196 Paper3Module-3

Final Course
(Revised Scheme of Education and Training)

Study Material
(Modules 1 to 3)
Paper 3
Advanced Auditing and

Professional Ethics
Module – 3
BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
© The Institute of Chartered Accountants of India

ii
This study material has been prepared by the faculty of the Board of Studies. The objective of the
study material is to provide teaching material to the students to enable them to obtain knowledge
in the subject. In case students need any clarifications or have any suggestions for further
improvement of the material contained herein, they may write to the Director of Studies.
All care has been taken to provide interpretations and discussions in a manner useful for the
students. However, the study material has not been specifically discussed by the Council of the
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represent the views of the Council or any of its Committees.
Permission of the Institute is essential for reproduction of any portion of this material.
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otherwise, without prior permission, in writing, from the publisher.
Edition : August, 2019
Website : www.icai.org
E-mail : bosnoida@icai.in
Committee/ : Board of Studies

Department
ISBN No. :
Price (All Modules) : `
Published by : The Publication Department on behalf of The Institute of Chartered

Accountants of India, ICAI Bhawan, Post Box No. 7100,
Indraprastha Marg, New Delhi 110 002, India.
Printed by :

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CONTENTS
MODULE – 1
Chapter 1: Auditing Standards, Statements and Guidance Notes – An Overview
Chapter 2: Audit Planning, Strategy and Execution
Chapter 3: Risk Assessment and Internal Control
Chapter 4: Special Aspects of Auditing in an Automated Environment
Chapter 5: Audit of Limited Companies
Chapter 6: Audit Reports
MODULE – 2
Chapter 7: Audit Committee and Corporate Governance
Chapter 8: Audit of Consolidated Financial Statements
Chapter 9: Audit of Banks
Chapter 10: Audit of Insurance Companies
Chapter 11: Audit of Non Banking Financial Companies
Chapter 12: Audit under Fiscal Laws
MODULE – 3
Chapter 13: Audit of Public Sector Undertakings
Chapter 14: Liabilities of Auditors
Chapter 15: Internal Audit, Management and Operational Audit
Chapter 16: Due Diligence, Investigation and Forensic Audit
Chapter 17: Peer Review and Quality Review
Chapter 18: Professional Ethics

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DETAILED CONTENTS MODULE - 3
CHAPTER 13: AUDIT OF PUBLIC SECTOR UNDERTAKINGS
LEARNING OUTCOMES ......................................................................................................... 13.1

CHAPTER OVERVIEW ........................................................................................................... 13.2
Contents:
1. Introduction ............................................................................................................... 13.2
2. Framework for Government Audit ............................................................................... 13.2
3. Objective and Scope of Public Enterprises Audit......................................................... 13.6
3.1 Elements of PSU Audits ................................................................................ 13.8
3.2 Principles of PSU Audits ............................................................................... 13.9
4. Audit of Government Companies .............................................................................. 13.10
5. Financial Audit ......................................................................................................... 13.11
6. Compliance Audit ..................................................................................................... 13.12
7. Performance Audit ................................................................................................... 13.13
7.1 Provisions contained in Companies Act, 2013 and C&AG’s
(Duties, Powers and Conditions of Service) Act, 1971.................................. 13.15
7.2 Objectives of Performance Auditing ............................................................. 13.16
7.3 Planning for Performance Audit ................................................................... 13.17
8. Comprehensive Audit ............................................................................................... 13.23
9. Propriety Audit ......................................................................................................... 13.24
9.1 Definition and Principles ............................................................................. 13.25
9.2 Relevant provisions in the Companies Act, 2013 ......................................... 13.26
9.3 Propriety Elements under CARO, 2016 ....................................................... 13.28
10. Audit Report of the Comptroller and Auditor General ................................................ 13.32
TEST YOUR KNOWLEDGE .................................................................................................. 13.32

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CHAPTER 14: LIABILITIES OF AUDITOR

Contents:
1. Nature of Auditor’s Liability ....................................................................................... 14.2
1.1 Taking assistance in the discharge of his duties ............................................ 14.2
1.2 Basis of liability ............................................................................................. 14.3
2. Professional negligence ............................................................................................. 14.4
3. Cases concerning the civil liability of auditors for negligence..................................... 14.14
4. Civil liabilities under the Companies Act ................................................................... 14.17
5. Criminal liability under the Companies Act ................................................................ 14.23
5.1 Cases in which an auditor has been held to have incurred
Criminal Liability............................................................................................. 14.25
6. Case concerning the misconduct of auditors under the
Chartered Accountants Act....................................................................................... 14.27
7. Liabilities under Income-tax Act 1961 ....................................................................... 14.29
CHAPTER 15: INTERNAL AUDIT MANAGEMENT AND OPERATION AUDIT

Contents:
1. Internal Audit ............................................................................................................. 15.3
2. Management Functions and Scope of Internal Auditing ............................................... 15.6
3. Integrity, Objectivity and Independence of Internal Auditor ........................................ 15.10
4. Qualifications of Internal Auditor ............................................................................... 15.11
5. Internal Audit Report ................................................................................................ 15.11
5.1 Essential features of a good Internal Audit Report ....................................... 15.14
5.2 Follow up .................................................................................................... 15.16

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6. Relationship between Internal and External Auditors ................................................ 15.16

6.1 Determining whether, in which areas, and to what extent the
work of the Internal Audit function can be used ............................................ 15.18
6.2 Determining the Nature and Extent of work of the
Internal Audit function that can be used ....................................................... 15.18
6.3 Determining whether in which areas, and to what extent Internal
Auditors can be used to provide direct assistance ....................................... 15.19
6.4 If the external auditor uses internal auditors to provide direct
assistance on the audit, the external auditor shall include
in the audit documentation .......................................................................... 15.19
7. Management Audit ................................................................................................... 15.20
7.1 Management and Operational Audit ............................................................ 15.21
7.2 Scope ......................................................................................................... 15.21
7.3 Desirability of Management Audit ................................................................ 15.23
7.4 Organising the Management Audit .............................................................. 15.24
7.5 Conducting a Management Audit ................................................................. 15.26
7.6 Concluding a Management Audit ................................................................. 15.27
7.7 Management Audit Report........................................................................... 15.28
7.8 Behavioral Aspects encountered in a Management Audit ............................. 15.31
8. Operational Audit .................................................................................................... 15.34
8.1 Relationship between Internal Auditing and Operational Auditing ................ 15.34
8.2 Qualities of Operational Audit ..................................................................... 15.37
8.3 Why Operational Audit ................................................................................ 15.38
8.4 Types of Operational Audit .......................................................................... 15.39
8.5 Objectives of Operational Audit ................................................................... 15.40
9. Review of System and Procedures ........................................................................... 15.42
9.1 Systems ..................................................................................................... 15.42
9.2 Procedure ................................................................................................... 15.42
9.3 Review of Systems and Procedures ............................................................ 15.43
10. Management Audit Questionnaire............................................................................. 15.44

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CHAPTER 16-DUE DILIGENCE, INVESTIGATION & FORENSIC AUDIT

Contents:
UNIT 1: DUE DILIGENCE
1. Overview ................................................................................................................... 16.2
2. Difference between due diligence and audit ................................................................ 16.2
3. Importance of Due Diligence ...................................................................................... 16.3
4. Classification of Due-Diligence ................................................................................... 16.3
5. Work Approach to Due diligence .............................................................................. 16.10
6. How to Conduct Due Diligence ................................................................................. 16.11
7. Contents of a Due Diligence Report ................................................................................... 16.12
UNIT 2: INVESTIGATION
1. Overview ................................................................................................................. 16.13
2. Audit versus Investigation ........................................................................................ 16.13
3. Steps in Investigation ............................................................................................... 16.15
4. Special Issues in Investigations ................................................................................ 16.18
5. Special Aspects in Connection with Business Investigations ..................................... 16.20
6. Types of Investigation .............................................................................................. 16.27
6.1 Investigation under the Companies Act, 2013 .............................................. 16.28
6.2 Investigation on behalf of an incoming partner ............................................. 16.35
6.3 Investigation for valuation of shares in private companies ............................ 16.37
6.4 Investigation on behalf of a bank proposing to advance
loan to a company ........................................................................................... 16.39
6.5 Investigation of Frauds ................................................................................ 16.42
6.6 Investigation on behalf of an Individual or Firm Proposing
to Buy a Business ....................................................................................... 16.53
6.7 Investigation in connection with review of profit/financial forecasts ............... 16.53

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UNIT 3: FORENSIC AUDIT

1. Overview ................................................................................................................. 16.54
2. Audit v/s Forensic Accounting/Forensic Audit ........................................................... 16.55
3. Forensic Auditor ...................................................................................................... 16.57
3.1 A Forensic Auditor is often involved in ......................................................... 16.57
3.2 Who Retains Forensic Auditors ................................................................... 16.58
3.3 Importance of Forensic Auditors ................................................................. 16.58
3.4 Services rendered by Forensic Auditors ...................................................... 16.58
4. Process of Forensic Accounting ............................................................................... 16.60
5. Forensic Audit Techniques ....................................................................................... 16.62
6. Forensic Audit Report .............................................................................................. 16.65
CHAPTER 17: PEER REVIEW & QUALITY REVIEW

Contents:
UNIT- 1: PEER REVIEW
1. Introduction ............................................................................................................... 17.2
2. Objectives of Peer Review ......................................................................................... 17.2
3. Scope of Peer Review ................................................................................................ 17.3
4. Applicability ............................................................................................................... 17.5
5. Peer Review Board .................................................................................................... 17.7
5.1 Eligibility to be a Reviewer ............................................................................ 17.7
5.2 Qualified Assistant ........................................................................................ 17.8
5.3 Confidentiality ............................................................................................... 17.8
6. Approach of the Reviewer .......................................................................................... 17.9
7. The Peer Review Process ........................................................................................ 17.10
7.1 Selection of Practice Unit & Appointment of Reviewer.................................. 17.10

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7.2 Planning ..................................................................................................... 17.10

7.3 Execution ................................................................................................... 17.11
74 Reporting.................................................................................................... 17.13
8. Inherent Limitations of Review ................................................................................. 17.15
9. Illustrative checklist of Audit Programme of a Practice Unit ....................................... 17.15
UNIT 2: QUALITY REVIEW
1. Introduction ............................................................................................................. 17.20
2. Objectives of Quality Review .................................................................................... 17.20
3. Scope of Quality Review .......................................................................................... 17.21
4. The Quality Review Board (QRB) ............................................................................. 17.22
4.1 Constitution and Composition of Quality Review Board ................................ 17.22
4.2 Functions of Quality Review Board .............................................................. 17.22
4.3 Powers of Quality Review Board … .......... ……………………………………….17.23
5. Selection of Audit Firms ........................................................................................... 17.23
6. The Quality Review Process .................................................................................... 17.24
6.1 Various Stages involved in the conduct of the Quality Review Assignments . 17.25
6.2 Objective of Technical Review .................................................................... 17.26
6.3 Independence and Qualifications of Technical Reviewers ............................ 17.27
6.4 Empanelment of Technical Reviewers ........................................................ 17.27
6.5 On-site visit and Qualified Assistant ............................................................ 17.28
6.6 Confidentiality ............................................................................................ 17.28
6.7 Stage-wise approach of Quality Review Process ........................................ 17.29
6.8 Evaluation of findings .................................................................................. 17.30
7. Reporting and other procedures ............................................................................... 17.30
8. Actions that may be recommended by the Quality Review Board .............................. 17.36
9. Quality Review Checklist .......................................................................................... 17.36

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CHAPTER 18: PROFESSIONAL ETHICS

Contents:
1. Introduction ............................................................................................................... 18.3
2. Part A: General Application of The Code ....................................................................... 18.4
2.1 Introduction and Fundamental Principles - Section 100 .................................. 18.4
2.2 Part B: Professional Accountants in Public Practice ...................................... 18.8
2.3 Part C: Professional Accountants in Business.............................................. 18.12
3. Membership of the Institute ...................................................................................... 18.12
3.1 Disabilities for the Purpose of Membership .................................................. 18.12
3.2 Types of Members of the Institute ............................................................... 18.13
3.3 Removal of Name from the Register ............................................................ 18.14
3.4 Restoration of Membership ......................................................................... 18.14
3.5 Penalty for Falsely Claiming to be a Member etc. ....................................... 18.15
4. Chartered Accountants in Practice ........................................................................... 18.15
4.1 Significance of the Certificate of Practice..................................................... 18.16
4.2 Cancellation and Restoration of Certificate of Practice ................................ 18.17
4.3 Members - deemed to be in Practice ........................................................... 18.17
4.4 Companies not to Engage in Accountancy ................................................... 18.21
4.5 Member in Practice Prohibited from using a designation Other Than
Chartered Accountant ................................................................................ 18.21
4.6 Maintenance of Branch Offices.................................................................... 18.22
4.7 KYC Norms for CA in Practice ..................................................................... 18.25
5. Chartered Accountants in Service ............................................................................ 18.26
6 Disciplinary Procedure ............................................................................................. 18.26
7 Types of Misconduct- Professional or Other ............................................................. 18.28
7.1 Professional Misconduct ............................................................................. 18.28
7.2 Other Misconduct........................................................................................ 18.28

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8. Schedules to the Act ..................................................................................................... 18.29

8.1 The First Schedule ...................................................................................... 18.30
8.2 The Second Schedule: ................................................................................ 18.77
9. Council Guidelines ................................................................................................. 18.100
10. Recommended Self-Regulatory Measures .............................................................. 18.109
10.1 Branch Audits ........................................................................................... 18.109
10.2 Joint Audit ................................................................................................ 18.109
10.3 Ratio Between Qualified and Unqualified Staff ........................................... 18.109
10.4 Disclosure of Interest by Auditors in other Firms ........................................ 18.109
ANNEXURE – 1 .................................................................................................................. 18.110
ANNEXURE – 2 .................................................................................................................. 18.114
ANNEXURE – 3 .................................................................................................................. 18.119
TEST YOUR KNOWLEDGE ................................................................................................ 18.127

13
AUDIT OF PUBLIC SECTOR

UNDERTAKINGS
LEARNING OUTCOMES
After studying this chapter, you will be able to:

 Understand & explain the concept of Compliance Audit, Performance
Audit, Comprehensive Audit & Propriety Audit in relation to C&AG of India.
 Apply & analyse the above-mentioned concepts in moderately complex
scenarios.
CHAPTER OVERVIEW
Audit of Public Sector

Undertakings (PSUs)
Objective
Framework
and Scope Audit of Compliance Comprehensive
for Financial Performance Propriety Audit
of Audit of Government Audit Audit
Government Audit Audit Audit Report
Public Companies
Audit
Enterprises
Elements of Principles of
PSU Audits PSU Audits

13.2 ADVANCED AUDITING AND PROFESSIONAL ETHICS
1. INTRODUCTION
Public sector undertakings in India are fundamentally owned or controlled by central government, or any
state government or governments, or partly by the central government and one or more state
governments. The public enterprises have been assigned a key
role in the socio-economic development of the country. These
enterprises are industries supplying basic inputs to industry and
agriculture, such as coal, oil, steel, minerals and metals,
cement, chemicals and fertilizers and heavy equipment. Public
utilities like the railways, postal and telecom services, electricity
generation and supply, road transport, etc. constitute another
class of public enterprises. Though in the past, the public sector
in India has achieved a dominant role in the national economy,
the private sector is also now actively allowed in various sectors
like electricity generation, telecom services, etc.
Fig.: Audit of PSUs ∗
For example,
Departmentally managed
Indian Railways, Postal
undertakings which form part
Services, Security Printing
and parcel of government
Press, Canteen Stores
activities
Department, etc.
Categories for Government companies and

deemed government
organisation of companies set up under the
PSUs Companies Act, 2013
Corporations set up under For example,

the specific Acts of the Life Insurance Corporation,
legislature Unit Trust of India, etc.
2. FRAMEWORK FOR GOVERNMENT AUDIT

As defined under section 2(45) of the Companies Act, 2013, a “Government Company” is a
company in which not less than 51% of the paid-up share capital is held by the Central Government
or by any State Government or Governments or partly by the Central Government and partly by one
∗
Source of image: Times of India

AUDIT OF PUBLIC SECTOR UNDERTAKINGS 13.3
or more State Governments, and includes a company which is a subsidiary company of such a
Government company.
Government Company
[section 2(45)]
Includes subsidiary
≥ 51% of the paid-up company of a
share capital held by Government company
Any State Government Partly by the Central Government and

Central Government
or Governments partly by one or more State Governments
In India, audit of the above government companies is performed by an independent constitutional

authority, i.e. Comptroller and Audit General of India (C&AG), through the Indian Audit and Accounts
Department. The Constitution of India gives a special status to the C&AG and contains provisions
to safeguard his independence.
Article 148 to 151 of the Constitution prescribes the role of C&AG as follows:
• Appointment of C&AG by the President.

Article • Special procedure for removal of C&AG, only on the ground of proven
148 misbehaviors or incapacity.
• Salary and other conditions of service to be determined by the Parliament.
• Perform such duties and exercise such powers in relation to the accounts of
the Union and States and of any other authority or body as may be pre-
Article scribed by or under any law made by the Parliament.
149 • The C&AG’s (Duties, Powers and Conditions of Service) Act, 1971 defines
these functions and powers in detail.
Article • On the advice of the C&AG, President to prescribe such form in which
150 accounts of the Union and States shall be kept.
Article • Audit reports of the C&AG relating to the accounts of the Central/ State
Government should be submitted to the President/Governor of the State who
151 shall cause them to be laid before Parliament/State Legislative Assemblies.
The Comptroller and Audit General’s (Duties, Power and Conditions of Services) Act, 1971,
prescribes that the C&AG shall hold office for a term of six years or upto the age of 65 years,
whichever is earlier. He can resign at any time through a resignation letter addressed to the
President. The Act also assigns the duties regarding the audit to be followed by C&AG.

The number of organisations subject to the audit of the Comptroller and Auditor General of
India is very large. This includes:
Public commercial
All the Union and State
enterprises controlled by
Government departments
the Union and State
and offices including the
governments, i.e.
Indian Railways and Posts
government companies
and Telecommunications.
and corporations.
Non-commercial
autonomous bodies and Authorities and bodies
authorities owned or substantially financed from
controlled by the Union or Union or State revenues.
the States.
As a result of these numerous audits carried out every year, the Comptroller and Auditor General of
India has been issuing a large number of audit reports.
Audit of Government Companies (Commercial Audit) – There is a special arrangement for the
audit of companies where the equity participation by Government is 51 percent or more. The auditors
of these companies are firms of Chartered Accountants, appointed by the Comptroller & Auditor
General, who gives the auditor directions on the manner in which the audit should be conducted by
them. He is also empowered to comment upon the audit reports of the auditors. In addition, he has
a right to conduct a supplementary audit of such companies and cause test audit if considered
necessary, by an order.
[Note: Audit of Government companies is discussed separately under Para 4]
Audit Board Setup in Commercial Audit – A unique feature of the audit conducted by the Indian
Audit and Accounts Department is the constitution of Audit Boards for conducting comprehensive
audit appraisals of the working of Public Sector Enterprises engaged in diverse sectors of the
economy.
These Audit Boards associate with them experts in disciplines relevant to the appraisals. They discuss their
findings and conclusions with the managements of the enterprises and their controlling ministries and
departments of government to ascertain their view points before finalisation.
The results of such comprehensive appraisals are incorporated by the Comptroller and Auditor
General in his reports.
These Audit Boards have have no separate legal entity and work under the supervision and control
of the Comptroller and Auditor General.
Action on Audit Reports – The scrutiny of the Annual Accounts and the Audit Reports thereon by
the Parliament as a whole would be an arduous task, considering their diverse and specialised

nature, besides imposing excessive demands on the limited time available to the Parliament for
discussion of issues of national importance.
Therefore, the Parliament and the State Legislatures have, for this purpose, constituted specialized
Committees like the Public Accounts Committee (PAC), Estimates Committee and the Committee
on Public Undertakings (COPU), to which these audit Reports and Annual Accounts automatically
stand referred.
Public Accounts Committee (PAC) – It is the duty of the Public Accounts Committee to satisfy
itself:
(i) that the moneys were disbursed legally on the service or purpose to which they were applied;
(ii) that the expenditure incurred was authorised;
(iii) that re-appropriation has been made in accordance with the provisions made (i.e. distribution
of funds).
It is also the duty of the PAC to examine the statement of accounts of autonomous and semi-
autonomous bodies, the audit of which is conducted by the Comptroller & Auditor General either
under the directions of the President or by a Statute of Parliament.
Estimates Committee – The Committee examines the estimates with a view to:
(i) report that economies, improvements in organization, efficiency, consistent with the policy
underlying the estimates may be effected;
(ii) suggest alternative policies;
(iii) examine whether the money is well laid out within the limit; and
(iv) suggest the form in which the estimates shall be presented to Parliament.
The Committee does not comment upon a policy approved by Parliament, but where there is
evidence that a particular policy is not leading to the desired results, or is leading to waste, it is the
duty of the Committee to bring it to the notice of the House.
Committee on Public Undertakings (COPU) – The Committee on Public Undertakings exercises
the same financial control on the public sector undertakings as the PAC exercises over the
functioning of the Government departments. The functions of the Committee are -
(i) to examine the reports and accounts of public undertakings.
(ii) to examine the reports of the C&AG on public undertakings.
(iii) to examine the autonomy and efficiency of public undertakings and to see whether they are being
managed in accordance with sound business principles and prudent commercial practices.
(iv) to exercise such other functions vested in the PAC and the Estimates Committee as are not
covered above and as may be allotted by the Speaker from time to time.

The examination of public enterprises by the Committee takes the form of comprehensive appraisal
or evaluation of performance of the undertaking. It involves a thorough examination, including
evaluation of the policies, programmes and financial working of the undertaking.
The objective of the Financial Committees, in doing so, is not to focus only on the individual
irregularity, but on the defects in the system which led to such irregularity, and the need for correction
of such systems and procedures.
C&AG's Role – The Comptroller & Auditor General of India plays a key role in the functioning of the
financial committees of Parliament and the State Legislatures. He has come to be recognised as a
'friend, philosopher and guide' of the Committees.
(i) His Reports generally form the basis of the Committees' working, although they are not
precluded from examining issues not brought out in his Reports;
(ii) He scrutinises the notes which the Ministries submit to the Committees and helps the
Committees to check the correctness of submissions to the Committees and facts and figures
in their draft reports;
(iv) The Financial Committees present their Report to the Parliament/ State Legislature with their
observations and recommendations.
The various Ministries / Department of the Government are required to inform the Committees
of the action taken by them on the recommendations of the Committees (which are generally
accepted) and the Committees present Action Taken Reports to Parliament / Legislature;
(v) In respect of those Audit Reports, which could not be discussed in detail by the Committees,
written answers are obtained from the Department / Ministry concerned and are sometimes
incorporated in the Reports presented to the Parliament / State Legislature.
This ensures that the Audit Reports are not taken lightly by the Government, even if the entire
report is not deliberated upon by the Committee.
3. OBJECTIVE AND SCOPE OF PUBLIC ENTERPRISES

AUDIT
The C&AG’s (Duties, Power and Conditions of Services) Act, 1971 specifies the entities that come
under audit purview of C&AG at the Union and State level. However, the scope and extent of audit
is determined by the C&AG itself.

