim
financial report and to prescribe principles for recognition and measurement in a
complete or condensed financial statement for an interim period.

Issues as to calculation of taxes, retirement benefits, damages, seasonal effect, intra-

company transactions in interim reports are discussed here.

(AS 26) Intangible assets:-

Purpose of this Standard is to provide the accounting treatment for intangible assets that
are not dealt in any other Standard. Issues dealt here are:

• Criteria of recognition of intangibles are -identifiably, control, future economic

benefits and measurement of cost.

• Amortization methods of intangibles.

• Brand valuation, HR valuation.

(AS 27) Financial reporting of interest in joint ventures (JVs):-

Purpose this standard is to set out principles and procedures for accounting for interest
in JVs and reporting of JV assets, liabilities, income, expenses in financial statement of
investor or venturer.

(AS 28) Impairment of Assets:-

Scams like that of World.com occurred due to non-disclosure of erosion in value of

assets. Purpose of this standard is to disclose fair value of assets by providing for
impairment (reduction in value).

Issues dealt here are:

• Factors which decide impairment can be internal or external sources of

information.

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• Net selling price based on binding sale, active market, best estimate are the
valuation methods of assets.

• If value in use is more than recoverable value, providing for impairment is

necessary.

• Annual review, reversal of impairment is to be made.

(AS 29) Provisions, Contingent liabilities and assets:-

This standard provides standards as to when and how provisions are to be made for
liabilities; How to differentiate a liability from contingent liability and how to identify and
treat a contingent asset.

Q.3. What is SOX? Explain the main features of SOX.

Answer:
The Sarbanes–Oxley Act of 2002, also known as the 'Public Company Accounting
Reform and Investor Protection Act' (in the Senate) and 'Corporate and Auditing
Accountability and Responsibility Act' (in the House) and commonly called Sarbanes–
Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, which
set new or enhanced standards for all U.S. public company boards, management and
public accounting firms. It is named after sponsors U.S. Senator Paul Sarbanes (D-MD)
and U.S. Representative Michael G. Oxley (R-OH).

The bill was enacted as a reaction to a number of major corporate and accounting
scandals including those affecting Enron, Tyco International, Adelphia, Peregrine
Systems and WorldCom. These scandals, which cost investors billions of dollars when
the share prices of affected companies collapsed, shook public confidence in the
nation's securities markets.

It does not apply to privately held companies. The act contains 11 titles, or sections,
ranging from additional corporate board responsibilities to criminal penalties, and
requires the Securities and Exchange Commission (SEC) to implement rulings on
requirements to comply with the new law. Harvey Pitt, the 26th chairman of the
Securities and Exchange Commission (SEC), led the SEC in the adoption of dozens of
rules to implement the Sarbanes–Oxley Act. It created a new, quasi-public agency, the
Public Company Accounting Oversight Board, or PCAOB, charged with overseeing,
regulating, inspecting and disciplining accounting firms in their roles as auditors of public
companies. The act also covers issues such as auditor independence, corporate
governance, internal control assessment, and enhanced financial disclosure.

The act was approved by the House by a vote of 421 in favor, 3 opposed, and 8
abstaining and by the Senate with a vote of 99 in favor, 1 abstaining. President George
W. Bush signed it into law, stating it included "the most far-reaching reforms of American
business practices since the time of Franklin D. Roosevelt."

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Debate continues over the perceived benefits and costs of SOX. Supporters contend the
legislation was necessary and has played a useful role in restoring public confidence in
the nation's capital markets by, among other things, strengthening corporate accounting
controls. Opponents of the bill claim it has reduced America's international competitive
edge against foreign financial service providers, saying SOX has introduced an overly
complex regulatory environment into U.S. financial markets. Proponents of the measure
say that SOX has been a "godsend" for improving the confidence of fund managers and
other investors with regard to the veracity of corporate financial statements.