Audit Conducted by C&AG
Financial Compliance Performance
(1) Audit of PSUs not constrained to Financial and Compliance Audit: Audit of public
enterprises in India is not restricted to financial and compliance audit; it extends also to
performance (efficiency, economy and effectiveness) with which these operate and fulfill their
objectives and goals.
(2) Propriety Audit: Another aspect of audit relates to questions of propriety. This audit is
directed towards an examination of management decisions in sales, purchases, contracts,
etc. to see whether these have been taken in the best interests of the undertaking and
conform to accepted principles of financial propriety.
(3) Comprehensive Audit: Under comprehensive audit, the C&AG do not really cover again the
field which has already been covered. He conducts an appraisal or an efficiency-cum-
performance audit. He sees whether the undertakings have fulfilled the objectives for which
they have been established, whether value-for-money spent has been obtained, whether the
targets have been achieved, etc. He locates the areas of weakness including review of the
decisions taken by the management and a comprehensive appraisal of the performance of
the undertaking.
(4) Organisation’s Decision to be taken by Competent Authority: In examining the decisions
of a management, the auditor examines that these were taken by the competent authority
after examination of all aspects (economic, technological, public interest) on the basis of all
the relevant information available at that time and taking into consideration the different
alternatives available to management and that the decisions were consistent with the aims
and objectives of the enterprise.
(5) Helping Government: Audit is an instrument of accountability. But an equally important
purpose of audit of public enterprises in India is to help the Government and the enterprise
managements improve their efficiency and effectiveness. This is achieved by bringing out
financial and operational deficiencies, inadequacies or ineffectiveness of systems, shortfalls
in performance, etc. and by analysing the causes of shortfall from acceptable standards of
performance.
(6) Highlighting Issues of Efficient and Economic Operations: Financial performance is
linked with physical performance and issues of efficient and economic operations and
management of resources are highlighted. There is an increasing emphasis on audit being
an instrument of improvement.

(7) Fiscal and Managerial Accountability: In the broader context, Government audit
encompasses two main elements, viz., (a) Fiscal Accountability: It includes audit of
provisions of funds, sanctions, compliances and propriety; and (b) Managerial
Accountability: It includes audit of efficiency, economy and effectiveness (This is often
referred to as efficiency-cum-performance audit).
3.1 Elements of PSU Audits
Public sector auditing augments the confidence of the intended users by providing relevant
information and independent and objective assessments concerning deviations from accepted
standards or principles of good governance.
Audit of all public-sector undertakings has the following basic elements:
Basic Elements
of PSU Audits
Subject matter,
criteria and Types of
Three parties
subject matter engagement
information
Direct
Responsible Attestation
Auditor Intended users Reporting
party Engagements
Engagement
(a) The Three parties - Auditor, Responsible Party and Intended Users.
Auditor: The role of auditor is fulfilled by Supreme Audit Institution (SAI), India and by its
personnel delegated with the duty of conducting audits.
Responsible Party: The relevant responsibilities are determined by constitutional or
legislative arrangement. Generally, auditable entities and those charged with governance of
the auditable entities would be the responsible parties. The responsible parties may be
responsible for the subject matter information, for managing the subject matter or for
addressing recommendations.
Intended Users: Intended users are the individuals, organizations or classes thereof for
whom the auditor prepares the audit report.

(b) Subject matter, criteria and subject matter information.
• This refers to the information, condition or activity that is

Subject matter
measured or evaluated against certain criteria.
Criteria • These are the benchmarks used to evaluate the subject matter.
Subject matter • This refers to the outcome of evaluating or measuring the subject
information matter against the criteria.
(c) Types of engagement - Attestation Engagements and Direct Reporting Engagement.
Attestation Engagements:
In attestation engagements, the responsible party measures the subject matter
against the criteria and presents the subject matter information, on which the
auditor then gathers sufficient and appropriate audit evidence to provide a
reasonable basis for expressing a conclusion.
Direct Reporting Engagement:
In direct reporting engagements, it is the auditor who measures or evaluates the

subject matter against the criteria.
Financial audits are always attestation engagements, as they are based on financial information
presented by the responsible party.
Performance audits and compliance audits are generally direct reporting engagements.
3.2 Principles of PSU Audits

The principles of PSU Audits constitute the general standards that apply to SAI India’s personnel as
auditors and are fundamental to the conduct of all types of PSU Audits.
The principles are categorized into two distinct groups as below:
I. General Principles
II. Principles related to the Audit Process

General Principles
Audit
Professional
Ethics & Team
Judgement, Quality Documen- Commun-
Indepen- Manage- Audit Risk Materiality
due care and Control tation ication
dence ment &
skepticism
Skill
Principles related to the Audit Process

Planning the Audit
Conducting the Audit Reporting & Follow-up
• Establish the terms of the audit.

• obtain understanding of the • Perfom the planned audit • Prepare a report based on
entity. procedures to obtain audit the conclusions reached.
• Conduct Risk assessment of evidence. • Follow-up on reported
problem analysis. • Evaluate audit evidence and draw matters as relevant.
• Identify risks of fraud. conclusions.
• Develop an audit plan.
4. AUDIT OF GOVERNMENT COMPANIES

The following steps are involved in the audit of government companies:
(a) Appointment of Auditors under Section 139(5) and 139(7) read with section 143(5) of the
Companies Act, 2013 - Statutory auditors of Government Companies are appointed or re-
appointed by the C&AG. There is thus, a departure from the practice in vogue in the case of private
sector companies where appointment or re-appointment of the auditors and their remuneration
are decided by the members at the annual general meetings. In the case of government
companies, though the appointment of statutory auditors is done by the C&AG, the remuneration
is left to the individual companies to decide based on certain guidelines given by the C&AG in this
regard.
The C&AG may direct the appointed auditor on the manner in which the accounts of the
Government company are required to be audited and the auditor so appointed has to submit
a copy of the audit report to the Comptroller and Auditor-General of India. The report, among
other things, includes the directions, if any, issued by the C&AG, the action taken thereon
and its impact on the accounts and financial statement of the company.
The report under section 143(5) is in addition to the reports issued by the Statutory Auditors
under various other clauses of section 143.
(b) Supplementary audit under section 143(6)(a) of the Companies Act, 2013 - The
Comptroller and Auditor-General of India shall within 60 days from the date of receipt of the
audit report have a right to conduct a supplementary audit of the financial statements of the
government company by such person or persons as he may authorize in this behalf and for

the purposes of such audit, require information or additional information to be furnished to

any person or persons, so authorised, on such matters, by such person or persons, and in
such form, as the C&AG may direct.
(c) Comment upon or supplement such Audit Report under section 143(6)(b) of the
Companies Act, 2013 - Any comments given by the C&AG upon, or in supplement to, the
audit report issued by the statutory auditors shall be sent by the company to every person
entitled to copies of audited financial statements under sub-section (1) of section 136 of the
said Act i.e. every member of the company, to every trustee for the debenture-holder of any
debentures issued by the company, and to all persons other than such member or trustee,
being the person so entitled and also be placed before the annual general meeting of the
company at the same time and in the same manner as the audit report.
(d) Test audit under section 143(7) of the Companies Act, 2013 - Without prejudice to the
provisions relating to audit and auditor, the C&AG may, in case of any company covered
under sub-section (5) or sub-section (7) of section 139 of the said Act, if he considers
necessary, by an order, cause test audit to be conducted of the accounts of such company
and the provisions of section 19A of the Comptroller and Auditor-General's (Duties, Powers
and Conditions of Service) Act, 1971, shall apply to the report of such test audit.
Audit of Government Companies
Section 143(5)
Section 143(6)
↓ Section 143(7)
↓
Appointment of auditor by C&AG as per section 139(5) or ↓
139(7) C&AG's right to-
* Conduct supplementary C&AG may, by
+ an order, cause
Directions by C&AG, the manner in which accounts shall be audit
test audit
audited * Comment upon or
+ supplement such audit
report
Submission of Auditor's Report to C&AG including-
* Directions issued, if any
* Action taken thereon
* Impact on Accounts
Diagram showing provisions of the Companies Act, 2013 related to Government Audit
5. FINANCIAL AUDIT
Financial audit is primarily conducted to:
express an audit opinion on the financial statements; and
enhance the degree of confidence of intended users in the financial statements.
The C&AG shall express an opinion as to whether the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting framework.

In the case of financial statements prepared in accordance with a fair presentation financial reporting
framework, whether the financial statements are presented fairly, in all material respects, or give a
true and fair view, in accordance with that framework.
6. COMPLIANCE AUDIT
Compliance audit is the independent assessment of whether a given subject matter is in
compliance with the applicable authorities identified as criteria.
This audit is carried out by assessing whether activities, financial transactions and information
comply in all material respects, with the regulatory and other authorities which govern the audited
entity.
Compliance audit is concerned with:
(a) Regularity- adherence of the subject matter to the formal criteria emanating from relevant
laws, regulations and agreements applicable to the entity.
(b) Propriety- observance of the general principles governing sound financial management and
the ethical conduct of public officials.
While regularity is emphasized in compliance auditing, propriety is equally pertinent in the public-
sector context, in which there are certain expectations concerning financial management and the
conduct of officials.
Perspective of Compliance Audit: Compliance Audit is part of a combined audit that may also
include other aspects. Compliance auditing is generally conducted either-
(i) in relation with the audit of financial statements, or
(ii) separately as individual compliance audits, or
(iii) in combination with performance auditing.
(i) audit of financial

statements, or
Compliance Auditing is generally (ii) separately as individual

conducted either: compliance audits, or
(iii) in combination with

performance auditing.

7. PERFORMANCE AUDIT
A performance audit is an objective and systematic examination of evidence for the purpose of
providing an independent assessment of the performance of a government organization,
program, activity, or function in order to provide information to improve public accountability and
facilitate decision-making by parties with responsibility to oversee or initiate corrective action.
Performance audit in PSUs is conducted by the C&AG (Supreme Audit Institutions) through various
subordinate offices of Indian Audit and Accounts Department (IAAD).
In conducting performance audit, the subordinate offices are guided by manual and auditing
standards prescribed by C&AG.
This audit promotes accountability by assisting those charged with governance and oversight
responsibilities to improve performance through an examination of whether:
(a) decisions by the legislature or the executive are efficiently and effectively prepared and
implemented; and
(b) tax payers or citizens have received value for money.
According to the guidelines issued by the C&AG, Performance Audits usually address the issues of:
Economy
Effectiveness Efficiency
(i) Economy- It is minimising the cost of resources used for an activity, having regard to
appropriate quantity, quality and at the best price.
Judging economy implies forming an opinion on the resources (e.g. human, financial and
material) deployed. This requires assessing whether the given resources have been used
economically and acquired in due time, in appropriate quantity and quality at the best price.

(ii) Efficiency- It is the input-output ratio. In the case of public spending, efficiency is achieved
when the output is maximised at the minimum of inputs, or input is minimised for any given
quantity and quality of output.
Auditing efficiency embraces aspects such as whether:
(a) sound procurement practices are followed;
(b) resources are properly protected and maintained;
(c) human, financial and other resources are efficiently used;
(d) optimum amount of resources (staff, equipment, and facilities) are used in producing
or delivering the appropriate quantity and quality of goods or services in a timely
manner;
(e) public sector programmes, entities and activities are efficiently managed, regulated,
organised and executed;
(f) efficient operating procedures are used; and
(g) the objectives of public sector programmes are met cost-effectively.
(iii) Effectiveness- It is the extent to which objectives are achieved and the relationship between
the intended impact and the actual impact of an activity.
In auditing effectiveness, performance audit may, for instance:
(a) assess whether the objectives of and the means provided (legal, financial, etc.) for a
new or ongoing public sector programme are proper, consistent, suitable or relevant
to the policy;
(b) determine the extent to which a program achieves a desired level of program results;
(c) assess and establish with evidence whether the observed direct or indirect social and
economic impacts of a policy are due to the policy or to other causes;
(d) identify factors inhibiting satisfactory performance or goal-fulfilment;
(e) assess whether the programme complements, duplicates, overlaps or counteracts
other related programmes;
(f) assess the effectiveness of the program and/or of individual program components;
(g) determine whether management has considered alternatives for carrying out the
program that might yield desired results more effectively or at a lower cost;
(h) assess the adequacy of the management control system for measuring, monitoring
and reporting a programme's effectiveness;
(i) assess compliance with laws and regulations applicable to the program; and
(j) identify ways of making programmes work more effectively.

Performance Audit Cycle
7.1 Provisions contained in Companies Act, 2013 and C&AG’s (Duties,

Powers, and Conditions of Service) Act, 1971
According to section 19(1) of the Comptroller and Auditor General (Duties, Powers, and Conditions
of Service) Act, 1971, the duties and powers of the Comptroller and Auditor General in relation to
the audit of the Accounts of Government companies shall be performed and exercised by him in
accordance with the provisions of the Companies Act.

Sub-section (6) and (7) of section 143 of the Companies Act, empowers Comptroller and Auditor
General of India to conduct supplementary audit or test audit of Government companies.
The supplementary or test audit conducted by the Comptroller and Auditor General is in the
nature of efficiency-cum-performance appraisal.
Section 143(5) of Companies Act requires the statutory auditor (chartered accountant appointed by
C&AG under section 139(5) or 139(7) of the Act) to submit a copy of his audit report on the accounts
of the Government company to C&AG.
Thus, section 143(6) and 143(7) of the Companies Act empowers C&AG to conduct supplementary
audit and test audit respectively of annual accounts of a Government company.
In so far as statutory corporations are concerned, the respective Statutes provide for audit by C&AG.
The scope includes conducting performance audit of these corporations also though specifically not
stated so.
7.2 Objectives of Performance Auditing
The objectives of performance auditing are evaluation of economy, efficiency, and effectiveness of
policy, programmes, organization and management. It also promotes accountability by assisting
those charged with governance and oversight responsibilities to improve performance; and
transparency by affording taxpayers, those targeted by government policies and other stakeholders
an insight into the management and outcomes of different government activities.
Performance auditing focuses on areas in which it can add value which have the greatest potential
for development. It provides constructive incentives for the responsible parties to take appropriate
action.
Example
Performance Audit of enforcement mechanism for administering the provision of Minimum
Wages Act (a social welfare legislation)
The auditors, who undertake performance audit of a program or unit, must possess knowledge of
the industries or labor contracts where these provisions are applicable and also identify the
population thereof before carrying out audit program. He shall evaluate the standard of living before
implementation and after implementation of the Act.
Further, the auditor shall have to evaluate the evidence available as to nature of returns prescribed
and obtained for taking appropriate action.
The Performance Auditor shall also have to evaluate the economy, efficiency and effectiveness in
the welfare systems to be audited. He can then study the shortcomings in the coordination between
different agencies like labor department, EPF and ESI organization and the control systems and
point out a set of relevant problems.
The auditor shall also have to point out lacuna, if any in the existing legal frame work or enforcement
mechanism to strengthen the objective of legislation. Another possible area of critical audit may be

to study actual level of compensation required in each area keeping in mind the local living conditions
and where the minimum wages prescribed in the statute is demonstrably different from this level he
may report the same to the Government for taking appropriate action.
In this manner, the performance audit can not only examine the reasons for such vagaries but also
ensures that the legislation serves the intended purpose. By reporting the same to the legislature,
the corrective is made possible.
[Note: Interested students may refer to Background Material on Performance Audit of Public Sector
Enterprises in India published by the CPE Committee of ICAI for further reference].
7.3 Planning for Performance Audit
Understanding the entity/programme
Defining the objectives and the scope of audit
Determining audit criteria
Deciding audit approach
Planning for Developing audit questions

Performance Audit
Assessing audit team skills and whether outside
expertise required
Preparing Audit Design Matrix
Establishing time table and resources
Intimation of Audit programme to audit entities
The following steps are suggested to the auditors for planning while conducting the performance
audit:
(A) Understanding the Entity/Programme - It is the starting point for planning individual
performance audit.
Sources for Understanding

the Entity
Academic Special
Documents Legislative Policy Media
or special Past audits focus
of the entity documents documents coverage
research groups

The auditor may use the following sources for understanding the entity:
(i) Documents of the entity: Documents on administration and functions of the entity,
policy files, annual reports, budget documents, accounts, minutes of meetings,
information on the website, internal audit reports, electronic databases and MIS
reports, RTI material etc.
(ii) Legislative documents: Legislation, parliamentary questions and debates, reports of
the Public Accounts Committee, the Committee on Public Undertakings, the Estimates
Committee and letters from Members of Parliament.
(iii) Policy documents: Documents of Planning Commission, Ministry of Finance etc.
(iv) Academic or special research: Independent evaluations on the entity, academic
research and similar work done by other governments and other SAIs.
(v) Past audits: Past financial and performance audits of the entity provide a major
source of information and understanding.
(vi) Media coverage: Print and electronic media - their systematic documentation on
regular basis in a transparent manner.
(vii) Special focus groups: Audit Advisory Committee concerns, annual and special
reports of World Bank, Reserve Bank of India, reports by special interest groups,
NGOs, etc.
(B) Defining the Objectives and the Scope of Audit - The audit objectives should be defined
in a succinct manner as they will impact the nature of the audit, govern its conduct and affect
audit conclusions. Setting audit objectives ensures good quality performance audits. It
facilitates clarity, demonstrates consistent quality of audit and serves as a measure of quality
assurance of the audit.
Defining the scope constricts the audit to significant issues that relate to the audit objectives.
It mainly focuses the extent, timing and nature of the audit.
(C) Determining Audit Criteria - Audit criteria are the standards used to determine whether a
program meets or exceeds expectations. It provides a context for understanding the results
of the audit. Audit criteria are reasonable and attainable standards of performance against
which economy, efficiency and effectiveness of programmes and activities can be assessed.
The audit criteria may be sought to be obtained from the following sources:
(i) procedure manuals of the entity.
(ii) policies, standards, directives and guidelines.
(iii) criteria used by the same entity or other entities in similar activities or programmes.
(iv) independent expert opinion and know how.

(v) new or established scientific knowledge and other reliable information.

(vi) general management and subject matter literature and research papers.
(D) Deciding Audit Approach - There is no uniform audit approach prescribed that can be
applicable to all types of subjects of performance audits. Selection of approach also
determine methods and means used for conducting the audit.
Some of the methods which could be used in conducting performance audits include:
Analysis of Use of existing

Case studies
procedures data
Analysis of Quantitative
Surveys
results analysis
(i) Analysis of procedures: It involves review of the systems in place for planning,
conducting, checking and monitoring the activity. This would consist of examination of
documents such as financial reports, budgets, programme guidelines, procedure
manuals, etc.
(ii) Case studies: A case study is a descriptive analysis of an entity, scheme or a
programme. It involves analysis of a particular issue within the context of the whole
area under review.
(iii) Use of existing data: The audit staff should investigate the data held by entity
management and by other relevant sources. Audit conclusions based on testing of
available data for correctness and completeness enhances the assurance level.
(iv) Surveys: Survey is a method of collecting information from members of a population
to assess the interrelation of events and conditions. Surveys on predetermined
parameters can supplement the audit findings and conclusions adding value to the
performance audits.
(v) Analysis of results: It requires the auditor to carry out actual output-input analysis to
determine the efficiency of the programme.
(vi) Quantitative analysis: It involves examination of available data relating to financials
like earnings, revenue, or data relating to programme implementation like details of
beneficiaries etc. However, it may not be possible for the auditor to work with complete
data due to its high volume. In such cases, sampling techniques are required to be
used.

(E) Developing Audit Questions - Subsequent to designing of audit objectives and

determination of audit criteria, the audit team is required to prepare a list of questions to which
they would seek answers. The questions should be framed in comprehensive manner
involving detailed hierarchy of questions.
(F) Assessing Audit Team Skills and whether Outside Expertise required - It is essential that
the performance auditors possess special aptitude and knowledge. The Auditing Standards
of C&AG of India provide that the audit institution should develop and train the auditors to
enable them to perform their tasks effectively & efficiently and should prepare manuals &
other written guidance notes & instructions concerning conduct of audits.
Given the diverse range of subjects of performance auditing, the audit team needs to develop
sound understanding of the programme or entity proposed to be audited.
The audit team needs to decide at the planning stage on which aspect expertise is required.
Though, the Accountant General may use the work of an expert, he retains full responsibility
for the expression of opinion in the auditor’s report.
(G) Preparing Audit Design Matrix (ADM) - Having determined the audit objective, audit criteria,
audit approach, data collection etc., audit team should prepare an Audit Design Matrix. It is
a structured and highly focused approach to designing a performance audit study.
The ADM highlights the data collection and analysis method as well as the type and sources
of evidence required to support audit opinion/findings.
A specimen of ADM is given as under:
Audit Objective Audit Questions Audit Criteria Evidence Data Collection and
Analysis Method
(1) (2) (3) (4) (5)
An ADM is prepared on the basis of information and knowledge obtained during the planning
stage. A well-designed ADM leads to effective audits thus providing highest assurances to
the auditing entities. It is desirable to prepare ADM for each of the audit objectives.
(H) Establishing Time Table and Resources - It is significant to determine the timetable and
desirable resources. Selection of appropriate audit team is the most vital component in
planning an audit. Considerations for selection of an appropriate audit team should be
recorded along with the proposed timelines for various activities to be undertaken as a part
of audit process. The progress should also be monitored against these timelines. The
Accountant General would be liable for ensuring that the performance audit is completed on
time. The variations between the required and actual time spent should be compared and
approved from the competent authority.
The team should build time for translation, approval and possible delays in their own schedule
in order to meet the targets.

(I) Intimation of Audit Programme to Audit Entities - Audited entities must be intimated about
the intention of taking up planned performance audit with the scope and extent of audit
including the constitution of audit team and the tentative time schedule, well before the
commencement of Audit. Acknowledgement of this may be requested and placed on record.
It may be required to refine an audit's objectives as the audit progresses for gathering the
requisite information to fulfill the audit. The reasons for such changes in the objectives should
also be recorded and approved from the competent authority.
The audit programme should be flexible and reviewed from time to time as it is not possible
to anticipate all the contingencies at the early stage.
The Accountant General should share all significant refinements in the approach and
additional tests and findings, concurrently with other audit teams when different persons
conduct the audit at different locations. The system of sharing of the significant field audit
experience should be documented and reviewed.
Performance Audit Planning

Specimen (abridged) Performance Report issued by

the Comptroller and Auditor General of India
I. Performance Audit on functioning of Internal Audit in Income Tax Department
for the year ended March, 2015
This Report for the year ended March, 2015 has been prepared for submission to the President
under Article 151 of the Constitution of India.
Income Tax Department (ITD) is subjected to Internal Audit of assessment and accounting functions.
The audit objectives of the “Functioning of Internal Audit Wing in Income Tax Department’’ were to
derive an assurance whether:
(a) Internal audit is effective in providing reasonable assurance to the CBDT and Senior
Management regarding achievement of objectives relating to compliance, assessment and
other interrelated activities, as determined by CBDT.
(b) Internal audit is playing an effective role in enhancing the quality of assessments.
(c) There is an effective and efficient follow-up mechanism of internal audit findings and
recommendations.
We examined the control issues relevant to CIT (Audit) charges and monitoring mechanism at the
level of DIT (Audit) as well as Regional Supervisory Authorities administering the CIT (Audit)
charges.
We found that Action Plan was not prepared in 17 CIT (Audit) charges. We noticed that list of
auditable cases were not received on a regular basis in 19 CsIT (Audit) charges from administrative
CsIT under Pr. CCsIT/CCsIT of 12 regions.
We noticed that out of 7,00,398 cases assigned, Internal Audit examined only 5,73,457 cases resulting
in shortfall in coverage of 1,26,941 cases. The practice of selection of high risk units is not in place.
We found that there were delays in initiation of remedial action in 6,172 cases (13 regions) and
delays in completion of remedial action in 1,640 cases (10 regions). We noticed 73 cases involving
tax effect of ` 134.10 crore in six regions where Internal Audit objections were settled without proper
reply or completion of remedial action. Inadequate follow up of Internal Audit objections resulted in
time barring of 1,553 cases involving tax effect of ` 392.65 crore in 11 CsIT (Audit) charges.
The audit has been conducted in conformity with the Auditing Standards issued by the Comptroller
and Auditor General of India.
Audit wishes to acknowledge the cooperation received from the Department of Revenue - Central
Board of Direct Taxes at each stage of the audit process.
II. Performance of 100% Export Oriented Unit (EOU) scheme of Department of
Revenue-Indirect Taxes, Customs for the year ended March, 2014
This Report for the year ended March, 2014 has been prepared for submission to the President of
India under Article 151 of the Constitution of India.

A Performance Audit on the working of the EOU, corresponding to the Foreign Trade Policy
(2009-14), was conducted with a view to seek an assurance that:
(a) there exits adequate statutory provision/rules regulation, instructions/notification with regards
to approval, creation, functioning and monitoring of EOUs.
(b) the EOUs fulfilled the import conditions as laid down in the relevant notifications and FTP and
applicable provisions of HBP.
(c) the EOUs were able to fulfill the intended objectives as stated in the Foreign Trade Policy.
(d) the internal controls system and monitoring mechanism are effective.
The total number of EOUs has gone down from 3109 in 2009-10 to 2608 in 2013-14. While the
number of functional units has come down from 2279 to 2095 during the same period, the percentage
of functional units to total units has declined from 83 per cent in 2010-11 to 80 per cent in 2013-14
with corresponding increase in percentage of non-functional and deboned units. There has been a
gradual reduction in EOUs after the SEZ Act came into force in 2006-07.
Government of India had forgone significant customs revenue amounting to ` 32,932 crore during
2009-10 to 2013-14 on EOU/EHTP/STP schemes. Government has fallen short by almost 33 per
cent (US$ 150 billion) of its export target in 2013-14 vis-a-vis its Strategic Plan (DoC).
Audit wishes to acknowledge the cooperation received from Ministry of Commerce and Industry
(DoC) and Department of Revenue (DoR) and its field formations at each stage of the audit process.
8. COMPREHENSIVE AUDIT
The Comptroller and Auditor General assists the legislature in reviewing the performance of public
undertakings. He conducts an efficiency-cum-performance audit other than the field which has
already been covered either by the internal audit of the individual concerns or by the professional
auditors. He locates the area of weakness and extravagance for managements’ information.
The areas covered in comprehensive audit naturally vary from enterprise to enterprise depending
on the nature of the enterprise, its objectives and operations. However, in general, the covered areas
are those of investment decisions, project formulation, organisational effectiveness, capacity
utilisation, management of equipment, plant and machinery, production performance, use of
materials, productivity of labour, idle capacity, costs and prices, materials management, sales and
credit control, budgetary and internal control systems, etc.
Some of the issues examined in comprehensive audit are:
(a) How does the overall capital cost of the project compare with the approved planned costs?
Were there any substantial increases and, if so, what are these and whether there is evidence
of extravagance or unnecessary expenditure?
(b) Have the accepted production or operational outputs been achieved? Has there been under-
utilisation of installed capacity or shortfall in performance and, if so, what has caused it?

(c) Has the planned rate of return been achieved?

(d) Are the systems of project formulation and execution sound? Are there inadequacies? What
has been the effect on the gestation period and capital cost?
(e) Are cost control measures adequate and are there inefficiencies, wastages in raw materials
consumption, etc.?
(f) Are the purchase policies adequate? Or have they led to piling up of inventory resulting in
redundancy in stores and spares?
(g) Does the enterprise have research and development programmes? What has been the
performance in adopting new processes, technologies, improving profits and in reducing
costs through technological progress?
(h) If the enterprise has an adequate system of repairs and maintenance?
(i) Are procedures effective and economical?
(j) Is there any poor or insufficient or inefficient project planning?
The Bureau of Public Enterprises has issued guidelines to be followed by the public sector
enterprises in respect of general management, financial management, materials management,
production management, construction management, etc. and these guidelines provide another basis
for appraising enterprise performance and its systems. Another source of criteria is industrial
engineering and other technical studies by internal and external experts and the standards given in
these. Then there are standards of financial propriety.
The starting point of a comprehensive appraisal of a public enterprise, which covers aspects of
economy, efficiency and effectiveness, is the preparation of an audit programme based on the study
of decisions relating to the setting up of the enterprise, its objectives, the areas of operation,
organisation, financial and operational details available in the annual reports and accounts, capital
and operational budgets, deliberations of the board of directors, material in the earlier audit
inspection reports on the enterprise and other relevant available papers. These audit programmes
(or guidelines) identify the areas/aspects which require further detailed audit analysis and criteria,
the data required for such analysis and the sources of such data, the extent of the audit analysis
including the test checks to be applied and the instructions to the audit parties assigned to the work.
9. PROPRIETY AUDIT
Auditing, as a composite concept, looks into accounting and arithmetical accuracy, adherence to
applicable rules and regulations, propriety and the ‘’truth and fairness’’ of the end result. According
to the varied requirements, the emphasis on each of the aforesaid factors differs between various
types of audit. All the requirements of section 143 of the Companies Act, 2013 are also applicable
to a Government Company. The analysis that follows shows that some of the provisions of section
143 really are propriety based. In addition, the Companies (Auditor’s Report) Order, 2016 issued

under section 143(11) of the Companies Act is also applicable to a Government Company, provided
the Government Company belongs to any of the categories of companies to which the Order applies.
Propriety aspects in an audit already exists in the audits carried on by the C&AG.
9.1 Definition and Principles
Propriety audit stands for verification of transactions on the tests of public interest, commonly
accepted customs and standards of conduct.
E.L. Kohler has defined the term propriety as “that which meets the tests of public interest,
commonly accepted customs, and standards of conduct, and particularly as applied to
professional performance, requirements of law, Government regulations and professional
codes”.
On an analysis, the tests boil down to tests on economy, efficiency and faithfulness. Instead of too
much dependence on documents, vouchers and evidence, it shifts the emphasis to the substance
of transactions and looks into the appropriateness thereof on a consideration of financial prudence,
public interest and prevention of wasteful expenditure.
Thus, propriety audit is concerned with scrutiny of executive actions and decisions bearing on
financial and profit and loss situation of the company, with special regard to public interest and
commonly accepted customs and standards of conduct. It is also seen whether every officer has
exercised the same vigilance in respect of expenditure incurred from public money, as a person of
ordinary prudence would exercise in respect of expenditure of his own money under similar
circumstances.
In ‘propriety audit’, the auditors try to bring out cases of improper, avoidable, or infructuous
expenditure even though the expenditure has been incurred in conformity with the existing rules and
regulations. A transaction may satisfy all the requirements of regularity audit insofar as the various
formalities regarding rules and regulations are concerned, but may still be highly wasteful.
For example, a building may be constructed for installing a telephone exchange but may
not be used for the same purpose resulting in infructuous expenditure or a school building
may be constructed but used after five years of its completion is a case of avoidable
expenditure.
Audit should, therefore, try to secure a reasonably high standard of public financial morality by
looking into the wisdom, faithfulness and economy of transactions. These considerations have led
to the evolution of audit against propriety which is now being combined by the audit authorities with
their routine function of regularity audit. It is hard to frame any precise rules for regulating the course
of audit against propriety. Such an objective of audit depends for its acceptance on its appeal to the
common sense and straight logic of the auditors and of those whose financial transactions are
subjected to propriety audit. However, some general principles have been laid down in the Audit
Code, which have for long been recognised as standards of financial propriety.

Propriety requires the transactions, and more particularly expenditure, to conform to certain
general principles. These principles are:
(i) that the expenditure is not prima facie more than the occasion demands and that every official
exercises the same degree of vigilance in respect of expenditure as a person of ordinary
prudence would exercise in respect of his own money;
(ii) that the authority exercises its power of sanctioning expenditure to pass an order which will
not directly or indirectly accrue to its own advantage;
(iii) that funds are not utilised for the benefit of a particular person or group of persons and
(iv) that, apart from the agreed remuneration or reward, no other avenue is kept open to indirectly
benefit the management personnel, employees and others.
It may be stated that it is the responsibility of the executive departments to enforce economy in
public expenditure. The function of audit is to bring to the notice of the proper authorities of
wastefulness in public administration and cases of improper, avoidable and infructuous expenditure.
9.2 Relevant Provisions in the Companies Act, 2013
The Parliament and Government, with a view to knowing the standards of efficiency, propriety, cost
consciousness and economy, have also come up with some provisions in the Companies Act, having
direct or indirect bearing on propriety. These provisions are:
1. Section 143(1) requiring enquiry into certain specified matters.
2. Section 143(6) and 143(7) requiring a supplementary audit and test audit respectively in
respect of the Government companies on matters specified.
3. Section 148 relating to Cost Records and Audit.
4. Additional information in Part II of Schedule III.
All these are applicable to Government Companies. The requirement of the provisions of section
143(1) is essentially propriety-oriented as much as some specific dubious practices are required to
be looked into by the auditor. Areas of propriety audit under the provisions of Section 143(1) may
be following:
(a) Whether the terms on which secured loans and secured advances have been made are
prejudicial to the interests of the company or its members.
It may be appreciated that the terms of loans include such matters as security, interest,
repayment period and other business considerations. The auditor has to inquire whether the
terms are such that they can be adjudged as prejudicial to the legitimate interest of the
company or of its shareholders. This is a process of judging a situation by reference to certain
objective standards or reasonableness whether the terms entered into are prejudicial or not,
not only to the company but also to the shareholders.

(b) Whether transactions of the company which are represented merely by book entries
are prejudicial to the interests of the company.
This proposition has got to be inquired into by reference to the effects of the book entries,
unsupported by transactions, on the legitimate interests of the company. The auditor has to
exercise his judgment based on certain objective standards. It is also possible that some
transactions may not adversely affect the interests of the company. The auditor has to
judiciously consider what does and does not constitute the interest of the company.
(c) Whether investment of companies, other than a banking or an investment company, in
the form of shares, debentures and other securities have been sold at a price lower
than the cost.
Apparently, this is a matter of verification by the auditor. The intention, however, is not known
whether loss has occurred due to the sale. The auditor is required to inquire into
circumstances of sale of investments that resulted in loss. Obviously, the duty cast on him is
propriety based, i.e., reasonableness of the decision to sell at a loss. It involves exercise of
judgment having regard to the circumstances in which the company was placed at the time
of making the sale.
(d) Whether loans and advances made by the company have been shown as deposits.
Again, considering the propriety element, rationalizing the proper disclosure of loans
and advance given by company is made.
(e) Whether personal expenses have been charged to revenue.
It is an accepted principle that expenses which are not business expenses should not be
charged to revenue. The effect of charging personal expenses to the business is to distort
the profitability of the company and to secure a personal gain at the cost of the company.
Obviously, propriety is involved in this; charging personal expenses to business account is
highly improper and abusive hence this provision.
(f) In case it is stated in the books and papers of the company that shares have been
allotted for cash, whether cash has actually been received in respect of such allotment,
and if no cash actually received, whether the position in books of account and balance
sheet so stated is correct, regular and not misleading.
A control has been set up to verify the receipt of cash in case of allotment of shares for cash.
Further, if cash is not received, the books of accounts and statement of affairs shows the true
picture.
Cost records and the provisions of cost audit are designed to inculcate cost consciousness in the
management and to know whether productivity is of acceptable order and whether undue wastage
or loss etc. has occurred. It would be useful to go into some of the specific requirement of cost audit
report in this context. Some of the matters in the additional information sought through the Statement
of Profit and Loss (i.e., Part II of Schedule III) provide a basis for making more searching enquiries

into such vital matters as consumption of raw materials under broad heads, goods purchased under
broad heads, work in progress under broad heads, any item of income or expenditure which exceeds
one percent of the revenue from operations or ` 1,00,000, whichever is higher, etc.
The implications of the Companies (Auditor’s Report) Order, 2016 and the provisions of the section
143(6) and the directions issued by the Comptroller and Auditor General also contain significant
elements of propriety.
9.3 Propriety Elements under CARO, 2016
(a) If the company has granted any loans, secured or unsecured, to companies, firms limited
liabilities partnerships or other parties covered in the register maintained under section 189
of the Companies Act, whether the terms and conditions of the grant of such loans are not
prejudicial to the company’s interest, whether the repayment of the principal amount and
interest are stipulated and whether repayments or receipts are regular. For this, the auditor
should take note of repayment schedule. If loan agreements are not executed, any other
equivalent documents may be referred to arrive at the terms of receipt of interest, for example,
letters of understanding, acknowledgement by the party of the terms and conditions
communicated by the company, etc. The dates of receipt of principal amount and interest
thereof needs to be verified with reference to the books of accounts of the company to come
to the conclusion whether such receipts are regular.
(b) If the amount is overdue, state the total amount overdue for more than ninety days, and
whether reasonable steps have been taken by the company for recovery of the principal and
interest. In making this examination, the auditor would have to consider the facts and
circumstances of each case, including the amounts involved. It is not necessary that steps to
be taken must necessarily be legal steps. Depending upon the circumstances, period of delay
and other similar factors, issue of reminders or sending of advocate’s or solicitor’s notice may
amount to reasonable steps. The auditor should ask the management to give in writing the
steps which have been taken. The auditor should arrive at his opinion only after consideration
of the management’s representations.
(c) In respect of loans, investments, guarantees, and security whether provisions of section 185
and 186 of the Companies Act, 2013 have been complied with. If not, provide the details
thereof.
(d) Whether maintenance of cost records has been specified by the Central Government under
section 148(1) of the Companies Act, 2013 and whether such accounts and records have
been so made and maintained.
(e) Whether the company is regular in depositing undisputed statutory dues including provident
fund, employees' state insurance, income-tax, sales-tax, service tax, duty of customs, duty
of excise, value added tax, cess and any other statutory dues to the appropriate authorities
and if not, the extent of the arrears of outstanding statutory dues as on the last day of the

financial year concerned for a period of more than six months from the date they became
payable, shall be indicated; by the auditor. In addition, where dues of income tax or sales tax
or service tax or duty of customs or duty of excise or value added tax have not been deposited
on account of any dispute, then the amounts involved and the forum where dispute is pending
shall be mentioned by the auditor. It may be noted that mere representation to the concerned
Department shall not be treated as a dispute.
(f) If the company has defaulted in repayment of loans or borrowing to a financial institution,
bank, Government or dues to debenture holders? If yes, the period and the amount of default
to be reported (in case of defaults to banks, financial institutions, and Government, lender
wise details to be provided). The auditor should obtain a schedule of repayments to banks,
financial institutions and debenture holders from the management of the company. He should
examine the agreement or other documents containing the terms and conditions of the loans
and borrowings of the company from banks and financial institutions. The auditor should also
examine the debenture trust deed. This examination would enable the auditor in verifying the
amount and due dates of the payments mentioned in schedule of repayments provided by the
management of the company. The auditor should then verify whether the repayments as per
the books of account are in accordance with the terms and conditions of the relevant
agreement. The auditor should also satisfy himself that the repayment have actually been
made to the party concerned.
(g) Whether the term loans were applied for the purpose for which the loans were obtained. The
auditor should examine the terms and conditions subject to which the company has obtained
the term loans. The auditor may also examine the proposal for grant of loan made to the
bank. The auditor should compare the purpose for which term loans were sanctioned with the
actual utilisation of the loans. He should obtain sufficient appropriate audit evidence regarding
the utilisation of the amounts raised.
(h) Whether moneys raised by way of initial public offer or further public offer (including debt
instruments) and term loans were applied for the purposes for which those are raised. If not,
the details together with delays or default and subsequent rectification, if any, as may be
applicable, be reported;
(i) Whether any fraud by the company or any fraud on the Company by its officers or employees
has been noticed or reported during the year; If yes, the nature and the amount involved is
to be indicated;
For this, while planning the audit, the auditor should discuss with other members of the audit
team, the susceptibility of the company to material misstatements in the financial statements
resulting from fraud. The auditor should examine the reports of the internal auditor with a
view to ascertain whether any fraud has been reported or noticed by the management. The
auditor should examine the minutes of the audit committee, if available, to ascertain whether
any instance of fraud pertaining to the company has been reported and actions taken thereon.
The auditor should also discuss the matter with other employees of the company.

This reporting for any fraud committed by the company is in addition to the reporting required
under section 143(12) wherein the auditor has to directly report to the central government on
certain types of frauds.
(j) Whether managerial remuneration has been paid or provided in accordance with the requisite
approvals mandated by the provisions of section 197 read with Schedule V to the Companies
Act? If not, state the amount involved and steps taken by the company for securing refund of
the same;
(k) Whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio
of 1: 20 to meet out the liability and whether the Nidhi Company is maintaining ten per cent
unencumbered term deposits as specified in the Nidhi Rules, 2014 to meet out the liability;
(l) Whether the company has made any preferential allotment or private placement of shares or
fully or partly convertible debentures during the year under review and if so, as to whether
the requirement of section 42 of the Companies Act, 2013 have been complied with and the
amount raised have been used for the purposes for which the funds were raised. If not,
provide the details in respect of the amount involved and nature of non-compliance;
(m) Whether the company has entered into any non-cash transactions with directors or persons
connected with him and if so, whether the provisions of section 192 of Companies Act, 2013
have been complied with;
From the above analysis, it is clear that under the Companies Act, we already have tools which bring
about a blending of propriety audit. However, a word of caution is necessary in this context. The
audit conducted by the C&AG is a rule, procedure and propriety-based one; and often it is said that
the desired flexibility is lacking in the system and this has contributed in a large measure to the lack
of rapport between the auditor and the audit-units. Honesty is open to question, if that honesty has
deviated from laid down rules and procedures. In turn, this has tended to foster a tendency amongst
Government officials to just conform to the rules and provide a show of compliance with the
standards of propriety. This is not intended to be little the contribution of this audit in ensuring
appropriate use of fund of the Government. In Government, because of the enormous amounts
involved and the massive volume of transactions and in view of public interest, it is but necessary
that compliance with rules should be insisted upon and non-compliance enquired into. But the benefit
derived is at least partly offset by the element of distrust and often the truth remains buried.
As mentioned earlier, excepting the directions of the C&AG under the Companies Act, the rest of
the provisions are applicable equally to Government and Non-Government companies. Whatever
elements of propriety are discernible in them are also present in the audit of Non-Government
companies. The directions generally known as C&AG’s directions, however, are exclusively
applicable to the audit of Government companies.
Propriety Audit-Problems - Problems in propriety audit, however, arise mainly because of its
distinct nature. The expression “propriety” is a moral term and can be understood by reference to
the concept of morality accepted by the society at a given time. In any auditing, the essential test

lies in formulation of auditing propositions. In the audit of financial accounts by reference to financial
and legal requirements, propositions are built up about happening of events, existence, accuracy,
title, ownership, compliance with law and internal regulations etc., which are all verifiable. In
propriety audit the formulation of verifiable auditing propositions poses the problem.
Propriety audit has an inherent element of subjectivity because it is very difficult to establish
standards of public interest, commonly accepted customs, standards for conduct which are not firm
basis for audit evaluation. To take care of this situation, the C&AG has developed the norms of
propriety for expenditure of public funds in our country. By laying down the standards of propriety
for Government expenditure the C&AG has really tried to tackle in a practical way the complex
problem of subjectivity inherent in a situation calling for propriety consideration.
The norms so developed provide the basis of verifying expenditure incurred by various Government
departments. It may be appreciated that the norms of propriety applicable to governmental
transactions may not ipso facto apply to transactions of private sector which have distinct and more
limited, objectives suited to them. Each private sector entity may have its unique objectives related,
to its management philosophy and the transactions should be geared to achieve those. For example,
a management which is operating for maximization of profits without infringing, any legal regulations
may follow certain policies while another management believing in a wider measure of social justice
may follow different policies. Despite these clear angularities, certain commonness can also be
discerned in the policies and approaches of different managements. They include efficient
operations, higher productivity and higher profit, reduction of wasteful expenditure etc. Above all,
each entity has its impact on the society and building up propriety audit propositions becomes of
paramount importance.
It is felt that if the management of each entity, irrespective of any legal requirements, formulates
norms of propriety for the entity, taking full note of wider social repercussions inherent in its
operations; a formidable hurdle in the way of wider introduction of propriety audit can be removed.
The element of subjectivity in propriety evaluation will get reduced.
Propriety as a moral element should be a matter of evaluation based on objectives and prevailing
circumstances. For example, a travel by air as such should not be considered wasteful unless it is
proved that a travel by rail would have been feasible in the circumstances and would have brought
the same results brought by the air travel.
The element of subjectivity has sometimes resulted in proper discharge of duty very delicate and
which demands discretion, but wisdom of taking commercial decisions under dynamic environment
(the economic, social and political) must be evaluated with reference to the circumstances in which
these were taken (and not on hindsight) and therefore, the auditor in his field must reconstruct such
circumstances. The judgment of the auditor must be objective as otherwise it would dampen the
initiative of management and others in taking commercial decisions and propriety audit would prove
itself to be counter-productive.

10. AUDIT REPORT OF THE COMPTROLLER AND

AUDITOR GENERAL
To facilitate a proper consideration, the reports of the C&AG on the audit of PSUs are presented to
the Parliament in several parts consisting of the following:
(a) Introduction containing a general review of the working results of Government companies,
deemed Government companies and corporations;
(b) Results of comprehensive appraisals of selected undertakings conducted by the Audit Board;
(c) Resume of the company auditors’ reports submitted by them under the directions issued by
the C&AG and that of comments on the accounts of the Government companies; and
(d) Significant results of audit of the undertakings not taken up for appraisal by the Audit Board.
For certain specified states, the C&AG submits a separate audit report (commercial) to the
legislature, while for other States/Union Territories with legislature, there is a commercial chapter in
the main audit report. The State audit reports, contains both the results of audit appraisal of
performance of selected companies/corporations as well as important individual instances of
financial irregularities, wasteful expenditure, system deficiencies noticed by the statutory auditors,
comments noticed in Government audit in the audit functions of certification of accounts and a
general review of the working results of Government companies and corporations.
TEST YOUR KNOWLEDGE

Theoretical Questions
1. What are the principles involved regarding “Propriety audit’ in the case of Public Sector
Undertaking?
2. Write a short explanatory note on –
(a) Areas of propriety audit under Section 143(1) of the Companies Act, 2013.
(b) Role of C&AG in the Audit of a Government company.
3. ABG & Co., a Chartered Accountant firm has been appointed by C & AG for performance
audit of a Sugar Industry. What factors should be considered by ABG & Co., while planning
a performance audit of Sugar Industry?
Multiple Choice Questions
1. Setir Ltd is a company in which 59% of the paid up share capital is held by Punjab
Government. The company is engaged in the business of providing consultancy services in
relation to construction projects.
The Punjab Government is also planning to induct funds in the company in future, if required.