Overview:-
Sarbanes-Oxley contains 11 titles that describe specific mandates and requirements for
financial reporting. Each title consists of several sections, summarized below:

TITLE I – “Public Company Accounting Oversight Board (PCAOB)” :-

Title I establishes the Public Company Accounting Oversight Board (PCAOB), to provide
independent oversight of public accounting firms providing audit services ("auditors"). It
also creates a central oversight board tasked with registering auditors, defining the
specific processes and procedures for compliance audits, inspecting and policing
conduct and quality control, and enforcing compliance with the specific mandates of
SOX. Title I consists of nine sections.

TITLE II - “Auditors Independence”:-

Title II, which consists of nine sections, establishes standards for external auditor
independence, to limit conflicts of interest. It also addresses new auditor approval
requirements, audit partner rotation policy, conflict of interest issues and auditor
reporting requirements. Section 201 of this title restricts auditing companies from doing
other kinds of business apart from auditing with the same clients.

TITLE III - “Corporate Responsibility”

Title III mandates that senior executives take individual responsibility for the accuracy
and completeness of corporate financial reports. It defines the interaction of external
auditors and corporate audit committees, and specifies the responsibility of corporate
officers for the accuracy and validity of corporate financial reports. It enumerates specific
limits on the behaviors of corporate officers and describes specific forfeitures of benefits
and civil penalties for non-compliance. For example, Section 302 implies that the
company board (Chief Executive Officer, Chief Financial Officer) should certify and
approve the integrity of their company financial reports quarterly. This helps establish
accountability. Title III consists of eight sections.

TITLE IV - “Enhanced Financial Disclosures”:-

Title IV consists of nine sections. It describes enhanced reporting requirements for
financial transactions, including off-balance sheet transactions, pro-forma figures and
stock transactions of corporate officers. It requires internal controls for assuring the
accuracy of financial reports and disclosures, and mandates both audits and reports on
those controls. It also requires timely reporting of material changes in financial condition
and specific enhanced reviews by the SEC or its agents of corporate reports.

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TITLE V - “Analyst Conflicts of Interest”:-

Title V consists of only one section, which includes measures designed to help restore
investor confidence in the reporting of securities analysts. It defines the codes of
conduct for securities analysts and requires disclosure of knowable conflicts of interest.

TITLE VI - “Commission Resources and Authority”:-

Title VI consists of four sections and defines practices to restore investor confidence in
securities analysts. It also defines the SEC’s authority to censure or bar securities
professionals from practice and defines conditions under which a person can be barred
from practicing as a broker, adviser or dealer.

TITLE VII – “Studies and Reports”:-

Title VII consists of five sections. These sections 701 to 705 are concerned with
conducting research for enforcing actions against violations by the SEC registrants
(companies) and auditors. Studies and reports include the effects of consolidation of
public accounting firms, the role of credit rating agencies in the operation of securities
markets, securities violations and enforcement actions, and whether investment banks
assisted Enron, Global Crossing and others to manipulate earnings and obfuscate true
financial conditions.

TITLE VIII – “Corporate and Criminal Fraud Accountability”:-

Title VIII consists of seven sections and it also referred to as the “Corporate and
Criminal Fraud Act of 2002.” It describes specific criminal penalties for fraud by
manipulation, destruction or alteration of financial records or other interference with
investigations, while providing certain protections for whistle-blowers.

TITLE IX – “White Collar Crime Penalty Enhancement”:-

Title IX consists of two sections. This section is also called the “White Collar Crime
Penalty Enhancement Act of 2002.” This section increases the criminal penalties
associated with white-collar crimes and conspiracies. It recommends stronger
sentencing guidelines and specifically adds failure to certify corporate financial reports
as a criminal offense.

TITLE X – “Corporate Tax Returns”:-

Title X consists of one section. Section 1001 states that the Chief Executive Officer
should sign the company tax return.

TITLE XI – “Corporate Fraud Accountability”:-

Title XI consists of seven sections. Section 1101 recommends a name for this title as
“Corporate Fraud Accountability Act of 2002” . It identifies corporate fraud and records
tampering as criminal offenses and joins those offenses to specific penalties. It also
revises sentencing guidelines and strengthens their penalties. This enables the SEC to
temporarily freeze large or unusual payments.