Nocri Ltd is a company controlled by Setir Ltd. The business of Nocri Ltd is construction and
has an annual turnover of INR 2500 crores approx.
The audit of the financial statements of Nocri Ltd for the financial year ended 31 March 2019
got completed but Nocri Ltd observed that during the course of audit, there was lot of
intervention of Comptroller & Auditor General of India, wherein C&AG was giving directions
to the auditors on the manner in which audit should be conducted in respect of certain areas.
Further, it also received comments from C&AG on the audit report of the auditors. Nocri Ltd
is seeking legal opinion to go against C&AG so that they can avoid unnecessary interference
of C&AG and is also looking to have new auditors appointed by Nocri Ltd with whom they will
have an engagement letter with the terms that those auditors don’t accept any interference
of C&AG which the existing auditors have not been able to avoid.
In this context, please advise which of the following should be correct?
(a) The stand of the existing auditors should have been better i.e. not to accept any
interference of C&AG.
(b) Management could have planned the audit work better by including the same terms in
engagement letter with existing auditors instead of appointing another auditors.
(c) C&AG involvement could have been accepted if this was the audit of Setir Ltd but not
in case of Nokri Ltd and hence Nokri Ltd should also reach out to its parent company
to get this resolved.
(d) Stand of Nokri Ltd is wrong as the C&AG may get involved in the audit of Nokri Ltd.
2. CGN Ltd is a large company engaged in the business of oil exploration in India. The Tamil
Nadu Government and the Central Government hold 37% and 20% respectively of the paid
up share capital of this company.
The C&AG appointed the statutory auditors of this company as per requirements of the
Companies Act 2013. The company had a concern regarding this appointment because
company wanted to appoint another auditors as per their assessment, however, considering
the legal hassles which would have got involved, the company decided to go ahead with this.
The audit of the financial statement for the year ended 31 March 2019 got completed by the
auditors appointed by the C&AG. Subsequent to this, the C&AG also issued an order to
conduct test audit of the accounts of the company which was objected by the management
of the company.
The management objected saying that the complete set of financial statements have been
audited by auditors appointed by the C&AG and hence this order is not acceptable because
this would lead to duplication of work.
Moreover, the management has also written to the C&AG that for the next financial year, the
existing auditors should either resign so that the management may bring in their own auditors

or the C&AG should have faith in the work of the auditors appointed by them. Please suggest
how to resolve this matter.
(a) The management’s stand is not correct. The C&AG may order test audit as per the
requirements of the Companies Act 2013.
(b) The management’s stand is not correct. The C&AG may order test audit as per the
requirements of the Indian Penal Code.
(c) The management is correct and in this situation they get the right to appoint another
auditor considering the fact that the C&AG has lost faith in the work of auditors
appointed by them.
(d) Such type of matters should be taken to arbitration as per the requirements of the
Arbitration Act.
3. NOP Ltd is a joint venture of Central Government and a private company and is engaged in
the business of distribution of electricity in Chennai. The Central Government holds 51%
shares of the company.
The company is acknowledged for its consumer-friendly practices. Initially it was completely
owned by the Government and was running into significant losses but after the joint venture,
the aggregate technical and commercial losses of the company showed a record decline.
The operations of the company have improved significantly as claimed by the management
of the company.
The C&AG wants to conduct the performance audit of one of the departments of the company
through a subordinate office of Indian Audit and Accounts Department.
For this purpose, the audit programme has also been finalized and the Accountant General
has intimated the company that the audit would start within a day’s time. The company is
concerned because the programme which has been received from the Accountant General is
quite detailed and would involve significant time. Further the management of the company is
quite surprised as to why this audit should be conducted as this is not a company subject to
such types of audits as per law.
The management of the company would like to have your inputs in respect of this matter.
Please guide.
(a) The notice for such type of audit should give reasonable time to the management to
prepare themselves. Further it should not be a detailed audit requiring significant time
of the company.
(b) The C&AG may conduct such type of audits in respect of NOP Ltd which would get
covered in this criteria, however, the notice for conducting such type of audit should
give reasonable time to the management to prepare themselves.

(c) In case of a joint venture such type of audit cannot be performed as per the Companies
Act 2013. The company should write to the Registrar of Companies in respect of this
matter and till that time no audit can be started.
(d) In case of a joint venture such type of audit cannot be performed as per the Companies
Act 2013. Further wherever this is applicable that is only for a small period of time.
The company should write to the Ministry of Corporate Affairs in respect of this matter.
4. AJ Petroleum & Refining Ltd is a Maharatna Central Public Sector Undertaking (PSU) in India
having its registered office in Uttranchal.
It is engaged in the business of oil refining, pipeline transportation & marketing, exploration
& production of crude oil & gas, petrochemicals, gas marketing and other downstream
operations.
The PSU has global aspirations for which its management is working on various plans/
programmes so that the same can be achieved in future. It is also planning to pursue diverse
business interests by setting up of various joint ventures with reputed business partners from
India and abroad to explore global opportunities.
Considering these objectives and other factors, the C&AG directed the performance audit in
respect of its certain activities/ functions which has been in progress. Before starting the
audit, the detailed scope and composition of audit team was shared with the management of
the company and tentative timelines were also given with which the management was fine.
However, during the course of the audit the audit team changed its audit programme to
achieve the desired objectives which was approved by the competent authority, however, the
management was not happy with those changes.
The management wants the audit team to conclude the audit with the same scope as this is
a special type of audit wherein such flexibility cannot be accepted as that would defeat the
purpose of the law. However, the audit team has a different view. Please guide.
(a) Changes in audit programme in such type of audits are not acceptable as specified by
the Companies Audit and Auditors Rules 2014.
(b) Changes in audit programme in such type of audits are not acceptable as specified by
the Companies Audit and Auditors Rules 2014 and the Ministry of Law.
(c) Changes in audit programme in such type of audits can be accepted provided those
are discussed with the management and approved by the Competent Authority.
(d) The C&AG should get involved in this matter after taking permission from the Central
Government and would require to change the audit team if the scope requires any
changes as the same should have been properly assessed by the audit team before
commencing the audit.

5. In Case of PSU, Direct Reporting Engagement does not include

(a) Performance audits
(b) Compliance audits
(c) Financial audits
(d) Comprehensive Audit
Answers to Theoretical Questions
1. Companies Act, lays down special provisions regarding audit of accounts of public sector
undertakings registered as Government Companies. Section 143 of the Companies Act, 2013
empowers C&AG to conduct supplementary or test audit. Audit of public enterprises in India
is not restricted to financial and compliance audit; it extends also to efficiency, economy and
effectiveness with which these operate and fulfill their objectives and goals. Another aspect
of audit relates to questions of propriety; this audit is directed towards an examination of
management decisions in sales, purchases, contracts, etc. to see whether these have been
taken in the best interests of the undertaking and conform to accepted principles of financial
propriety. Propriety audit stands for verification of transactions on the tests of public interest,
commonly accepted customs and standards of conduct. On an analysis, these tests boil down
to tests of economy, efficiency and faithfulness. Instead of too much dependence on
documents, vouchers and evidence, it shifts the emphasis to the substance of transactions
and looks into the appropriateness thereof on a consideration of financial prudence, public
interest and prevention of wasteful expenditure. Thus, propriety audit is concerned with
scrutiny of executive actions and decisions bearing on financial and profit and loss situation
of the company, with special regard to public interest and commonly accepted customs and
standards of conduct. It is also seen whether every officer has exercised the same vigilance
in respect of expenditure incurred from public money, as a person of ordinary prudence would
exercise in respect of expenditure of his own money under similar circumstances. Some
general principles have been laid down in the Audit Code, which have for long been
recognised as standards of financial propriety. Audit against propriety seeks to ensure that
expenditure conforms to these principles which have been stated as follows:
(i) The expenditure should not be prima facie more than the occasion demands. Every
public officer is expected to exercise the same vigilance in respect of expenditure
incurred from public moneys as a person of ordinary prudence would exercise in
respect of expenditure of his own money.
(ii) No authority should exercise its powers of sanctioning expenditure to pass an order
which will be directly or indirectly to its own advantage.
(iii) Public moneys should not be utilised for the benefit of a particular person or section
of the community.

(iv) Apart from the agreed remuneration or reward, no other avenue is kept open to
indirectly benefit the management personnel, employees and others.
It may be stated that it is the responsibility of the executive departments to enforce economy
in public expenditure. The aim of propriety audit is to bring to the notice of the proper
authorities of wastefulness in public administration and cases of improper; avoidable and in
fructuous expenditure.
2. (a) Areas of Propriety Audit under Section 143(1): Section 143(1) of the Companies
Act, 2013 requires the auditor to make an enquiry into certain specific areas. In some
of the areas, the auditor has to examine the same from propriety angle as to -
(i) whether loans and advances made by the company on the basis of security have
been properly secured and whether the terms on which they have been made are
prejudicial to the interests of the company or its members;
(ii) whether transactions of the company which are represented merely by book entries
are prejudicial to the interests of the company; Again, considering the propriety
element, rationalizing the proper disclosure of loans and advance given by
company is made;
(iii) where the company not being an investment company or a banking company,
whether so much of the assets of the company as consist of shares, debentures
and other securities have been sold at a price less than that at which they were
purchased by the company;
(iv) whether loans and advances made by the company have been shown as deposits;
(v) whether personal expenses have been charged to revenue account;
(vi) where it is stated in the books and documents of the company that any shares have
been allotted for cash, whether cash has actually been received in respect of such
allotment, and if no cash has actually been so received, whether the position as
stated in the account books and the balance sheet is correct, regular and not
misleading.
A control has been set up to verify the receipt of cash in case of allotment of shares
for cash. Further, if cash is not received, the books of accounts and statement of affairs
shows the true picture.
(b) Role of C&AG in the Audit of a Government company: Role of C&AG is prescribed
under sub section (5), (6) and (7) of section 143 of the Companies Act, 2013.
In the case of a Government company, the comptroller and Auditor-General of India
shall appoint the auditor under sub-section (5) or sub-section (7) of section 139 i.e.
appointment of First Auditor or Subsequent Auditor and direct such auditor the manner
in which the accounts of the Government company are required to be audited and

thereupon the auditor so appointed shall submit a copy of the audit report to the
Comptroller and Auditor-General of India which, among other things, include the
directions, if any, issued by the Comptroller and Auditor-General of India, the action
taken thereon and its impact on the accounts and financial statement of the company.
The Comptroller and Auditor-General of India shall within sixty days from the date of
receipt of the audit report have a right to:
(i) conduct a supplementary audit of the financial statement of the company by such
person or persons as he may authorize in this behalf; and for the purposes of such
audit, require information or additional information to be furnished to any person or
persons, so authorised, on such matters, by such person or persons, and in such
form, as the Comptroller and Auditor-General of India may direct; and
(ii) comment upon or supplement such audit report.
It may be noted that any comments given by the Comptroller and Auditor-General
of India upon, or supplement to, the audit report shall be sent by the company to
every person entitled to copies of audited financial statements under sub-section
(1) of section 136 i.e. every member of the company, to every trustee for the
debenture-holder of any debentures issued by the company, and to all persons
other than such member or trustee, being the person so entitled and also be placed
before the annual general meeting of the company at the same time and in the
same manner as the audit report.
Test Audit: Further, without prejudice to the provisions relating to audit and auditor,
the Comptroller and Auditor- General of India may, in case of any company covered
under sub-section (5) or sub-section (7) of section 139, if he considers necessary,
by an order, cause test audit to be conducted of the accounts of such company and
the provisions of section 19A of the Comptroller and Auditor-General's (Duties,
Powers and Conditions of Service) Act, 1971, shall apply to the report of such test
audit.
3. Factors to be considered while planning the Performance Audit: Refer Para 7.3.
Answers to Multiple Choice Questions
1. (d) 2. (a) 3. (b) 4. (c) 5. (c)

14
LIABILITIES OF AUDITOR
LEARNING OUTCOMES
 Understand the nature of auditor’s liability and professional negligence.
 Identify the Civil Liabilities and Criminal Liabilities under the Companies
Act, 2013.
 Learn the liabilities under Income Tax Act, 1961.
 Gain the knowledge of cases concerning civil liability of auditor for

negligence and misconduct of auditor under The Chartered Accountants
Act, 1949.
CHAPTER OVERVIEW
Professional Negligence Civil Liability
Auditors'Liability
Criminal Liability Liability under Income tax Act

1. NATURE OF AUDITOR’S LIABILITY

A member of the accounting profession, when he is in practice, offers to perform a larger variety of
professional services and also holds himself out to the public as an accountant qualified to
undertake these assignments. When, therefore, he is appointed under a statute or under an
agreement to carry out some professional work it is to be
presumed that he shall carry them out completely and with
the care and diligence expected of a member of the
profession. In view, however, of the fact that the standards
of competence may vary from individual to individual and
also the concept of the function of an audit and that of its
technique, may from time to time undergo change, the
auditor is expected to discharge his duties according to
“generally accepted auditing standards” obtaining at the
time when the professional work is carried out.
Fig.: Auditor’s Liability ∗
The implications of a professional engagement have been explained in the case Lanphire v.
Phipos (1838) & Case & P. 475 cited in “Professional Negligence” by J.P.Eddy, as follows:
“Every person who enters into a learned profession undertakes to bring to the exercise of it a
reasonable degree of care and skill. He does not undertake, if he is an attorney, that at all events
he shall gain his case, nor does a surgeon undertake that he will perform a cure; nor does he
undertake to use the highest degree of skill. There may be persons who have a higher education
and greater advantages than he has; but he undertakes to bring a fair, reasonable and competent
degree of skill.”
Either absence of the requisite skill or failure to exercise reasonable skill can give rise to an action
for damage for professional negligence.
1.1 Taking Assistance in the Discharge of his Duties

It is a well accepted legal principle that duties under a contract can be assigned only in cases
where it does not make any difference to the person to whom the obligation is owed, which of the
two persons discharges it. But contracts involving personal skill, or other personal qualifications
normally cannot be assigned. It, therefore, follows that the work of an auditor being of a personal
character, it must be performed either by him or by his persons under his supervision since he
himself remains finally responsible. Only to ensure that this scheme shall be adhered to in all
cases, clause (12) of Part I of First Schedule to the Chartered Accountants (Amendment) Act,
∗
Source : NovoJuris Legal

LIABILITIES OF AUDITOR 14.3
2006 makes it obligatory that reports on financial statements would be signed either by the
member or his partner.
It is quite common for the auditors to engage persons some of whom are professionally qualified,
while others are not, to assist them in their work. The principals, however, are expected to guide
and supervise their work and are personally responsible for any dereliction of duty or absence of
care or skill in performance of an audit or any other professional engagement. They cannot
ordinarily shift any part of this liability to their employees.
Such legal position is clearly borne by the following extracts from the judgements in two
renowned cases:
(1) In Henry Squire (Cash Chemists) Ltd. v. Ball Baker & Co.: “The principal must not excuse
himself for his clerk’s negligence by saying that he employed a clerk.”
(2) In the Superintendent of Police v. M. Rajamany: “No auditor can escape from personal
liability by taking shelter under the misconduct of his own employees.”
The decision in the Rajamany’s case also places a limitation on the extent to which an auditor may
delegate his duties to his assistants:
“Callousness and irresponsible abdication of his (auditor’s) work can never be regarded as
anything but misconduct. An auditor who does not personally look into the accounts but merely
delegated it to his assistants cannot be said to be acting with due skill and care.”
Despite the fact the principal is responsible for the misdemeanor and misdeeds of his employees, in
order that some of them as are qualified may discharge their duties, which are assigned to them
with adequate skill and care, the Council has issued the following Council General Guidelines, 2008
No. 1-CA(7)02/2008 dated 8th August 2008 in the exercise of powers vested in it by Chapter II:
“In exercise of the powers conferred by Chapter II of Council General Guidelines, 2008 No.
1-CA(7)02/2008 dated 8th August 2008, a member of the Institute who is an employee shall
exercise due diligence and shall not be grossly negligent in the conduct of his duties.”
In the absence of this clause, only the Chartered Accountant who had signed the report would be
liable and it would not be possible to reach the employee chartered accountant on grounds of
misconduct. The above Council General Guidelines, 2008 No. 1-CA (7)02/2008 dated 8th August
2008 safeguards the interest of members who engage Chartered Accountants and issue reports on
the basis of the work carried on by them.
1.2 Basis of Liability

The liability for professional negligence may arise either under a statute or an agreement; the
liability may be civil or criminal, disciplinary action for professional misconduct under section 21 of
the Chartered Accountants Act can also be taken against a Chartered Accountant for failure to
discharge his professional duties competently or diligently.

2. PROFESSIONAL NEGLIGENCE
Negligence, which is culpable, generally consists of under mentioned three elements:
Negligence
Existence of Duty or Occurrence of Loss or Detriment

Responsibility Breach
(a) existence of duty or responsibility owed by one party to another to perform some act with
certain degree of care and competence;
(b) occurrence of a breach of such duty; and
(c) loss or detriment, being suffered by the party to whom the duty was owed as a result of
negligence.
In this context, professional negligence would constitute failure to perform duties according to “accepted
professional standards”, resulting in some loss or damage to a party to whom the duty is owed.
(A) To whom is the duty owed?

A professional man is deemed to have been negligent only when he owed a duty to a person or
persons and he had failed to perform or had performed it negligently. If a loss had been suffered
by a client through the action of the auditor, his liability would be determined on the basis of the
contract of engagement according to which the auditor had undertaken to provide service. When a
loss has been suffered by a third party who is not privy to the arrangement between the clients and
the auditor for determining whether he is liable, it is necessary to find out whether the auditor owed
any duty to him. This will be apparent from the summary of legal decisions discussed hereinafter.
The financial statements, on which the auditors report, are designed to serve the needs of a
variety of users, particularly owners and creditors. There are users who have direct economic
interest in the concerned business enterprise like the owners, creditors and suppliers, potential
owners, management, taxation authorities, employees and customers. There are also others who
have indirect interests like financial analysts and advisers, stock exchanges, lawyers, regulatory
authorities, financial press, trade associations and labour unions. Usually, these parties are not in
privity with the auditor. Under what circumstances these parties not in privity should with the
auditor be allowed to recover from the auditor losses that they incur as a result of the auditor’s
dereliction of duty? The solution seems difficult. To hold a negligent auditor liable “in an
indeterminate amount for an indeterminate time to an indeterminate class” will be stretching the
limit too far. We cannot at the same time brush aside the whole concept of auditors’ liability to
those parties with whom he has no privity of contract. If responsibility is to be imposed where
specific users are identified, then to what extent will it be imposed and what criteria will be used to
determine the specific user to whom the auditor should be responsible? Liability imposed should
have some relation to the responsibility reasonably assumed and the fees charged.

The evolution of law in this regard varies widely in England and the United States. So far as our
country is concerned, we should say that much headway has not been made. Hence, it will be
highly instructive to analyse the situation under the following three heads:
English Scene. American Scene. Indian Scene .

1. English scene:
The general rule in England is that only parties to a contract may enforce the rights under the
contract.
Direct case on an Accountant’s liability to third parties: The question of Accountant’s liability
to third parties directly came up for consideration in England in the case of Candler v. Crane
Christmas & Co.
Case of Candler v. Crane Christmas & Co.
Findings of the Case: A firm of accountants had been engaged by a company to prepare the
company’s accounts. The accountants knew that the statements of account would be shown to third
parties. Relying on the statements of account reported upon by the accountants, the plaintiff had
invested money in the company and it was lost. The statements in question had been prepared
negligently but there was no fraud.
Judgement/ Decision : Cohen and Asquith L.J.(Denning, LJ. dissenting), held that a false
statement made carelessly, as contrasted with one fraudulently made by one person to another,
though acted on by that other to his detriment was not action in the able absence of any contractual
or fiduciary relationship between the parties Lord Denning, however, dissented, and said:
“ .................... the Accountant, who certifies the accounts of his client is always called upon to
express his personal opinion whether the accounts exhibit a true and correct view of his client’s
affairs; and he is required to do this not so much for the satisfaction of his own client but more
for the guidance of shareholders, investors, revenue authorities, and others who may have to
rely on the accounts in serious matters of business. If we should decide this case in favour of
the Accountants there will be no reason why Accountants should ever verify the word of the
man in a one man company, because there will be no one to complain about it. The one man
who gives them wrong information will not complain if they do not verify it. He wanted their
backing for misleading information he gives them and he can only get it if they accept his word
without verification. It is just what he wants so as to gain his own ends. And the persons who
are misled cannot complain because the accountants owe no duty to them. If such be the law, I
think it is to be regretted, for it means that the accountant’s certificate which should be a
safeguard, becomes a share for those who rely on it. I do not myself think it is the law. In my
opinion Accountants owe a duty of care not only to their own clients; but also to those who they
know will rely on their accounts in the transactions for which these accounts are prepared.”

A turning point: Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd. (1963) All E.R. 575:(1964). I
Camp L.J., 14, the House of Lords. In the case, the subject of liability to third parties for
negligence of a professional person has been comprehensively reviewed. The House of Lords
unanimously overruled the majority decision in Candler v. Crane, Christmas & Co. and upheld Lord
Denning’s dissenting opinion in that case. Though the Hedley Byrne case did not directly concern
an Accountant, the principle laid down in the case is applicable to Accountants.
However, for recent cases have suggested a break away from the Hedley Byrne ‘special
relationship principle.’
Case of Jeb Fasteners, Marks, Bloom and Co.,
Findings of the Case : Jeb Fasteners - In 1975, Marks, Bloom and Co., the defending firm of
auditor reported on the annual financial statements of B.G. fasteners Ltd. for the year ended 31
October, 1974. Stock had been valued at net realisable value of £23,000. instead of at cost of
£11,000 resulting in overstated income and balance sheet figure. The auditors were aware of
the company’s liquidity problems, and had discussions with Jeb Fasteners, the plantiffs, at the
time of takeover negotiations.
Jeb Fasteners subsequently purchased the company, but the takeover was not a success.
Consequently, Jeb sued the auditors on the grounds that they were made into purchasing the
company by the mis-stated financial statement, and that the auditors had a duty of care to
persons whom they could have reasonably foreseen would rely on their audit report.
Judgement/ Decision : Justice Woolf ruled that such a duty of care did exist, but the auditors
escaped liability on the grounds that the alleged negligence was not the cause of the loss. The
judge ruled that the primary purpose of the takeover appeared to be the acquisition of the
services of the two B.G. directors, and that a purchase would probably have taken place on the
same basis even had the true financial position been known.
Justice Woolf applied a ‘reasonable foresight’ test, as opposed to the ‘special relationship test
of Hedley Byrne. This was based on a judgement by Lord Woolf force in the 1977 case of
Annsv. London Borough of Merton, in which it was held that: ‘First, one has to ask whether, as
between the alleged wrongdoer and person who has suffered damage there is a sufficient
relationship of neighbourhood such that, in the reasonable contemplation of the former,
carelessness on his part may be likely to cause damage to the latter, in which case a prima
facie duty of care arises.
‘Second, if the first question is answered affirmatively, it is necessary to consider whether there
are any considerations which ought to negate, or reduce or limit the scope of the duty of the
class of person to whom it is owed or the danger to which any breach of it may give rise.’
In Jeb Fasteners, Justice Woolf ruled that the auditors were aware of the liquidity problems of
B.G. and that financial assistance would become necessary and that a takeover was certainly
one method which, was within the contemplation of Mr. Marks (the auditor). Consequently, the

judge decided that the events leading to the takeover of B.G. were foreseeable, although it
agreed by all parties that at the time of the audit Marks, Bloom and Co. were not aware of
reliance by the plaintiffs or even of the fact that a takeover was contemplated.
The Court of Appeal agreed that there was a lack of causal connection between the auditor’s
negligence and Jeb’s loss. It further stated that it was not necessary for it to decide on the
extent of liability to confirm in favour of the defendant.
Accordingly, Justice Woolf’s ruling has some authority but leaves the extent of third party
liability still unconfirmed.
A usual argument against the extension of liability to third parties is that company law requires the
auditor to report to the existing shareholders, for the purposes of stewardship only. And that the
accounts have not necessarily been prepared with others in mind. This latter is not a powerful
argument, for it is hard to imagine a situation where accounts which are true and fair to members
will be sufficiently misleading to others to provide the basis of a claim for negligence. Financial
loss to creditors or other third parties will normally only occur as a result of the auditor’s default, if
the auditors have made some very significant ‘goof.’ And auditor’s, insurers should be well able to
cover this risk, which could otherwise unfairly result in individuals bearing the loss.
On the other hand, it can be strongly argued that if the company law wants auditors to report to
creditors, and others, it should clearly say so. And tort should not be used as a backdoor approach
for creating such a liability; although on grounds of equity one can question whether the auditor
should in fact be held responsible for the financial loss of every potential investor and every creditor
who seeks to rely on his report. In the words of Cardozo in the famous American case of the
Ultramares Corporation v. Touche,”......... it would be wrong for accountants to be exposed ‘to liability
in an indeterminate amount for an indeterminate time to an indeterminate class’. The amounts
involved could indeed be almost infinite, and the fact of reliance very difficult to prove projectively
(herein would lie the auditors’ the greatest safeguard). Furthermore, it is the directors who should
really take primary responsibility for loss through misleading accounts. Yes so often they are ‘men of
straw’ so there is no point in pursuing them; the auditors, with their insurance cover, will prove a
much better bet. But should we have to entirely bear this heavy burden, via our insurance premiums,
whereas directors can often escape with a suspended jail sentence and their illgotten spoils?
Perhaps directors should also carry a mandatory indeminity insurance, as a requirement of holding
office.
Case of CAPARO Industries V. Touche Ross
Findings of the Case : CAPARO Industries V. Touche Ross -M/s. Touche Ross, a firm of
accountants had appealed to the House of Lords from a decision of the Court of Appeal which
held that auditors could be sued by an investing shareholder for inaccuracy in accounts or
misleading accounts by which a pre-tax profit should have been shown as a loss. On the facts, it
was alleged that CAPARO would not have bid for the takeover of Fidelity, a public company, if
the true accounts were known.
Judgement/ Decision : The House of Lords opined that in advising his clients, the professional
owed a duty to exercise the standard of skill and care appropriate to his professional status. He

would be liable to contract and tort for losses his client might suffer from breach of the duty. The
House of Lords observed that where a statement was put into general circulation and might forcibly
be relied on by strangers for anyone of a variety of different purposes which the makers of the
statement had no specific reason to anticipate, the duty to use care did not exist. The auditors owed
no duty of care to the members of the public who relied on the accounts in deciding to buy shares.
It was difficult to visualise a situation in which individual shareholders could claim to have sustained
loss in respect of existing shareholdings referable to auditors’ negligence which could not be
recouped by the company. A purchaser of additional shares stood in the public to whom the
auditors owed no duty. It was also held that the purpose of the auditor’s certificate was to provide
those entitled to the report within information to enable them to exercise their proprietary powers. It
was not for individual speculation with a view to profit. The purpose of annual accounts so far as
members are concerned, was to enable them to question past management, to exercise voting
rights and to influence future policy management.
It is interesting to note that Touche Ross, the auditors in

the case, made an out of court settlement with Caparo of
£1.35m in July, 1994 to avoid any further legal action.
They denied any negligence, a position they have
maintained throughout the case.
The learned judges disclosed that for a duty to exist the following conditions must be
satisfied:
(i) the defendant would (ii) he must know that his
need to be fully aware of the advice or information would (iii) he must know that the
nature of the transaction the be directly or indirectly plaintiff was likely to rely on
plaintiff had in mind; communicated to the plaintiff; the advice or information in
and deciding on the transaction
that he had in mind.
In Al Saudi Bank and others v Clark Pixley and another (1990), the Caparo principles were applied
and, because the auditor had not directly sent a copy of the audited statements to a bank about to
grant a loan to his client, and had not been aware that the statements had been distributed, the
relationship to the client was not deemed to be sufficiently close. The fact that a potential lender
could foreseeably come to possess statements was not enough to create the necessary
relationship.
Subsequent to the Caparo case, three more cases have endorsed its doctrine. They are James
Mc Naughton Paper Group Ltd v Hicks Anderson and Co (1991), where a duty of care was denied
again because, it applied to shareholders as a class not as individuals; Berg Sons and Coand
others v, Adams and others (1992), which showed that the auditor’s work had been performed only
to satisfy the statutory audit requirement and no more, and could not support a duty of care to a
finance house that had discounted Berg’s bills; and Goloo and others v Bright Grahame andMurray

(1993) which would not extend the classes of persons to whom the accountant might be liable and
which reinforced the view that it must be proved that an auditor’s negligence must be the “effective
and dominant cause” of loss for a liability to exist.
Clearly these recent cases have upheld the principles established in the Caparo judgement.
Only one case, Morgan Crucible Co PLC v Hill Samuel and Co Ltd (1991) has threatened to dilute
the effects of the Caparo decision. The facts of the case were that company taking over another,
relying on information provided by the auditor of the target company, as in Caparo. Since the
directors of the target company circularised all their shareholders forecasting a sizeable increase in
pre-tax profits, supported by a letter from the auditors and the auditors’ opinion was issued after the
takeover had commenced, and thus the plaintiff was not relying solely on the accounts but also on
these further representations. Thus, it was held the auditor had a duty of care in that, whereas in the
Caparo case the audited accounts had been drafted for one purpose but had been relied upon for a
different purpose, in this case, the opinion had been relied upon for the purpose for which it was
issued. The degree of proximity was such that the defendant could well be liable. The case was
settled out of court. Similarly, in Columbia Coffee and Tea Party Ltd v. Churchill and others (1992),
the Court held that a third party investor was owed a duty of care on the basis of an assumption of
responsibility flowing from statements in the defendant’s auditor manual which brought a potential
purchaser of shares within the ambit of persons to whom a duty of care was owed. In Possfund v.
Diamond (1996), it is being argued that a duty of care is assumed and owed to these investors who
(as intended) rely on the contents of the prospectus in making subsequent purchases.
2. American Scene:
The common law liability of the auditor to third parties is important in any discussion of the
auditor’s legal liability. A third party may be defined as an individual who is not in privity with the
parties to a contract.
From a legal stand-point, there are two classes of third parties:
Two classes of third

parties:
Primary beneficiary Other beneficiaries.
identified to the auditor by

unnamed third parties
name prior to the audit

A primary beneficiary is anyone identified to the auditor by name prior to the audit who is to be
the primary recipient of the auditor’s report.
If at the time the engagement letter is signed, the client informs the auditor that the
report is to be used to obtain a loan at the city national bank, the bank becomes a
primary beneficiary.
In contrast, other beneficiaries are unnamed third parties.
Other beneficiaries such as creditors,
stockholders, and
potential investors.
The auditor is liable to all third parties for gross negligence and fraud under tort law. In contrast,
the auditor’s liability for ordinary negligence has traditionally been different between the two
classes of third parties.
Liability towards Primary Beneficiaries - The privity of contract doctrine extends to the primary
beneficiary of the auditor’s work. The landmark case, Ultramares Corp. v. Touche (now deloitte
and Touche), and its major findings are as follows.
Case of , Ultramares Corp. v. Touche (now deloitte and Touche)
Findings of the Case: Ultramares upheld the privity of contract doctrine under which third
parties cannot sue auditors for ordinary negligence. However, judge Cardozo’s decision
extended to primary beneficiaries the rights of one in privity of contract. Hence, Ultramares as a
primary beneficiary could sue and recover for losses suffered because of the auditor’s ordinary
negligence.
The defendant auditors, Touch, failed to discover fictitious transactions that overstated assets
and stockholders equity by $700,000 in the audit of Fred Stern & Co. On receiving the audited
financial statements, Ultramares loaned Stern large sums of money that Stern was unable to
repay because it was actually insolvent. Ultramares sued the CPA firm for negligence and fraud.
Judgement/ Decision : The court found the auditors guilty of negligence but ruled that
accountants should not be liable to any third party for negligence except to a primary
beneficiary.
An analysis of the decision reveals several significant environmental factors that are particularly
interesting in view of the current legal environment.

First, the judge recognized that extending liability for ordinary negligence to any third part
might discourage individuals from entering the accounting profession, thus depriving society
of a valuable service.
Second, he feared the impact that a broader encroachment on the privity doctrine might
have on other professionals such as lawyers and doctors.
Third, the decision reaffirmed the auditor’s liability to any third party for gross negligence
or fraud.
Liability towards Other Beneficiaries - The Ultramares decision remained virtually unchallenged
for 37 years, and it still is followed today in many jurisdictions. However, since 1968, several court
decisions have served to extend the auditor’s liability for ordinary negligence beyond the privity of
contract doctrine.
A Foreseen Class: The first shift away from Ultramares occurred in the form of judicial
acceptance of the specifically foreseen class concept. This concept is explained as follow:
If the client informs the CPA that the audit report is to be used to obtain a bank loan, all
banks are foreseen parties, but trade creditors and potential stockholders would not be
part of the foreseen class.
The liability is limited to losses suffered through reliance on the information in a transaction known
by the auditor or a similar transaction. In the above instance, this means that the accountant would
not be liable if the audit report was used by a bank to invest capital in the client’s business in
exchange for common stock instead of granting a loan.
The foreseen class concept does not extend to all present and future investors, stockholders, or
creditors. Court decisions have not required that the injured party be specifically identified, but the
class of persons to which the party belonged had to be limited and known at the time the auditor
provided the information.
Foreseeable Parties: Individuals or entities whom the auditor either knew or should have known
would rely on the audit report in making business and investment decisions are foreseeable
parties. This concept extends the auditor’s duty of due care to any foreseeable party who suffers a
pecuniary loss from relying on the auditor’s representation.
Foreseeable parties include all creditors’, Stock holders and present and future investors.
Foreseeability is used extensively by the courts in cases involving physical injury.
Foreseeablility is almost universally used in product liability cases when the
manufacturer’s negligence causes the physical injury. This concept was first applied in
an audit negligence case in the early 1980s. Rusch Factors Inc v. Levin (1968)

Cases Illustrating Liability to Other Beneficiaries: The leading cases that extended the
accountant’s liability for ordinary negligence to foreseen parties and to foreseeable parties are as
follows:
Case of, Rush Factors Inc. vs. Levin
Findings of the Case: In Rush Factors Inc. vs. Levin (1968), the plaintiff had asked the
defendant accountant to audit the financial statements of a corporation seeking a loan. The
certified statements indicated that the potential borrower was solvent when, in fact, it was
insolvent. Rush Factors sued the auditor for damages resulting from its reliance on negligent
and fraudulent misrepresentations in the financial statements. The defendant asked for
dismissal on the basis of lack of privity of contract.
Judgement/ Decision : The court ruled in favour of the plaintiff. While the decision could have been
decided on the basis of the primary benefit rule set forth in ultramares, the court instead said:
The accountant should be liable in negligence

for careless financial misrepresentation relied
upon by actually foreseen and limited classes
of persons. In this case, the defendant knew
that his certification was to be used for
potential financial of the corporation
(emphasis added).
3. The Indian Scene:

Commissioner of Income Tax v. G.M. Dandekar: This is the only decision on the auditor’s
liability to a third party by an Indian Court.
Case of, Commissioner of Income Tax v. G.M. Dandekar
Findings of the Case: Mr. Dandekar had been engaged by Messrs A. Mohamad & Co., Madras
and had prepared the statements of account and Income-tax Return on the basis of account
produced to him. During the course of assessment, it was discovered that Messrs. Mohamad &
Co. had maintained two sets of account-regular Day Books and ledgers for the open market
transactions and a separate book for the black market transactions. While the former contained
detailed entries, relative to daily transactions, the latter contained only consolidated entries,
made at the end of the week of the transactions of that week. At the end of the financial year, all
the weekly entries in the separate sets of books of account were to called up and were entered
in the regular books of account. Mr. Dandekar had examined only the regular books of account
of the assessee and prepared the statements of account and the Income-tax Return on the
basis of these units. All the statements were signed by him and there was also endorsement at
the foot of the Balance Sheet that it had been verified and found to be correct. Mr. Dandekar

had forwarded the statements of account to the Income-Tax Officer and, while doing so had
stated particulars of books of account that he had examined.
Judgement/ Decision : On examination, the statements of account having been found to be
wrong, the Income-tax department took up the matter against Mr. Dandekar and filed a
complaint with the Institute of Chartered Accountants of India.
When the matter was subsequently considered by the Madras High Court it was held that “he
(Mr. Dandekar) was under an obligation to perform auditing with due skill and diligence; if he did
that; it would be difficult to see what further obligations he had in the matter and in the favour of
whom. The Accountant is under a duty to prepare and resend correct statements of account of
the assessee and he should, of course, neither suggest nor assist in the preparations of false
accounts. But, he is under no duty to investigate whether the accounts prepared by the
assesses are correct or not. The charge is that he owed a duty to the Department to himself
investigate the truth and correctness of the accounts of the assessee and not merely to act as
their Post Office in transmitting them. We do not agree that the respondent is under any such
duty to the Department and, therefore, no question of negligence arises.”
In view of the English decision (Hedley Byrne’s Case) mentioned earlier, the decision in this case
may any more be considered to be good law. For, very likely, the Indian Courts may hereafter
follow the decision in the Hedley Byrne case and hold that the auditor is responsible to all those
persons for negligence who had relied on a financial accounts or statement prepared by him which
is incorrect, if he knows or ought to have known that it has been prepared for a particular person or
class of persons or may be relied on by the person, or class of persons in that particular
connection.
The effect of the Hedley Byrne decision is that someone possessed of a special skill may, quite
irrespective of a contract, be considered to have undertaken to apply that skill for the assistance of
another person and thereby to have accepted a duty of care to that person. A negligent though
honest, misrepresentation which causes financial loss to another may thus, in certain
circumstances, give rise to an action for damages at the suit of a person with whom no contract
exists.
This doctrine is of particular concern to practising accountants, an important part of whose work
consists of preparing, examining or expressing an opinion on financial statements of various kinds
which may be relied on by persons other than those for whom they were originally intended; the
implications should not be overlooked by any accountant who knows that his professional skill,
exercised in an independent capacity, whether gratuitously or not, will be relied on by others.
(B) Breach of Duty or Negligence: To charge a professional man with breach of duty or
negligence, it is necessary to prove that there has been a deviation from the standard of care
which he was expected to exercise in the performance of his duties. A professional man does not
guarantee the success of his professional effort. Nevertheless he is expected to possess a certain
amount of knowledge and experience and he must exercise a reasonable degree of care and skill

for the performance of duties. If there is any default or failure in the conduct of an audit or in
carrying out any other engagement judged by professional standards the person responsible,
therefore, would be guilty of negligence.
The auditor being an expert, skilled in the techniques of accounting and auditing, is expected that
he would be in possession of certain standards of knowledge and experience. He also must
exercise the same degree of prudence, skill and care, as any other professional person, in similar
circumstances, would be expected to do. In other words, he must carry out the audit according to
‘accepted professional standards’ (the implications of these words are explained hereafter) and
having regard to all facts known to him about the financial solvency of the client.
The auditor, however, is not expected to be a detective nor is he required to approach his work
with a suspicious or pre-conceived notion that there is something wrong. He is a watch dog but not
a ‘blood hound’. However, if there is any thing that excites suspicion in him, he should delve deep
into the matter. But, in the absence thereof, he is only required to be reasonably cautious and
careful.
In the case of non-company audit, where a detailed audit is not required the scope and extent of
routine checking that must be carried out is determined, on a consideration of the nature of
engagement. Nevertheless, it is expected that the auditor would carry out the checking of accounts
and verification of statements according to ‘Standards on Auditing.
The auditor who verifies the books of account of client by the application of test checks,
in a case where a complete audit should have been carried out, would be held guilty of
professional negligence if subsequently it is found that a mistake or fraud had remained
undetected which would have been unearthed if a detailed audit had been carried out.
Likewise, under the general principles of law, the auditors have been called upon to pay
compensation to their clients for the losses suffered by them through their negligence. Only in one
case, i.e. Armitage v. Brewer and Knott, the auditors were held responsible for the amount of
defalcations which arose subsequent to their failure to detect frauds in an earlier period.
3. CASES CONCERNING THE CIVIL LIABILITY OF

AUDITORS FOR NEGLIGENCE
In the series of cases considered below, action was brought against the auditors for damages
sustained through defalcation of employees or otherwise which, it has been alleged would have
been discovered by the auditors, if they had carried out their duties with the required degree of
care and skill. The plaintiffs in some cases were individuals or partners and directors in the other
companies but action was not brought under misfeasance proceedings of the Companies Act. It
may be observed that in general the defence was that the frauds were such that reasonable
diligence and careful audit would have failed to reveal them or they were caused by lack of
efficiency of the management, or in its supervision over the accounts.

1. London Oil Storage Co. v. Seear Hasulk & Co. (1904): In this case, the auditors were
charged with negligence for failure to discover the misappropriation of the petty cash
balance, which was shown by the petty cash book at 799 but in fact was only 30. The
auditor was found guilty of negligence in not verifying the petty cash balance as part of the
audit; but the damages awarded were limited to £5.5sh. on the ground that the damages
suffered were not due to the conduct of the auditor but that of directors who were guilty of
gross negligence in allowing the balance in the hands of the Petty Cashier to increase to
such a large amount.
2. Arthur E. Green & Co. v. The Central Advance and Discount Co. Ltd. (1901): The
auditors in this case had accepted the schedule of bad debts supplied to them by the
Managing Director although it was inaccurate and they were far from satisfied with it.
Despite the fact, they had failed to qualify their report. The claim filed by the liquidator of
the company against the auditors for negligence therefore, succeeded.
3. Pendleburys Ltd. v. Eills Green & Co. (1936): The charge in this case was that due to
failure on the part of the auditor to verify the amount recorded and received for cash sales,
the fraud of the cashier had not been discovered. But the charge did not succeed since the
auditors have repeatedly brought the lack of internal check on ‘cash receipts to the attention
of the three directors who were the only shareholders and debenture holders of the
company. In the course of judgement, the learned judge observed:
“He (the auditor) is there to see that the shareholders get a true representation of the
finances of the company as disclosed by its books, this he must do with reasonable care,
but in considering whether or not he has displayed reasonable care one must apply rules
of common sense. There is all the world of difference between a company which has a
large body of shareholders numbering say, six or seven hundred and a company which
has only three shareholders; all of whom happen to be the sole directors and the sole
debenture holders............ Where the interests of a small company are confined to a very
few persons and there are no outside people because all the interests in the company are
held by the directors themselves, if the auditor has, in fact, reported to the directors, what
more could he be expected to do?”.
4. Leads Estate and Investment Society Ltd. v. Shepherd (1887): In this case action was
brought by the liquidators against the auditors not under misfeasance proceedings, but
under a civil action for the recovery for amounts paid as dividend out of capital. In
examining the balance sheet, the auditor had not considered the provision in the Articles
and the balance sheet was not properly drawn up. In the course of the judgement, the
learned judge observed that it was the duty of the auditor in auditing the accounts of the
company not to confine himself to verifying the arithmetical accuracy of the balance sheet,
but to enquire into its substantial accuracy, and to ascertain that it contained the particulars
specified in the Articles of Association, and was properly drawn up so as to contain a true

and correct representation of the company’s affairs. The auditor was found negligent by the
Court.
5. Armitage v. Brewer & Knot (1942) ACTC (P 836): In this case, action was brought by
Mr. Joseph Armitage for alleged negligence in auditing the plaintiff’s books by reason of
which defalcations aggregating to £1440 were not detected. The defalcations consisted in
fraudulent alterations of time sheets and petty cash vouchers.
The plaintiff had arranged with the auditor that they would vouch all payments with the
receipts entered in the Petty Cash Account, check calculations and additions of wages
sheets, check totals of wages sheets into wages book and check weekly totals with other
detailed provisions.
Such a detailed audit had been called for since the plaintiff wanted protection against his
staff. A special fee was demanded and paid for this work. But it transpired after the audit
had been in progress for some two and half years, that the cashier of the plaintiff, by
altering systematically figures on vouchers of petty cash and making fraudulent entries on
time sheets, had misappropriated a large sum of money. During the course of the hearing, it
transpired that the auditors had not examined the books of account with sufficient care as a
result whereof the fraud committed by the cashier had remained undetected.
Mr. Justice Talbot, during the course of his judgement, observed that “Accountants
undertaking duties of that kind could not be heard to excuse themselves on the ground that
this or that was small matter.” The auditors were held guilty of negligence and a damage of
£1259 was awarded against them.
6. Tri-Sure India Ltd. v. A.F. Ferguson & Co.: Tri-Sure India Limited issued a prospectus of
February 75 inviting public to subscribe its share. The prospectus contained, inter alia, the
report of the auditors (the defendants) on the accounts of the company for the year 1973-74
which showed that there was an abnormal rise in the rate of profits for the year 1973-74.
The public issue was over-subscribed and the company proceeded to allot the shares as
per the term of the issue. An investigation later revealed that sales figures for 1973-74 had
been manipulated by a whole time director of the company with the active co-operation of
other top officials of the company. On discovery of this, the company offered to refund all
moneys which were subscribed by the allottees and also proceeded to sue the auditors for
damages of ` 63.85 lakhs. The company alleged that the auditors failed to examine and
ascertain any satisfactory explanation for steep increase in the rate of gross and net profits.
The other charges levelled against the auditors were (i) whether the consumption of raw
material was commensurate with the sharp increase in sales/production; (ii) the reasons for
disproportionate ratio of the total debts due by trade debtors to turnover as compared to the
previous years; (iii) the reason for material variation in the ratio of the value of stock on
hand to the cost of turnover for the year 1972-73 and for the year 1973-74; (iv) whether
there was any change in the prices of prime raw material; (v) whether there was any
improvement/deterioration in the usage of material; (vi) whether the company had got new

customers and/or there was any change in the terms of credit to customers; and (vii)
whether the production for the year was adequate to support the volume of sales and
closing stock for the year.
The Court held that the plaintiffs were not able to prove that the auditors were negligent in
the performance of their duties. The suit was, therefore, dismissed.
Regarding the duties of the auditor, the Court held that “the auditor is required to employ
reasonable skill and care, but he is not required to begin with suspicion and to proceed in
the manner of trying to detect a fraud or a lie, unless some information has reached which
excites suspicion or ought to excite suspicion in a professional man of reasonable
competence. An auditor’s duty is to see what the state of the company’s affairs actually is,
and whether it is reflected truly in the accounts of the company, upon which the balance
sheet and the profit and loss account are based, but he is not required to perform the
functions of a detective. What is reasonable care and skill must depend upon the
circumstances of each case. Where there is nothing to excite suspicion and there is an
atmosphere of complete confidence, based on the record of continued success in financial
matters, less care and less scrutiny may be considered reasonable.” Thus, the judgment
has re-emphasised that an auditor need not proceed with suspicion unless the cir-
cumstances are such as to arouse suspicion or ought to arouse suspicion in a professional
man of reasonable competence. The practice of resorting to selective verification where
internal controls are found to be satisfactory by an auditor has also been upheld in his
judgement.
4. CIVIL LIABILITIES UNDER THE COMPANIES ACT

Lord Justice Topes once famously remarked that “The Auditor is a watchdog and not
bloodhound.”
A civil action against the auditor may either take the form of claim for damages on account of
negligence or that of misfeasance proceeding for breach of trust or duty:
(I) Damages for negligence: Civil liability for mis-statement in prospectus under section 35 of
the Companies Act, 2013, are:
(1) Where a person has subscribed for securities of a company acting on any
statement included, or the inclusion or omission of any matter, in the prospectus
which is misleading and has sustained any loss or damage as a consequence
thereof, the company and every person who—
(a) is a director of the company at the time of the issue of the prospectus;
(b) has authorized himself to be named and is named in the prospectus as a
director of the company or has agreed to become such director either

immediately or after an interval of time;

(c) is a promoter of the company;
(d) has authorised the issue of the prospectus; and
(e) is an expert referred to in sub-section (5) of section 26,
shall, without prejudice to any punishment to which any person may be liable under
section 36, be liable to pay compensation to every person who has sustained such
loss or damage.
(2) No person shall be liable under sub-section (1), if he proves—
(a) that, having consented to become a director of the company, he withdrew his
consent before the issue of the prospectus, and that it was issued without his
authority or consent; or
(b) that the prospectus was issued without his knowledge or consent, and that on
becoming aware of its issue, he forthwith gave a reasonable public notice that
it was issued without his knowledge or consent.
(c) that, as regards every misleading statement purported to be made by an
expert or contained in what purports to be a copy of or an extract from a
report or valuation of an expert, it was a correct and fair representation of the
statement, or a correct copy of, or a correct and fair extract from, the report or
valuation; and he had reasonable ground to believe and did up to the time of
the issue of the prospectus believe, that the person making the statement was
competent to make it and that the said person had given the consent required
by sub-section (5) of section 26 to the issue of the prospectus and had not
withdrawn that consent before delivery of a copy of the prospectus for
registration or, to the defendant's knowledge, before allotment thereunder.
(3) Notwithstanding anything contained in this section, where it is proved that a
prospectus has been issued with intent to defraud the applicants for the securities
of a company or any other person or for any fraudulent purpose, every person
referred to in subsection (1) shall be personally responsible, without any limitation of
liability, for all or any of the losses or damages that may have been incurred by any
person who subscribed to the securities on the basis of such prospectus.
It may be noted that the term “expert” as defined in Section 2(38) of the Companies Act,
2013 includes an engineer, a valuer, a chartered accountant, a company secretary, a
cost accountant and any other person who has the power or authority to issue a
certificate in pursuance of any law for the time being in force. Also that under Section 26
of the Act a statement may be considered to be untrue, not only because it is so but also
if it is misleading in the form and context in which it is included.