SOX and Internal Control:-

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An Overview of Sarbanes-Oxley Act:-

• SOX became law on July 30, 2002(after the Enron Scam).

• The Act established a Board (PCAOB) to create auditing standards and

regulation for all Security Exchange Commission (SEC) registrants.

• It created specific corporate responsibility for financial reporting, internal controls

and audit committee standards.

• It enacted rules relevant to attorneys, securities analysts, auditors and brokers in

relation to financial reporting.

• It established criminal penalties for non-compliance of its provisions.

Objectives of SOX:-

• Provides confidence and trust to investors and public in the post-Enron era.

• Requires management accountability – focus on rapid identification & correction

of internal control weaknesses along with additional financial disclosure
requirements.

• Holds external auditors to higher attestation standards.

Key Sections of SOX:-

• Section 302 requires the CEO (Chief Executive Officer) and CFO(Chief Financial
Officer) of a Company to sign on a quarterly basis on financial statements of that
quarter, attesting fairness and internal control effectiveness. They also must
report any significant changes in internal controls since their last evaluation.

• Section 404 requires a separate management report on internal control

effectiveness and audit by the organization’s external financial statement auditor.

• Section 906 is related to Sections 302 and 404, and requires that CEOs and
CFOs ensure all financial reporting (including annual and periodic reports) fairly
presents, in all material respects, the financial condition and results of operations
of the issuer. It also provides for significant criminal penalties for non-compliance.

• Section 201 prohibits a registered public accounting firm from performing both
audit and non-audit services.

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• Section 301 requires an audit committee to establish “whistleblower” procedures

to allow the confidential and anonymous submission of concerns regarding
questionable accounting or auditing matters.

• Section 409 requires disclosure to the public on rapid and current basis
additional information concerning material changes in the financial condition or
operations of the issuer.

Effect of SOC on Internal Control:-

SOX was far-reaching and contained many new regulations. Of particular interest
to us are the new rules regarding the reporting of evaluations related to internal
control over financial reporting.

These are required by Section 404(a) and (b) of SOX details of which are as
follows:

Each annual report of a company has to contain an “internal control report”,

which shall:

• State the responsibility of management for establishing and maintaining an

adequate internal control structure and procedures for financial reporting.

• Contain an assessment, as of the end of the issuer’s fiscal year, of the

effectiveness of the internal control structure and procedures of the company for
financial reporting.

• In addition, the Act via Section 404(b) which covers Internal Control Evaluation
and reporting, requires in respect of the internal control assessment, that the
organization’s auditor shall attest to, and report on the assessment made by
Management.

Adequacy of SOX Regulation:-

Though SOX is regarded as effective measure to reduce fraudulent financial

reporting and enabler of strengthening of internal controls in companies few
regard that it is not adequate. Some comments on SOX are as follows:

• SOX focuses on one specific aspect of internal control, that related to internal
control over financial reporting whereas, as has been previously noted in Unit 01
the key internal control frameworks such as COSO, Turnbull and Co Co take a
wider business led approach and cover all controls.
• Assessments of internal control using the SOX definition are less likely to focus
on the business benefits that can result from a review of the wider aspects of
internal control and the related processes for risk management.

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New integrated approaches to internal control:-

New benchmarks with regard to internal controls are being suggested by many
reputed organizations like COSO which prescribe a principle based than rule
based view of internal controls.

For example, COSO has developed an Enterprise Risk Management Process

which is defined as:

“Enterprise risk management (ERM) is a process, effected by an entity’s board

of directors, management and other personnel, applied in strategy setting and
across the enterprise, designed to identify potential events that may affect the
entity, and manage risk to be within its risk appetite, to provide reasonable
assurance regarding the achievement of entity objectives.”

The key point here is that those charged with governance should adopt a risk-
based approach to internal control and any internal assessment of its
effectiveness. COSO’s ERM believes that this approach should be incorporated
into the strategic, governance and management processes of the company and
should encompass the wider aspects of internal control, not just those directly
related to financial reporting as in the case of SOX.

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