The liability would arise if the written consent of the auditor to the issue of the
prospectus, including the report purporting to have been made by him as an “expert”
has been obtained.
(II) Liability for misfeasance: The term “misfeasance” implies a breach of trust or duty. The
auditor of a company would be guilty of misfeasance if he has been guilty of any breach of
trust or negligence in the performance of his duties which has resulted in some loss or
damage to the company or its property.
A few cases in which action has been brought against the auditors under misfeasance
provisions of the Companies Act are summarised below:
1. In Re: The London and General Bank, (1895), held - The auditor who does not
report, to the shareholders the facts of the case, when the balance sheet is not
properly drawn up, is guilty of misfeasance.
The charge against the auditor in this case was that though he had submitted a
detailed report to the directors, as regards loans and overdrafts granted to
customers, in respect of which the security lodged was wholly insufficient and had
expressed his misgivings as regards recovery of interest on these accounts, included
in the Profit and Loss Account, he had neither disclosed the position to the
shareholders nor he had made any reference to the report which he had laid before
the directors. The words in his report, “the value of assets as shown on the Balance
Sheet is dependent upon realisation etc.” did not contain any warning to
shareholders and the mere presence of these words was not enough to excite
suspicion. The Court observed that the duty of the auditor was to convey information
and not to arouse enquiry and held that the auditor, by way of damages, was liable
to refund the amount of the second dividend (declared in 1892) on the ground that he
was aware of the critical position of the affairs and thus had acted negligently in not
reporting the facts to the shareholders although he had reported them to directors.
As regards the first dividend (declared in 1891), the auditor was not held liable, as he
was of the opinion that the evidence was not sufficiently strong to establish a case of
misfeasance against him, though he was guilty of an error of judgement.
2. In Re: Kingston Cotton Mills Co. Ltd. (1896), held - That it is not the duty of the
auditor to take stock and that he is not guilty of negligence if the certificate of a
responsible official is accepted in the absence of suspicious circumstances.
In this case, the profits of the company had been inflated fictitiously by the deliberate
manipulation of the quantities and values of stock-in-trade. The auditors had certified
the balance sheet on the basis of the certificate of the manager as to the correctness
of the stock-in-trade without checking the stock in detail and this fact was shown on
the fact of the balance sheet. Lopes L.J. exonerating the auditors of the charge of
negligence, in the course of judgement, made remarks to the following effect:

It is the duty of an auditor to bring to bear on the work, he has to perform the skill,
care and caution which a reasonably competent, careful and cautious auditor
ordinarily would use. What is reasonable skill, care and caution is a matter which
must be judged on consideration of the special circumstances of each case. An
auditor is not bound to act as a detective, or as had been said to approach his work
with suspicion or with a foregone conclusion that there is something wrong. ‘He is a
watch dog, but not a blood hound’. He is entitled to rely on the representation made
to him by the tried servants of the company in whom confidence has been placed by
the company, believing them to be honest and truthful. He must, however, take
reasonable care to find that the representations made by them are not palpably
false. If any matter is observed which is calculated to excite suspicion, he should
probe it to the bottom, but in the absence of anything of that kind he is only bound to
be reasonable, cautious and careful.
3. The Irish Woolen Co. Limited v. Tyson and others (1900) Act L.R. 23, held -That
an auditor is liable for any damages sustained by a company by reasons of
falsification of accounts which might have been discovered by the exercise of
reasonable care and skill in the performance of the audit.
In this case, under a special agreement with the company, the auditor was required
to conduct a monthly audit, despite the fact, the profit disclosed by the profit & loss
account was found to have been inflated by the suppression of certain purchase
invoices outstanding at the date of the balance sheet though the goods received in
respect thereof had been included in the closing stock. The learned judge hearing
the case found that the suppression of invoices would have been detected if the
auditor had called for the creditors’ statements of account on the basis of which
payment had been ordered, in the period subsequent to the audit, and had compared
them with ledger balance; also, if the entries in the ledger accounts were checked
with relevant invoices, it would have been discovered that these had not been posted
on the true dates. On these facts, he concluded that if due care and skill had been
exercised, the suppression of the invoices would have been discovered and held the
auditor liable for the damages which the company had suffered due to
understatement of liability in the Balance Sheet.
4. In Re: City Equitable Fire Insurance Co. Ltd., held -That an auditor is not justified
in omitting to make personal inspection of securities that are in the custody of a
person or a company with whom it is not proper that they should be left.
In this case, an action had been brought by the Official Receiver as liquidator of the
company against the directors and auditors for damages arising out of misfeasance.
The chairman of the company was also the senior partner in the firm of Ellis & Co.,
the company’s stock brokers who, at all material times, were heavily indebted to the
company.

The principal charge against the auditors was that they had failed to detect and
report to the shareholders that a number of company’s securities, which were in the
custody of Ellis & Co. were being pledged by the firm to its customers. The auditor
had relied on the certificate of Ellis & Co. that these securities were held by them.
The master of Rolls, on a consideration of the evidence led in this case, showed that
it was customary for the auditor to obtain certificate from banks in respect of
securities lodged with them and that the certificates were not accepted from brokers.
He made the following obiter dicta which is of great significance to auditors.
“I think he (the auditor) must take a certificate from a person who is in the habit of
dealing with, and holding securities, and who he, on reasonable grounds, rightly
believes to the exercise of the best judgement a trustworthy person to give such a
certificate.”
5. In Re: Westminster Road Construction and Engineering Co. Ltd. (1932), held-
That when there is time lag between the incurring of a liability and receipt of bills and
at the time of audit, sufficient time had not elapsed for the invoices relating to such a
liability to have been received it was the duty of auditor to make specific enquiries as
to the existence of such liabilities. He also must check the valuation of the work in
progress at which it is included in the Balance Sheet.
In this case, action had been brought against the auditor by the liquidator of the
company in respect of payment of dividend when there were in fact no profits of
which it could be paid. Negligence was alleged in respect of over valuation of work
in progress, omission of liabilities, etc. The Court held that the auditor was liable to
refund to the company the amount of dividend wrongly declared, with interest and
costs.
6. In Re: S.P. Catterson and Sons Ltd. (1947), held - That the primary responsibility
for the accountant of a company is of those who are in control of the company i.e.
the directors.
In the case, an application had been made by the liquidator that the auditor of the
company had been negligent in the performance of his duty and thus was liable to
compensate the company in respect of amounts misappropriated by an employee of
the company, which had become irrecoverable. Though the fact that the defalcation
had occurred was accepted, the auditor contended that he had drawn the attention of
the directors to the weakness of the system of recording cash and credit sales and
had recommended its alteration; notwithstanding this, the system had been
continued. Also, that the directors had failed to check adequately the cash records,
at the time money was duly handed over, day to day, by the manager.
7. In Re: Continental Vending Machine Corporation (1970) An American Case -
This is a significant case in as much as it seeks to provide guidelines for the exercise

of auditor’s judgement and discretion where conclusive accounting and auditing

principles are not available to guide the auditor. In this case, the auditor was held
guilty of not having reported a known fact. The President of the Continental Vending
Machine Corporation caused the diversion of a substantial sum of money of the
Corporation to his benefit by canalising it through an associated concern the audit of
which was conducted by another. A substantial part of the security for this
accommodation consisted of securities of the Continental Vending Co., itself. This
was not reported and since the amount advanced by this company became
irrecoverable, the auditors were held guilty of gross negligence.
The judgement is significant for what it says about the weight the law will attach to
the standards of accounting profession and for what it says about obligations of an
auditor over and above those imposed by the standards themselves. The test that
the Court applied was not whether the balance sheet was in accordance with
generally accepted accounting principles but whether the balance sheet fairly
represented the financial position.
The Court held that though in ordinary case disposition of funds advanced by the
client to its affiliates need not be disclosed by the auditor, such a disclosure
becomes necessary in cases of: (i) looting; (ii) known dishonesty by a high official;
(iii) corporation being operated to a material extent for the private benefit of its
President; and (iv) dishonest diversion of funds. Thus the Court laid down a special
rule for disclosure and emphasised that an auditor’s approach should not necessarily
be limited to the mere compliance with the accepted standards but should primarily
be governed by the objective to establish an honest and fair representation of
financial facts.
Damages must be suffered: In the various cases considered, it may be observed
that when an auditor has been found guilty of professional negligence and a loss has
been suffered, the Courts have held that the amount of loss should be made good by
the auditor. For instance, in the case of Leeds Estate Building and Investment Co.
Ltd. v. Shephered, under a civil action by the liquidator, the auditor was held liable to
make good, jointly with directors, the dividend paid out of capital.
Where, however, the loss has been occasioned through negligence of directors, the
fault of the auditor in failing to verify the asset has been considered to be only
technical and only nominal penalty has been imposed. For instance, in the case of
London Oil Storage Co. Ltd. v. Seear Husluck and Co.£ 5. 5sh was awarded as
damages against the auditor, although the loss was much more, on the ground that
professional negligence had not occasioned the loss.
In the case of Armitage v. Brewer and Knot, the auditors were held responsible even
for the amount of defalcations which has taken place subsequent to their failure to
detect fraud with regard to petty cash in an earlier period. It is the only case in which

the principle of consequential damages has been applied to audit claims, i.e. if an
auditor omits to detect a defalcation by an employee and, in the following year,
before there is a chance of any further audit, the employee emboldened by the non-
detection of the defalcation, embezzles a larger sum, the auditor would be liable both
for the original loss which he had failed to detect and the subsequent loss suffered
by the employer.
Apart from the liability for professional negligence, in the discharge of duties, an
auditor also may be penalised under section 147 of the Companies Act, 2013 for
failure to comply with any of the provisions contained in sections 143 and 145. He
incurs such a liability as auditor of the company.
As per Sec. 143 of Companies Act, 2013 if auditor does not report any matter of
fraud involving such amounts as may be prescribed he will be liable for
punishment.
[Note: Students may refer Chapter 5 for Punishment for Contravention as stated in
Section147]
5. CRIMINAL LIABILITY UNDER THE COMPANIES ACT

The circumstances in which an auditor can be prosecuted under the Companies Act, and the
penalties to which he may be subjected are briefly stated below:
(i) Criminal liability for Misstatement in Prospectus - As per Section 34 of the Companies
Act, 2013, where a prospectus issued, circulated or distributed includes any statement
which is untrue or misleading in form or context in which it is included or where any
inclusion or omission of any matter is likely to mislead, every person who authorises the
issue of such prospectus shall be liable under section 447.
This section shall not apply to a person if he proves that such statement or omission was
immaterial or that he had reasonable grounds to believe, and did up to the time of issue of
the prospectus believe, that the statement was true or the inclusion or omission was
necessary.
(ii) Punishment for false statement - According to Section 448 of the Companies Act, 2013 if
in any return, report, certificate, financial statement, prospectus, statement or other
document required by, or for, the purposes of any of the provisions of this Act or the rules
made thereunder, any person makes a statement —
(a) which is false in any material particulars, knowing it to be false; or
(b) which omits any material fact, knowing it to be material,
he shall be liable under section 447.

Fig.: Criminal Liability ∗

Punishment for Fraud- As per Section 447 of the Companies Act, 2013, without prejudice to
any liability including repayment of any debt under this Act or any other law for the time being in
force, any person who is found to be guilty of fraud [involving an amount of at least ten lakh rupees
or one per cent. of the turnover of the company, whichever is lower] shall be punishable with
imprisonment for a term which shall not be less than six months but which may extend to ten years
and shall also be liable to fine which shall not be less than the amount involved in the fraud, but
which may extend to three times the amount involved in the fraud:
It may be noted that where the fraud in question involves public interest, the term of
imprisonment shall not be less than three years.
It may also be noted that where the fraud involves an amount less than ten lakh rupees or one
per cent. of the turnover of the company, whichever is lower, and does not involve public interest,
any person guilty of such fraud shall be punishable with imprisonment for a term which may extend
to five years or with fine which may extend to fifty lakh rupees or with both.]
Explanation — For the purposes of this section—
(i) “fraud” in relation to affairs of a company or any body corporate, includes any act,
omission, concealment of any fact or abuse of position committed by any person or any
other person with the connivance in any manner, with intent to deceive, to gain undue
advantage from, or to injure the interests of, the company or its shareholders or its
creditors or any other person, whether or not there is any wrongful gain or wrongful loss;
(ii) “wrongful gain” means the gain by unlawful means of property to which the person
gaining is not legally entitled;
(iii) “wrongful loss” means the loss by unlawful means of property to which the person
losing is legally entitled.
Direction by Tribunal in case auditor acted in a fraudulent manner: As per sub-section (5) of
the section 140, the Tribunal either suo motu or on an application made to it by the Central
∗
Source: CA knowledge

Government or by any person concerned, if it is satisfied that the auditor of a company has,
whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by,
or in relation to, the company or its directors or officers, it may, by order, direct the company to
change its auditors.
However, if the application is made by the Central Government and the Tribunal is satisfied that
any change of the auditor is required, it shall within fifteen days of receipt of such application,
make an order that he shall not function as an auditor and the Central Government may appoint
another auditor in his place.
It may be noted that an auditor, whether individual or firm, against whom final order has been
passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any
company for a period of five years from the date of passing of the order and the auditor shall also
be liable for action under section 447.
It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner
or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation
to, the company or its director or officers.
5.1 Cases in which an Auditor has been held to have incurred

Ciminal Liability
1. Dambell Banking Co. Ltd. (1900) - The directors and auditors, in the case, were
prosecuted under section 221 of the Criminal Code of 1872 which is similar to Section 143
of the Companies Act, 2013, for having joined in the issue of false balance sheets, knowing
them to be false in material particulars, and with the intent to deceive and defraud
shareholders of the company. From the facts provided, it was clear that the accounts were
not only false but materially false; letters from the auditors to the managers showed that
they (the auditors) thought that overdrafts were bad although taken in as good. They had
told the managers that they held strong’ views about the overdraft, but did not state those
views in their certificates to the shareholders. The jury found all the defendants (including
the auditors) guilty, and they were sentenced to various terms of imprisonment.
2. Farrow’s Bank Ltd. (1921) - In this case, there had been a considerable writing up of
assets, obviously to show profits available for dividends. In one case a piece of property
that cost £5,500 was written up to £7,80,000. The auditor was in the company’s regular
employment as its accountant and was convicted on various charges of conspiracy and
fraud in connection with the published accounts of the bank, and sentenced to 12 months’
imprisonment.
3. Rex v. Lord Kylsant and Another (1931) - (Known as the Royal Mail Steam Packet
Company’s Case): This was a criminal prosecution in which Lord Kylsant who was
Chairman of the Board of Directors of Royal Mail Steam Packet Company was charged on
two counts

(a) of publishing an annual report for 1926, which he knew to be false in a material
particulars and that the said report concealed from the shareholders the true
position of the company, with intent to deceive the shareholders; and
(b) of publishing an annual report for the year 1927, which he knew to be false in a
material particular, with intent to deceive the shareholders. Mr. H.J. Morland the
auditor, was charged with aiding and abetting Lord Kylsant to commit these
offences. Both the accused were acquitted of respective charges, though Lord
Kylsant was found guilty and convicted on a separate charge of publishing false
prospectus for the issue of fresh debenture stock.
The facts of the case briefly were that the Profit and Loss Account for the year 1926
showed, ‘Balance for the year, including dividends on shares in allied and other companies,
adjustment of taxation reserves, less depreciation of fleet £4,30,212. Actually this apparent
surplus had been arrived at on including undisclosed credits of £5,50,000 from excess Profit
Duty, £2,75,000 from Income tax Reserve and £25,776 from investment Profit. If this was
not done there would have been a considerable deficit. In 1927, with practically identical
wording, a surplus of £2,24,907 was raised to £4,37,293 by similar credits totalling
£2,12,386. It must be added that almost the entire amounts of these credits had no relation
to the trading of the respective years 1926 and 1927. The contention of the crown was that
such item, in the accounts conveyed “a deliberate false representation to the shareholders
that the company was making a trading profit when, in fact, it was making a trading loss.”
The company, in fact, had been drawing upon its secret or hidden reserves from 1921 to
1927. The adjustment of these special credits enabled the company to pay its debenture
interest, and dividends on both the preference and ordinary stocks.
Note: The decision in the case has been principally responsible for the change in the
phraseology of the auditor’s report from ‘true and correct’ to ‘true and fair’ requiring a fuller
disclosure of any non-trading income or that not belonging to the year, adjusted in the Profit
and Loss Account.
4. Official Liquidator Karachi Bank v. The Directors, etc. of Karachi Bank Ltd. (1932) -
The directors of the Bank made a statement in the balance sheet that the profit earned by
the bank in 1927 amounted to ` 15,608. The amount of profit had been arrived at on taking
credit for a sum of ` 45,214, an amount held in suspense for bad or doubtful items of
interest. It was held that the official Liquidator should prosecute the managing directors,
manager and the auditors for an offence under section 232 of the Indian Companies Act,
1913 (now section 448) of the Companies Act, 2013.
Wild J.C. said “What the Directors of the bank have done is to show a cash profit for the
year by adding in a sum which is due, no doubt, but was never paid and was never likely to
be paid. The balance sheet, therefore, contains a false statement and a very material one
and I am unable to see how it can be argued that it was not intended to be misled.”

6. CASES CONCERNING THE MISCONDUCT OF AUDITORS

UNDER THE CHARTERED ACCOUNTANTS ACT
The code of conduct for an auditor should be taken into consideration and the different
circumstances under which disciplinary action can be taken against a member; the decisions in a
number of cases can be referred to. It being important, however, for students to understand what
constitutes ‘gross negligence’ in terms of Clauses 5 to 8 of Part I of the Second Schedule to the
Chartered Accountants Act, two decisions by Indian Courts which have become legal classics, are
considered below:
Case of Deputy Secretary of the Government of India, Ministry of Finance v. S. N. Dass Gupta:
Findings of the Case: In this case, action was brought against Shri S.N. Dass Gupta, a
member of the Institute, in respect of alleged negligence in the audit of accounts of Aryan Bank
Limited, for the years 1942 to 1944. It was alleged that the bank had resorted to manipulation of
accounts on an extensive scale. One of the charges was that in 1944 the bank has shown in its
Fixed Deposit Ledger certain large sums as having been received on fixed deposit from certain
concerns in which the Managing Director was interested but the Cash Book of the bank did not
show any corresponding entries on the relevant dates. Another charge was that though the
auditor had certain doubts as regard loans advanced against fixed deposits, he had not stated
the position clearly. It was also alleged that on a certain date in 1944 the Cash Book showed a
cash balance of ` 5,00,000 although the actual balance on the date was a little over ` 1,000.
The auditor in defence submitted that he had not verified the cash balance in hand and had
mentioned this fact in his Special Report.
Judgement/ Decision : The learned judge in this regard observed:
“If an auditor does not do what it is his duty to do, it is no defence for him to say in disciplinary
proceedings started under Chartered Accountants Act that he had told the shareholder that he
had not done it. The lapse is constituted by his failure to verify a duty without which an audit is
meaningless and it is not excused by giving information of the omission to the shareholders.
Authorities both legal and professional are unanimous that in a bank audit the cash balance
claimed by the management must be verified by the auditor because otherwise the management
might remove the greater part of the funds and show them falsely lying cash in hand and
thereby relieve themselves of the necessity of making up accounts showing the disposition of
money. In the matter of cash the auditor is not entitled to rely on the certificate of the manager
of accepted integrity, according to the principles laid down in the case Re: City Equitable Fire
Insurance Co.”
In the matter of the second charge against the auditor that though he had some doubts and
misgivings as regards certain losses which might be suffered by the bank due to certain
overdrafts accounts proving to be irrecoverable, he had failed to qualify the report in certain
terms indicating the true position of the debits and, instead, had made some cryptic remarks

about them in his special report. The learned judge observed, “Either he knew that some of the
debts were bad and some of the so called secured loans were not genuine, but he did not wish
to inform the shareholders of that fact but wanted at the same time to provide for his own safety
and, therefore, he inserted certain cryptic remarks in his Special Report; or he was careless and
neglected to give the shareholders the information which it was his duty to give”.
It was held that the respondent has committed a grave wrong and in consequence he was
suspended from the membership of the institute for two years.
The learned judge in his judgement also made the following observation as regards the duties of
auditor and methods they should follow for discharging them satisfactorily:
(a) Ascertaining reporting, not only whether the balance sheet exhibits a true and fair state of
affairs of the company, as shown by the books of the company, but also whether the books of
the company themselves exhibit a true and fair state of the company’s affairs.
If any matter has been kept out of the books, with the result that the auditor did not have access
to it, he is not responsible for its non disclosure to the shareholders. In this regard the dictum,
pronounced by Rigby L.J. in the case Re: London & General Bank, that the words as shown by
the books of the company, contained, in the report which the auditors make on the statements
of account relieve them the responsibility as regards disclosure of the affairs of the company
kept out of the books can be followed.
(b) Verifying not merely the arithmetical accuracy of the statements of account but also their
substantial accuracy by confirming that they include all the particulars requiring disclosure by
the Articles or the Companies Act and otherwise represents true and fair state of affairs of the
company.
(c) Checking the accounts and verifying the financial statements with reasonable care and
skill. For the purpose, the auditor may properly rely on the statements of the director-in-charge
or the Managing Director but only if he is satisfied that the representations made by him appear
to be an honest and truthful. All matters which are capable of direct verification should generally
be verified directly. But matters which require investigation rather than checking may be verified
on the basis of representation of officers of accepted competence and integrity provided there is
nothing unusual in the accounts.
(d) Examining the books of the company and obtaining such information or explanation which
he considers necessary but not with suspicious mind or by proceeding in a manner he would
adopt for detecting a fraud or a lie subject, however, to the fact that he is not in possession of
any information which excites suspicion or ought to excite suspicion of a professional man of
reasonable competence.
(e) Verifying the existence of assets and liabilities.
(f) Making a report to the shareholders as would give them information and not merely means
of information, in order that the shareholders may judge the position of the company for

themselves. If the auditor is not satisfied as to the accuracy of entries in the balance sheet or
they are such that, if disclosed, they would show the balance sheet in a different way, these
facts must be conveyed to the shareholders.
Case of Controller of Insurance vs H. C. Das:

Findings of the Case: In this case, action was brought against Messers H.C. Dass & Co. by the
Central Government in the matter of audit of accounts of Bhagya Laxmi Insurance Limited. The
auditors had audited the accounts of the company from 1936 until 1951 and had issued the
certificate required under Regulations 7(c) and 7(d) of Part I of the First Schedule to the Insurance
Act, 1938. On the appointment of the administrator subsequently under Section 52A of the
Insurance Act, a number of irregularities were discovered. The principal defence of the auditor in
respect of the charges was that he had relied on statements of the management in regard to
matters included in the statements certified by him.
Judgement / Decision: During the course of the judgement, the learned judge made the following
observation:
“As has been said, an auditor is not only blood hound, but he is not also an insurer. He does not
certify the absolute accuracy of the accounts which he audits and approves of, but only says that
he has taken all possible care and exercised reasonable skill and having done so has arrived at
the conclusions which are recorded in his certificate. But if, as we find to our regret to have been
the position here, an auditor does nothing at all in the way of scrutinising the books of the
company, but only relies upon statements made to him by the management, as his own case find it
impossible to hold that he exercised any skill or care of any kind.
“An auditor who construes his duty to shareholders or policy holders too narrowly and who passes
and approves of whatever is stated to him by the management of the company whose accounts he
audits does not serve the shareholders with the loyalty or efficiency expected of him and constitutes,
instead of a source of security to the shareholders, a positive danger to them.”
The auditor was held guilty of gross negligence.
7. LIABILITIES UNDER INCOME TAX ACT 1961

In connection with proceedings under the Income Tax Act 1961, a Chartered Accountant often acts
as the authorised representative of his clients and attends before an Income Tax Authority or the
appellate tribunal. His liabilities under the Income Tax Act of 1961 are as below:

Under Section 288
Under Section 278

Auditor's liabilities
under the Income Tax
Act, 1961 Under Rule 12A of the
Income Tax Rules
Under Section 271 J
(i) Under Section 288: A person who has been convicted of any offence connected with any
Income Tax proceeding or on whom a penalty has been imposed under the said Act (except
under clause (ii) of sub section (1) of Section 271) is disqualified from representing an
assesses. The Chief Commissioner/Commissioner of Income Tax has been given powers to
determine the period of such disqualification of a person.
Section 288 (4) & (5) of the Income Tax Act, 1961
Sub section 4 of Section 288 of the Income Tax Act:
No person-
(a) who has been dismissed or removed from Government service after the 1st day of
April, 1938; or
(b) Who has been convicted of an offence connected with any income tax proceeding or
on whom a penalty has been imposed under this Act, other than a penalty imposed
on him under [clause(ii) of sub section (1) of section 271 [or clause(d) of sub-section
(1) of section 272A]; or
(c) who has become an insolvent; or
(d) who has been convicted by a court for an offence involving fraud, shall be qualified
to represent an assesse under sub-section (1), for all times in the case of a person
referred to in clause(a), for such time as the Principal Chief Commissioner or Chief
Commission or Principal Commissioner or Commissioner may, by order determine in
the case of a person referred to in clause (b), for the period during which the
insolvency continues in the case of a person referred to in clause (c), and for a
period of ten years from the date of conviction in the case of a person referred to in
clause (d).
Sub section 5 of Section 288 of the Income Tax Act:
If any person-
(a) who is a legal practitioner or an accountant is found guilty of misconduct in his
professional capacity by any authority entitled to institute disciplinary proceedings
against him, an order passed by that authority shall have effect in relation to his right
to attend before an income-tax authority as it has in relation to his right to practice

as a legal practitioner or account, as the case may be;

(b) Who is not a legal practitioner or an accountant, is found guilty of misconduct in
connection with any income-tax proceedings by the prescribed authority, the
prescribed authority (Chief Commissioner or Commissioner having requisite
jurisdiction) may direct that he shall thenceforth be disqualified to represent an
assesse under sub section (1).
A Chartered Accountant found guilty of professional misconduct in his professional capacity
by the Council of the Institute of Chartered Accountants of India, can not act as an
authorised representative (for any matter within the definition of a member in practice) for
such time that the order of the Council disqualifies him from practising.
(ii) Under Section 278: “If a person abets or induces in any manner another person to make
and deliver an account or a statement or declaration relating to any income [or any fringe
benefits] chargeable to tax which is false and which he either knows to be false or does not
believe to be true or to commit an offence under sub-section (1) of section 276C, he shall
be punishable,-
Section 278 of the Income Tax Act, 1961:
(i) in a case where the amount of tax, penalty or interest which would have been
evaded, if the declaration, account or statement had been accepted as true, or
which is willfully attempted to be evaded, exceeds [twenty five] hundred thousand
rupees, with rigorous imprisonment for a term which shall not be less than six
months but which may extend to seven years and with fine;
(ii) in any other case, with rigorous imprisonment for a term which shall not be less
than three months but which may extend to [two] yeas and with fine
(iii) Under Rule 12A of the Income Tax Rules: Under this rule a Chartered Accountant who as
an authorised representative has prepared the return filed by the assessee, has to furnish
to the Assessing Officer, the particulars of accounts, statements and other documents
supplied to him by the assessee for the preparation of the return.
Where the Chartered Accountant has conducted an examination of such records, he has
also to submit a report on the scope and results of such examination. The report to be
submitted will be a statement within the meaning of Section 277 of the Income Tax Act.
Thus if this report contains any information which is false and which the Chartered
Accountant either knows or believes to be false or untrue, he would be liable to rigorous
imprisonment which may extend to seven years and to a fine.
(iv) Under Section 271J of the Income Tax Act: As per new section inserted by the Finance
Act, 2017 if an accountant or a merchant banker or a registered valuer, furnishes incorrect
information in a report or certificate under any provisions of the Act or the rules made
thereunder, the Assessing Officer or the Commissioner (Appeals) may direct him to pay a
sum of ten thousand rupees for each such report or certificate by way of penalty. [ section
271J]

TEST YOUR KNOWLEDGE

1. Indicate the precise nature of auditor's liability in the following situations and support your
views with authority, if any:
(i) A misstatement had occurred in the prospectus issued by the company.
(ii) Certain weaknesses in the internal control procedure in the payment of wages in a
large construction company were noticed by the statutory auditor who in turn brought
the same to the knowledge of the Managing Director of the company. In the
subsequent year huge defalcation came to the notice of the management. The origin
of the same was traced to the earlier year. The management wants to sue the
auditor for negligence and also plans to file a complaint with the Institute.
(iii) Based upon the legal opinion of a leading advocate, X Ltd. made a provision of
` 3 crores towards Income Tax liability. The assessing authority has worked out the
liability at ` 5 crores. It is observed that the opinion of the advocate was inconsistent
with legal position with regard to certain revenue items.
2. Write a short note on - Auditor’s liability in case of unlawful acts or defaults by clients.
3. Explain briefly duties and responsibilities of an auditor in case of material misstatement
resulting from Management Fraud.
4. In assessment procedure of M/s Cloud Ltd., Income Tax Officer observed some
irregularities. Therefore, he started investigation of Books of Accounts audited and signed
by Mr. Old, a practicing Chartered Accountant. While going through books he found that M/s
Cloud Ltd. used to maintain two sets of Books of Accounts, one is the official set and other
is covering all the transactions. Income Tax Department filed a complaint with the Institute
of Chartered Accountants of India saying Mr. Old had negligently performed his duties.
Comment.
5. Mr. Fresh, a newly qualified chartered accountant, wants to start practice and he requires
your advice, among other things, on criminal liabilities of an auditor under the Companies
Act, 2013. Kindly guide him.

1. OPE Ltd issued a prospectus in respect of an IPO which had the auditor’s report on the
financial statements for the year ended 31 March 2019. The issue was fully subscribed.
During this year, there was an abnormal rise in the profits of the company for which it was
found later on that it was because of manipulated sales in which there was participation of
Whole-time director and other top officials of the company. On discovery of this fact, the

company offered to refund all moneys to the subscribers of the shares and sued the
auditors for the damages alleging that the auditors failed to examine and ascertain any
satisfactory explanation for steep increase in the rate of profits and related accounts.
The company emphasized that the auditor should have proceeded with suspicion and
should not have followed selected verification. The auditors were able to prove that they
found internal controls to be satisfactory and did not find any circumstance to arouse
suspicion.
The company was not able to prove that auditors were negligent in performance of their
duties. Please suggest your views on this.
(a) The stand of the company was correct in this case. Considering the nature of the
work, the Auditors should have proceeded with suspicion and should not have
followed selected verification.
(b) The approach of the auditors look reasonable in this case. The auditors found
internal controls to be satisfactory and also did not find any circumstance to arouse
suspicion and hence they performed their procedures on the basis of selected
verification.
(c) In the given case, the auditors should have involved various experts along with them
to help them on their audit procedures. Prospectus is one area wherein management
involves various experts and hence the auditors should also have done that. In the
given case, by not involving the experts the auditors did not perform their job in a
professional manner. If they had involved experts like forensic experts etc, the
manipulation could have been detected. Hence the auditors should be held liable.
(d) In case of such type of engagements, the focus is always on the management
controls. If the controls are found to be effective then an auditor can never be held
liable in respect of any deficiency or misstatement or fraud.
2. Kshitij and a group of persons subscribed to the shares of JNN Ltd. JNN Ltd had issued a
prospectus for issuance of shares against which these persons had subscribed the shares.
It was later on found that some information as included in the prospectus was misleading.
These persons filed a case against the company covering all the parties who were
responsible for the prospectus on the ground that the information contained in the
prospectus was misleading and they suffered losses by relying on that information.
The company consulted this matter with its legal consultants in respect of the course of
action to be taken and also consulted that if the outcome of the case goes against the
company then which all parties may be held liable and what could be the other
consequences.

The prospectus included auditor’s report who had also given his clearance. Some of the
experts were also involved in respect of the information on which the litigation was filed.
Subsequently, it was proved that the contention of Kshitij and those persons was correct. It
was held that the directors, promoters of the company and the experts involved would be
liable to pay compensation to all these persons who had sustained losses or any damage.
The auditors of the company were also asked to make good the losses but they refused
with an argument that it is limited to directors, promoters and experts.
In this context, please suggest which of the following statement is correct.
(a) The argument of the auditors is valid. As per the final outcome of the litigation the
auditors were not held liable. However, on moral grounds the auditors should
contribute towards the losses suffered by any person.
(b) The argument of the auditors is valid. Since the final outcome of the litigation did not
held them liable, they cannot be asked to contribute towards the losses suffered by
any person.
(c) The argument of the auditors is not valid. The final outcome of the litigation covers
the experts and hence the auditors also get covered to contribute towards the losses
suffered by the persons.
(d) The outcome of the litigation seems to be completely wrong. The directors and
experts were held liable but along with that the statutory auditors, internal auditors,
tax auditors, Company Secretary, tax consultants and the legal advisors should also
have been held liable. Further the promoters cannot be held liable in such matters.
3. JK Ltd is a company engaged in the business of software development. It is one of the
largest companies in this sector with a turnover of INR 25,000 crores. The operations of the
company are increasing constantly, however, the focus of the management is more on cost
cutting in the coming years to improve its profitability.
In respect of the financial statements of the company which are used by various
stakeholders, some deficiencies were observed in respect of assets reported therein due to
which those stakeholders suffered damages. As a result, those stakeholders went for a civil
action against the company including all the parties who had the responsibility in respect of
those financial statements.
The statutory auditors of the company were also roped in. The statutory auditors went
against this civil action and were able to prove that there was no professional negligence on
their part.
It was decided that the loss was occasioned through the negligence of directors and the
fault of the auditor in failing to verify the asset was considered to be only technical.

On the basis of above mentioned facts, what should be the correct option out of the
following?
(a) A penalty should be levied on the auditors but that should not be equivalent to the
damages suffered by the stakeholders. The damages would be required to be made
good by the directors of the company.
(b) Both the auditors and the directors should be held liable in respect of the
deficiencies identified. Both of them should compensate these stakeholders in
respect of the damages and a further penalty of INR 10 lakhs would be imposed on
them.
(c) Auditors and directors should be held liable in this case. Further because the fault of
directors is bigger, they would be subject to a penalty of INR 10 crores or losses
suffered by the stakeholders, whichever is higher.
(d) Since the fault of the auditor is limited to technical in nature, he cannot be held liable
for any penalty or damages. However, he would not be allowed to work for this
company and any other company in similar industry for a period of next 5 years as
per the requirements of the Companies Act 2013.
4. KKR Ltd is a medium-sized company engaged in the business of e-commerce. The
company’s operations have remained stable over the years and its profitability has been
going down. The company also ventured into different markets over the last few years but
that has not helped much in terms of growth of business or increasing the profitability. The
company’s immediate plan is to expand its operations with focus on increasing the
profitability.
The company was looking for funds to achieve this objective and issued a prospectus to the
public to subscribe to its shares.
The financial statements of the company for the year ended 31 March 2018 included in the
prospectus showed a very different picture of the company particularly in respect of its
profits.
It was later on found that some of the information contained in the prospectus was
misstated i.e. it was untrue and misleading to attract the public to subscribe the shares of
the company.
Legal action was taken by the stakeholders against the company including its auditors and
the company’s management/ directors were confident that they would not be required to
face any action considering the fact that the financial statements were duly audited by a
reputed firm of Chartered Accountants. If at all any problem arises, it would be the
responsibility of the auditors.

Please advise whether anyone can be held liable in this matter or not. If yes, what action
can be taken against him/them? If no, what should be the corrective action?
(a) The understanding of the directors is correct and the auditors should be held liable
under section 447 of the Companies Act.
(b) The understanding of the directors is wrong. They would be held liable under section
447 of the Companies Act and not the auditors because responsibility for the
prospectus lies with the management.
(c) This may lead to criminal liability wherein every person who authorises the issue of
such prospectus shall be liable under section 447 of the Companies Act.
(d) This may lead to civil liability wherein every person who authorises the issue of such
prospectus shall be liable under section 447 of the Companies Act.
5. Vimal Kumar, a Chartered Accountant by profession, has been into practice for the over 6
years. He developed a specialization in respect of matters related to Income Tax and hence
got various clients to whom he was advising.
Other than the taxation work, Vimal was also good in accounting matters but he could not
develop his business/ clientele the accounting services over the period.
He used to represent his clients in respect of income tax returns.
For one of his clients, he, as an authorised representative, prepared the return of income
and furnished the same and other required documents (the particulars of accounts,
statements and other documents supplied to him by the assessee for the preparation of the
return) to the Assessing Officer. He had also conducted an examination of those records
and submitted a report on the scope and results of his examination.
The assesse in this case was a very old client of Vimal and also used to pay him very good
remuneration. In order to provide some benefits to the assesse, Vimal provided certain
information to the assessing officer which was found to be false later on.
In the given case, which of the following options should apply?
(a) Since Vimal only acted as a representative of the assesse, he cannot be held liable.
The assesse is the primary person responsible and accordingly the assessee would
be liable to rigorous imprisonment which may extend to seven years and to a fine.
(b) The given matter does not only relate to submission of the return of income but also
covers an examination of those records and a report on the scope and results of
examination by a Chartered Accountant. Because of the professional responsibilities
placed on a CA, it becomes his duty to carry out all the tasks in an objective manner
free from any bias. Hence Vimal would be liable to a penalty of ` seven crores and
imprisonment of seven years.

(c) Vimal would be liable to rigorous imprisonment which may extend to seven years and
to a fine.
(d) Vimal and his assessee would be liable to a penalty which may extend to ` 1 crore.
Further because of the fact that the particulars submitted with the assessing officer
belong to the assesse, hence the assesse would also be liable to imprisonment for
three years under the Indian Penal Code.
1. (i) Refer para 4.
(ii) In the given case, certain weaknesses in the internal control procedure in the
payment of wages in a large construction company were noticed by the statutory
auditor and brought the same to the knowledge of the Managing Director of the
company. In the subsequent year, a huge defalcation took place, the ramification of
which stretched to the earlier year. The management of the company desires to sue
the statutory auditor for negligence. The precise nature of auditor's liability in the
case can be ascertained on the basis of the under noted considerations:
(a) Whether the defalcation emanated from the weaknesses noticed by the statutory
auditor, the information regarding which was passed on to the management; and
(b) Whether the statutory auditor properly and adequately extended the audit
programme of the previous year having regard to the weaknesses noticed.
SA 265 on “Communicating Deficiencies in Internal Control to Those Charged
with Governance and Management” clearly mentions that, “The auditor shall
determine whether, on the basis of the audit work performed, the auditor has
identified one or more deficiencies in internal control. If the auditor has identified one
or more deficiencies in internal control, the auditor shall determine, on the basis of
the audit work performed, whether, individually or in combination, they constitute
significant deficiencies. The auditor shall communicate in writing significant
deficiencies in internal control identified during the audit to those charged with
governance on a timely basis. The auditor shall also communicate to management at
an appropriate level of responsibility on a timely basis”. The fact, however, remains
that, weaknesses in the design of the internal control system and non-compliance
with identified control procedures increase the risk of fraud or error. If circumstances
indicate the possible existence of fraud or error, the auditor should consider the
potential effect of the suspected fraud or error on the financial information. If the
auditor believes the suspected fraud or error could have a material effect on the
financial information, he should perform such modified or additional procedures as
he determines to be appropriate. Thus, normally speaking, as long as the auditor
took due care in performing the audit work, he cannot be held liable.

The fact that the matter was brought to the notice of the managing director may be a
good defence for the auditor as well. According to the judgement of the classic case
in re Kingston Cotton Mills Ltd., (1896) it is the duty of the auditor to probe into the
depth only when his suspicion is aroused. The statutory auditor, by bringing the
weakness to the notice of the managing director had alerted the management which
is judicially held to be primarily responsible for protection of the assets of the
company and can put forth this as defence against any claim arising subsequent to
passing of the information to the management. In a similar case S.P. Catterson &
Sons Ltd. (81 Acct. L. R.68), the auditor was acquitted of the charge.
(iii) SA 500 on "Audit Evidence" discusses the auditor's responsibility in relation to and
the procedures the auditor should consider in, using the work of an expert as audit
evidence. During the audit, the auditor may seek to obtain, in conjunction with the
client or independently, audit evidence in the form of reports, opinions, valuations
and statements of an expert, e.g., legal opinions concerning interpretations of
agreements, statutes, regulations, notifications, circulars, etc. Before relying on
advocate's opinion, the auditor should have seen that opinion given by the expert is
prima facie dependable. The question states very clearly that the opinion of the
advocate was inconsistent with legal position with regard to certain items. It is,
perhaps, quite possible that auditor did not seek reasonable assurance as to the
appropriateness of the source data, assumptions and methods used by the expert
properly.
In fact, SA 500 makes it incumbent upon the part of the auditor to resolve the
inconsistency by discussion with the management and the expert. In case, the
experts' work does not support the related representation in the financial information
the inconsistency in legal opinions could have been detected by the auditor if he had
gone through the same. This seems apparent having regard to wide difference in the
liability worked out by the assessing authority. Under the circumstance, the auditor
should have rejected the opinion and insisted upon making proper provision.
2. Auditor's liability in case of unlawful Acts or defaults by clients: The auditor's basic
responsibility is to report whether in his opinion the accounts show a true and fair view and
in discharging his responsibility he has to see as to how the particular situations affected
his position. The general thinking with regard to unlawful acts or defaults by clients appears
to be that the auditor should not 'aid or abet' but he is apparently not under any legal
obligation to disclose the offence. A professional accountant would himself be guilty of a
criminal offence if he advises his client to commit any criminal offence or helps or
encourages in planning or execution of the same or conceals or destroys evidence to
obstruct the course of public justice or positively assists his client in evading prosecution. A
professional accountant in his capacity as auditor, accountant, or tax representative has
access to a variety of information concerning his clients. On some occasions, he may

acquire knowledge that his client has been guilty of some unlawful act, default, fraud, or
other criminal offence. The duty of the professional accountant in such a case would
depend upon the actual circumstances of the situation. Due consideration should be given
to the exact nature of services that a professional accountant is rendering to his client, i.e.
is he representing the client in income-tax proceedings or is he acting in the capacity of an
auditor or an accountant or a consultant.
The Institute of Chartered Accountants of India has considered the role of chartered
accountants in relation to taxation frauds by an assessee and has made the following
major recommendations:
(i) A professional accountant should keep in mind the provisions of Section 126 of the
Evidence Act whereby a barrister, an attorney, a pleader or a Vakil is barred from
disclosing any communication made to him in the course of and for the purpose of
his employment.
(ii) If the fraud relates to past years when the accountant did not represent the client,
the client should be advised to make a disclosure. The accountant should also be
careful that the past fraud does not in any way affect the current tax matters.
(iii) In case of fraud relating to accounts examined and reported upon by the professional
accountant himself, he should advise the client to make a complete disclosure. In
case the client refuses to do so, the accountant should inform him that he is entitled
to dissociate himself from the case and that he would make a report to the
authorities that the accounts prepared or examined by him are unreliable on account
of certain information obtained later. In making such a report, the contents of the
information as such should not be communicated unless the client consents in
writing.
(iv) In case of suppression in current accounts, the client should be asked to make a full
disclosure. If he refuses to do so, the accountant should make a complete
reservation in his report and should not associate himself with the return.
However, it can be argued that the auditor has a professional obligation to ensure that the
client is fully aware of the seriousness of the offence and to seriously consider full
disclosure of the matter.
It has been clearly established in various case laws that the auditor is expected to know the
contents of documents and records and ascertain whether the affairs of the client are being
conducted in an unlawful manner. It is in the course of the work, he comes across any
unlawful acts, it is his duty to bring it to the notice of the client as also to make a disclosure
in his report in appropriate cases. In this regard, one has to bear in mind the consequence
of the act in relation to the professional code to which an auditor is subjected. Under the
code, an auditor cannot disclose confidential information unless permitted by the client or
unless required by law. Each case has to be judged on its circumstances. However, in

every case he has to assess the implications of the unlawful act or default on the true and
fair character of the accounting statements.
The question of liability of an auditor for unlawful acts or defaults by clients should be
considered in the light of the broad parameters given above. However, it appears that if an
auditor was aware of any unlawful act having been committed by client in respect of
accounts audited by him and the unlawfulness was not rectified by proper disclosure or any
other appropriate means, the auditor owes a duty to make a suitable report. If he does not,
he may be held liable, if the true and fair character of the accounts has been vitiated.
3. Duties & Responsibilities of an Auditor in case of Material Misstatement resulting
from Management Fraud: Misstatement in the financial statements can arise from fraud or
error. The term fraud refers to an ‘Intentional Act’ by one or more individuals among
management, those charged with governance. The auditor is concerned with fraudulent acts
that cause a material misstatement in the financial statements.
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements”, fraud can be committed by management overriding controls using
such techniques as engaging in complex transactions that are structured to misrepresent
the financial position or financial performance of the entity.
Fraud involving one or more members of management or those charged with the
governance is referred to as “management fraud”. The primary responsibility for the
prevention and detection of fraud rests with those charged with the governance and the
management of the entity.
Further, an auditor conducting an audit in accordance with SAs is responsible for obtaining
reasonable assurance that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error. Owing to the inherent limitations of an
audit, there is an unavoidable risk that some material misstatements of the financial
statements may not be detected, even though the audit is properly planned and performed
in accordance with the SAs.
The risk of the auditor not detecting a material misstatement resulting from management
fraud is greater than for employee fraud, because management is frequently in a position to
directly or indirectly manipulate accounting records, present fraudulent financial information
or override control procedures designed to prevent similar frauds by other employees
Auditor’s opinion on the financial statements is based on the concept of obtaining
reasonable assurance, hence in an audit, the auditor does not guarantee that material
misstatements will be detected.
Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company,
in the course of the performance of his duties as auditor, has reason to believe that an
offence of fraud involving such amount(s) as may be prescribed, is being or has been

committed in the co. by its officers or employees, the auditor shall report the matter to the
Central Government (in case amount of fraud is ` 1 crore or above)or Audit Committee or
Board in other cases (in case the amount of fraud involved is less than ` 1 crore) within
such time and in such manner as may be prescribed.
The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016,
Whether any fraud by the company or any fraud on the company by its officers or
employees has been noticed or reported during the year; If yes, the nature and the amount
involved is to be indicated.
If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor
encounters exceptional circumstances that bring into question the auditor’s ability to
continue performing the audit, the auditor shall:
(i) Determine the professional and legal responsibilities applicable in the circumstances,
including whether there is a requirement for the auditor to report to the person or
persons who made the audit appointment or, in some cases, to regulatory
authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where
withdrawal from the engagement is legally permitted; and
(iii) If the auditor withdraws:
(1) Discuss with the appropriate level of management and those charged with
governance, the auditor’s withdrawal from the engagement and the reasons for
the withdrawal; and
(2) Determine whether there is a professional or legal requirement to report to the
person or persons who made the audit appointment or, in some cases, to
regulatory authorities, the auditor’s withdrawal from the engagement and the
reasons for the withdrawal.
4. Liability of Auditor: “It is the auditor’s responsibility to audit the statement of accounts and
prepare tax returns on the basis of books of accounts produced before him. Also if he is
satisfied with the books and documents produced to him, he can give his opinion on the
basis of those documents only by exercising requisite skill and care and observing the laid
down audit procedure.
In the instant case, Income tax Officer observed some irregularities during the assessment
proceeding of M/s Cloud Ltd. Therefore, he started investigation of books of accounts
audited and signed by Mr. Old, a practicing Chartered Accountant. While going through the
books, he found that M/s Cloud Ltd. Used to maintain two sets of Books of Accounts, one is
the official set and other is covering all the transactions. Income Tax Department filed a
complaint with the ICAI saying Mr. Old had negligently performed his duties.

Mr. Old, the auditor was not under a duty to prepare books of accounts of assessee and he
should, of course, neither suggest nor assist in the preparations of false accounts. He is
responsible for the books produced before him for audit. He completed his audit work with
official set of books only.
In this situation, as Mr. Old, performed the auditing with due skill and diligence; and,
therefore, no question of negligence arises. It is the duty of the Department to himself
investigate the truth and correctness of the accounts of the assessee.
5. Refer Para 5.

1. (b) 2. (c) 3. (a) 4. (c) 5. (c)

15
INTERNAL AUDIT, MANAGEMENT

AND OPERATIONAL AUDIT
LEARNING OUTCOMES
After reading this chapter student shall be able to:
 Know the meaning of Internal Audit, Management and Operational Audit.
 Gain the knowledge of the management functions and scope of internal

auditing.
 Analyse the relationship between Internal and External Auditors.
 Understand the difference between Management Audit and Operational

Audit.

CHAPTER OVERVIEW
Internal Audit, Management and

Operational Audit
Internal Audit Management Audit Operational Audit
Management and Operational

Management Functions Audit
and Scope of Internal Internal Auditing and
Auditing Operational Auditing
Desirability of Management Audit
Qualities of Operational
Auditor
Integrity, Objectivity and Organising the Management
Independence of Audit
Internal Auditor
Why Operational Audit?
Conducting a Management Audit
Type of Operational Audits
Qualifications of Internal Concluding a Management Audit

Auditor
Objectives of Operational
Audit
Behavioural aspects encountered
Relationship between
Internal and External
Auditors
Management Audit Questionnaire

INTERNAL AUDIT, MANAGEMENT AND OPERATIONAL AUDIT 15.3
1. INTERNAL AUDIT
Many modern enterprises have become
huge and sophisticated. This has resulted in
decentralisation of their activities and
Assur- consequently the top management is
ance remotely concerned with the day-to-day
activities of the concern.
The Institute of Chartered Accountants of
Insight India has constituted a Committee on
Internal Audit (CIA) as a non-standing
committee on February 5, 2004. The CIA
Objectivity
was constituted (now known as Internal
Audit Standard Board) with the object of
formulating Standards and Guidance Notes
on Internal Audit.
As defined in scope of the Standards on Internal Audit, Internal Audit means “an independent
management function, which involves a continuous and critical appraisal of the functioning of an
entity with a view to suggest improvements thereto and add value to and strengthen the overall
governance mechanism of the entity, including the entity’s strategic risk management and internal
control system”.
The internal auditing need not to be confined to
financial transactions and its scope may be
extended to the task of reviewing whether the
resource utilisation of the enterprise is efficient and
economical. This would necessitate a review of all
operations of the enterprise as also an evaluation of
the effectiveness of management. We should not
however lose sight of the fact that internal auditing
is basically a service activity.
Fig.: Internal Audit ∗
The internal auditor should review and report, he is not expected to take upon himself functions of
the operational managers.
Applicability of Provisions of Internal Audit: As per section 138 of the Companies Act, 2013,
following class of companies (prescribed in rule 13 of Companies(Accounts)Rules,2014) shall be
required to appoint an internal auditor which may be either an individual or a partnership
firm or a body corporate, namely-
∗
Source: Slide Share

(a) every listed company;

(b) every unlisted public company having- (iii) outstanding loans or borrowings
(i) paid up share capital of fifty crore from banks or public financial
rupees or more during the preceding institutions exceeding one
financial year; or hundred crore rupees or more at
any point of time during the
(ii) turnover of two hundred crore rupees preceding financial year; or
or more during the preceding
financial year; or (iv) outstanding deposits of twenty
five crore rupees or more at any
point of time during the preceding
financial year; and
(c) every private company having- (ii) outstanding loans or borrowings
(i) turnover of two hundred crore rupees from banks or public financial
or more during the preceding institutions exceeding one
financial year; or hundred crore rupees or more at
any point of time during the
preceding financial year.
It is provided that an existing company covered under any of the above criteria shall comply with
the requirements within six months of commencement of such section.
CASE STUDY
JKT Pvt. Ltd. having ` 40 lacs paid up capital, `9.50 crores reserves and turnover of last three
consecutive financial years, immediately preceding the financial year under audit, being
` 49 crores, ` 145 crores and ` 260 crores, but does not have any internal audit system. In view of
the management, internal audit system is not mandatory. Comment.
Applicability of Provisions of Internal Audit: As per section 138 of the Companies Act, 2013,
read with rule 13 of Companies (Audit and Auditors) Rules, 2014, every private company shall be
required to appoint an internal auditor or a firm of internal auditors, having-
(i) turnover of two hundred crore rupees or more during the preceding financial year; or
(ii) outstanding loans or borrowings from banks or public financial institutions exceeding one
hundred crore rupees or more at any point of time during the preceding financial year.
Conclusion: In the instant case, JKT Pvt. Ltd. is having turnover of ` 260 crores during the
preceding financial year which is more than two hundred crore rupees. Hence, the company has the
statutory liability to appoint an Internal Auditor and mandatorily conduct internal audit.
Who can be Appointed as Internal Auditor?
• As per section 138, the internal auditor shall either be a chartered accountant or a cost
accountant (whether engaged in practice or not), or such other professional as may be

decided by the Board to conduct internal audit of the functions and activities of the companies.
The internal auditor may or may not be an employee of the company.
• To be effective, the internal auditor must be regarded as part of the management and not
merely as an assistant thereto. He must have authority to investigate from the financial
angles, every phase of the organisational activity under any circumstances.
AB Pvt. Ltd. company having outstanding loans or borrowings from banks exceeding
one hundred crore rupees wants to appoint Mr. X who is a practicing cost accountant
as internal auditor.
Provision & Conclusion: According to the provision given in section 138 of the companies Act,
2013, the internal auditor shall either be a chartered accountant or a cost accountant (whether
engaged in practice or not), or such other professional as may be decided by the Board to conduct
internal audit of the functions and activities of the companies. Thus Appointment of Mr. X as
internal Auditor of AB Pvt Ltd is valid.
His main responsibility, however, must be
to maintain adequate system of internal control by a continuous examination of accounting
procedures, receipts and disbursements and to provide adequate safeguards against
misappropriation of assets.
to operate independently of the accounting staff and must not in any way divest himself of
any of the responsibilities placed upon him.
Not to involve himself in the performance of executive functions in order that his objective
outlook does not get obscured by the creation of vested interest.
to observe facts and situations and bring them to notice of authorities who would otherwise
never know them; also, they critically appraise various policies of the management and draw
its attention to any deficiencies, wherever these require to be corrected.
to associate closely with management and his knowledge must be kept up to date by his
being kept informed about all important occurrences and events affecting the business, as
well as the changes that are made in business policies. He must enjoy an independent status.
In addition, the Audit Committee of the company or the Board shall, in consultation with the Internal
Auditor, formulate the scope, functioning, periodicity and methodology for conducting the internal
audit.
It may also be noted that the Central Government may, by rules, prescribe the manner and the
intervals in which the internal audit shall be conducted and reported to the Board.
(The Research Committee of the Institute of Chartered Accountants of India has brought out
“General Guidelines on Internal auditing”. The following discussion is based upon the above
publication.)

∗
Figure: Internal Auditor and Inspection Assignment
2. MANAGEMENT FUNCTIONS AND SCOPE OF

INTERNAL AUDITING
Management is a process by which the affairs of an enterprise are conducted in such a manner that
its goals and objectives are attained through optimum utilisation of all available resources, within the
legal, social, economic and environmental constraints. To achieve optimum utilisation of resources
management should determine the goals and objectives of the concern, quantify them to the extent
possible, develop major policies and plans, implement them and exercise control over such
implementation.
Each of the managerial functions should constantly be viewed by the internal auditor. The scope of
internal auditor’s work should include a review of-
∗
Source : Intact-systems.com

(i) Internal Control

System and Procedures
(ii)Custodianship and
Safeguarding of Assets
(iii) Compliance with

Policies, Plans,
Procedures and
Regulations
Scope of Internal
(iv) Relevance and
Auditor's Work include
Reliability of Information
review of-
(v)Organisational
Structure
(vi)Utilisation of
Resources
(vii)Accomplishment of
Goals and Objectives
On the basis of such review, the internal auditor should in his report, highlight the weaknesses
observed and give suggestions for improvement. We may now have a brief description on each of
the above areas of review:
(i) Review of Internal Control System and Procedures -
(a) The internal auditor should determine whether the internal control system is in con-
sonance with the organisational structure. As far as possible, controls should be in-
built in the operating functions, if they are to be cost effective.
The establishment of a separate credit control department would not be
justified if the objective of reducing credit risk and minimising debt recovery
period could be met through controls in-built in the accounting and sales
systems especially in smaller and medium sized concerns.

(b) Each control should be reviewed and analysed in terms of its costs and benefits. It
should also be seen whether the internal controls were in use throughout the period
of intended reliance. A break-down in internal controls for a specific portion of intended
reliance would need special attention.
(ii) Review of Custodianship and Safeguarding of Assets -
 The internal auditor should review the control systems to ensure that all assets are
accounted for fully. He should review the means used for safeguarding assets against
losses e.g. fire, improper or negligent activity, theft and illegal acts etc.
 He should review the control systems for intangible assets e.g. the procedures relating
to credit control. Where an enterprise uses electronic data processing equipment, the
physical and systems control on processing facilities as well as on data storage should
be examined and tested.
 He should also verify the existence of the assets.
(iii) Review of Compliance with Policies, Plans, Procedures and Regulations - It is essential
that the various functional segments of an enterprise comply with the relevant policies, plans,
procedures, laws and regulations so that the operations are carried out in coordinated
manner. He should examine the system of periodical review of existing policies particularly
when there is a change in the method and nature of operations of the enterprise. By
combining the results of his review of the adequacy of the systems with the result of his
compliance tests, the internal auditor should be able to evaluate the effectiveness of the
former. He should point out specific weaknesses and suggest remedial action.
(iv) Review of Relevance and Reliability of Information - The internal auditor should review
the information systems to evaluate the reliability and integrity of financial and operating
information given to management and to external agencies such as governmental bodies,
trade organisations and labour unions. He should examine the accuracy and reliability of
financial and operational records. The usefulness of the reports as well as of the records
should be evaluated with reference to their costs. The internal auditor should examine
whether the reporting is by exception i.e. the reports highlight the significant and distinctive
features.
(v) Review of the Organisation Structure - The internal auditor should conduct an appraisal of
the organisation structure to ascertain whether it is in harmony with the objectives of the
enterprise and whether the assignment of responsibilities is in consonance therewith. For this
purpose:
 He should review the manner in which the activities of the enterprise are grouped for
managerial control. It is also important to review whether responsibility and authority
are in harmony with the grouping pattern.

 The internal auditor should examine the organisation chart to find out whether the
structure is simple and economical and that no function enjoys an undue dominance
over the others.
 He should particularly see that the responsibilities of managerial staff at headquarters
do not overlap with those of chief executives at operating units. He should examine
whether there is a satisfactory balance between authority and responsibility of
important executives.
 The internal auditor should examine the reasonableness of the span of control of each
executive (the number of sub-ordinates that an executive controls). He should examine
whether there is a unity of command i.e., whether each person reports only to one
superior.
 Where dual responsibilities cannot be avoided, the primary one should be specified
and the specific responsibility to each senior fixed. This must be made known to all
concerned.
 Finally, he should evaluate the process of managerial development in the enterprise.
This is a vital aspect in a fast growing enterprise.
(vi) Review of Utilisation of Resources –
 The internal auditor should check whether proper operating standards and norms have
been established for measuring economical and efficient use of resources.
 They should be detailed enough to be identifiable with specific operating
responsibilities and should be capable of being used by operating personnel for
monitoring and evaluating their performance.
 The internal auditor should review the methods of establishing the operating standards
and norms. He should carefully examine the assumptions made while setting the
standards to ensure that they are appropriate and necessary.
 Where there is a wide divergence between actual performance and the corresponding
standards, reasons may be considered. As a part of evaluating resources utilisation,
identifying the facilities which are under-utilized is an important function of the internal
auditor.
For example: it may consist of under-utilized machines, unoccupied storage space, huge
cash or bank balances, idle man power etc. While commenting on staffing, the internal
auditor should pay special attention to non-productive work being performed. This would
require an enquiry into the job descriptions of employees combined with an intelligent
observation of the work being done.
(vii) Review of Accomplishment of Goals and Objectives - The internal auditor should review
the overall objectives of the enterprise to evaluate whether they are clearly stated and are

attainable. The internal auditor should examine whether to the extent possible, objectives are
expressed in precise quantifiable terms (both monetary and non-monetary) to facilitate
detailed planning to be made for achieving them. Budgeting forms an important part of such
planning. This will ensure that plans anticipate the problem areas. There should also be
sufficient flexibility in the plans to permit such improvements in their implementation, as would
benefit the enterprises as a whole.
3. INTEGRITY, OBJECTIVITY AND INDEPENDENCE OF

INTERNAL AUDITOR
As per Standard on Internal Audit (SIA) 2, Basic Principles Governing Internal Audit, issued by the
Council of the Institute of Chartered Accountants of India.
The internal auditor should:
1. be straightforward, honest and sincere in his approach to his

professional work;
2. be fair and must not allow prejudice or bias to override his objectivity;
3. should maintain an impartial attitude. He should not only be independent
in fact but also appear to be independent.
4. The internal auditor should not, therefore, to the extent possible,
undertake activities, which are or might appear to be incompatible with
his independence and objectivity.
For example, to avoid any conflict of interest, the internal auditor should not review an activity
for which he was previously responsible. It is also expected from the management to take steps
necessary for providing an environment conducive to enable the internal auditor to discharge his
responsibilities independently and also report his findings without any management interference.
For example, in case of a listed company, the internal auditor may be required to report directly
to those charged with governance, such as the Audit Committee instead of the Chief Executive
Officer or the Chief Financial Officer. The internal auditor should immediately bring any actual or
apparent conflict of interest to the attention of the appropriate level of management so that
necessary corrective action may be taken.

4. QUALIFICATIONS OF INTERNAL AUDITOR

1. The internal auditor should have the special expertise necessary for evaluating management
control systems, especially financial and accounting controls.
2. Accounting and finance functions provide basic data for management control of an enterprise.
Therefore the internal auditor must have accounting and financial expertise to be able to
discharge his duties.
3. The internal auditor is also expected to evaluate operational performance and non-monetary,
operational controls. This requires a basic knowledge of the technology and commercial
practices of the enterprise.
4. He should also have a basic knowledge of commerce, laws, taxation, cost accounting,
economics, quantitative methods and EDP systems.
5. An understanding of management principles and techniques is another essential qualification
of an internal auditor as also the ability to deal with people.
6. By his conduct the internal auditor should provide an assurance to the management that
confidentiality of such information would be maintained.
5. INTERNAL AUDIT REPORT

As per Standard on Internal Audit (SIA) 2, Basic Principles Governing Internal Audit, issued by the
Council of the Institute of Chartered Accountants of India, the internal auditor should carefully review
and assess the conclusions drawn from the audit evidence obtained, as the basis for his findings
contained in his report and suggest remedial action. However, in case the internal auditor comes
across any actual or suspected fraud or any other misappropriation of assets, it would be more
appropriate for him to bring the same immediately to the attention of the management.
Basic Elements of the Internal Audit Report: Basic elements of the internal audit report as per
Standard on Internal Audit (SIA) 4, on Reporting issued by the Council of the Institute of Chartered
Accountants of India. The internal auditor’s report includes the following basic elements, ordinarily,
in the following layout:
(a) Title;
(b) Addressee;
(c) Report Distribution List;
(d) Period of coverage of the Report;
(e) Opening or introductory paragraph;
(i) identification of the processes/functions and items of financial statements
audited; and

(ii) a statement of the responsibility of the entity’s management and the

responsibility of the internal auditor;
(f) Objectives paragraph - statement of the objectives and scope of the internal audit
engagement;
(g) Scope paragraph (describing the nature of an internal audit):
(i) a reference to the generally accepted audit procedures in India, as applicable;
(ii) a description of the engagement background and the methodology of the
internal audit together with procedures performed by the internal auditor; and
(iii) a description of the population and the sampling technique used.
(h) Executive Summary, highlighting the key material issues, observations, control
weaknesses and exceptions;
(i) Observations, findings and recommendations made by the internal auditor;
(j) Comments from the local management;
(k) Action Taken Report – Action taken/ not taken pursuant to the observations made in
the previous internal audit reports;
(l) Date of the report;
(m) Place of signature; and
(n) Internal auditor’s signature with Membership Number.
A measure of uniformity in the form and content of the internal auditor’s report is desirable because
it helps to promote the reader’s understanding of the internal auditor’s report and to identify unusual
circumstances when they occur.
(1) Title: The internal auditor’s report should have an appropriate title expressing the nature of
the Report.
(2) Addressee: The internal auditor’s report should be appropriately addressed as required by
the circumstances of the engagement. Ordinarily, the internal auditor’s report is addressed to
the appointing authority or such other person as directed.
(3) Report Distribution List, Coverage and Opening or Introductory Paragraph: There
should be a mention of the recipients of the report in the section on Report Distribution List.
The internal auditor’s report should identify the systems, processes, functional lines or other
items of the entity that have been audited, including the date of and period covered. The
report should include a statement that the operation of systems, procedures and controls are
the responsibility of the entity’s management and a statement that the responsibility of the
internal auditor is to express an opinion on the weaknesses in internal controls, risk
management and governance (entity level controls) framework, highlighting any exceptions
and cases of noncompliance and suggest or recommend improvements in the design and
operations of controls based on the internal audit.
(4) Scope Paragraph: The internal auditor’s report should describe the scope of the internal
audit by stating that the internal audit was conducted in accordance with generally accepted

audit procedures as applicable. The management needs this as an assurance that the audit
has been carried out in accordance with established Standards. “Scope” refers to the internal
auditor’s ability to perform internal audit procedures deemed necessary in the circumstances.
The report should include a statement that the internal audit was planned and performed to
obtain reasonable assurance whether the systems, processes and controls operate efficiently
and effectively and financial information is free of material misstatement. The internal
auditor’s report, in line with the terms of the engagement, should describe the internal
audit as including:
(i) examining, on a test basis, evidence to support the amounts and disclosures in
financial statements;
(ii) assessing the strength, design and operating effectiveness of internal controls at
process level and identifying areas of control weakness, business risks and
vulnerability in the system and procedures adopted by the entity;
(iii) assessing the accounting principles and estimates used in the preparation of the
financial statements; and
(iv) evaluating the overall entity-wide risk management and governance framework.
The Report should include a description of the engagement background, internal audit
methodology used and procedures performed by the internal auditor mentioning further that
the internal audit provides a reasonable basis for his comments.
(5) Executive Summary Paragraph: The Executive Summary paragraph of the internal auditor’s
report should clearly indicate the highlights of the internal audit findings, key issues and
observations of concern, significant controls lapses, failures or weaknesses in the systems
or processes.
(6) Observations (Main Report) Paragraph: The Observations paragraph should clearly
mention the process name, significant observations, findings, analysis and comments of the
internal auditor.
(7) Comments from Local Management: The Comments from Local Management Paragraph
should contain the observations and comments from the local management of the entity
provided after giving due cognizance to the internal auditor’s comments. This should also
include local management’s action plan for resolution of the issues and compliance to the
internal auditor’s recommendations and suggestions on the areas of process and control
weakness/ deficiency. The management action plan should contain, inter alia:
(i) the timeframe for taking appropriate corrective action;

(ii) the person responsible; and
(iii) resource requirements, if any, for ensuring such compliance. Further comments from
the internal auditor, in response to the auditee feedback, are to be clearly mentioned.

This paragraph should also contain the internal auditor’s suggestions and
recommendations to mitigate risks, strengthen controls and streamline processes
with respect to each of the observations and comments made.
(8) Action Taken Report Paragraph: The Action Taken Report paragraph should be
appended after the observations and findings and should include:
(i) Status of compliance / corrective action already taken / being taken by the auditee
with respect to previous internal audit observations;
(ii) Status of compliance / corrective action not taken by the auditee with respect to
previous internal audit observations and the reasons for non-compliance thereof;
and
(iii) Revised timelines for compliance of all open items in (b) above and fixation of the
responsibility of the concerned process owner.
(9) Date: The date of an internal auditor’s report is the date on which the internal auditor signs
the report expressing his comments and observations.
(10) Place of Signature: The report should name the specific location, which is ordinarily the city
where the internal audit report is signed.
(11) Internal Auditor’s Signature: The report should be signed by the internal auditor in his
personal name. The internal auditor should also mention the membership number assigned
by the Institute of Chartered Accountants of India in the report so issued by him.
Further, the internal auditor should exercise due professional care to ensure that the internal audit
report, inter alia, is:
(i) clear
(ii) factual – presents all significant matters with disclosure of material facts
(iii) specific
(iv) concise
(v) unambiguous
(vi) timely
(vii) complies with generally accepted audit procedures in India, as applicable.
5.1 Essential Features of a Good Internal Audit Report

The contents of an internal audit report are influenced by various factors such as the nature of
internal auditing function in the organisation, level of reporting, degree of management support and
capabilities of internal audit staff. However, for preparing a good internal audit report, the following
general rules may be observed:

(i) Objectivity - To maintain the credibility of internal audit function the comments and opinions
expressed in the report should be as objective and unbiased as possible.
(ii) Clarity - The language used should be simple and straight-forward. As far as practicable use
of technical terms and jargon should be avoided. Each draft of the report should be reviewed
by a senior who should attempt to read it from the point of view of the users of the report.
(iii) Accuracy - The information contained in the report, whether quantified or otherwise, should
be accurate. Where approximation or assumptions have been made the fact should be clearly
stated along with reasons, if material.
(iv) Conciseness - Brevity is vital subject, of course, to the condition that important information
should not be omitted.
(v) Constructiveness - Destructive criticism should carefully be avoided in the report. The report
should clearly demonstrate that the internal auditor is trying to assist the auditor in an effective
discharge of his responsibilities.
(vi) Readability - The reader’s interest should be captured and retained throughout. For this,
appropriate paragraph heading may be used.
(vii) Timeliness - The report should be submitted promptly because if the time lag between the
occurrence of an event and its reporting is considerable, the opportunity for taking action may
be lost or a wrong decision may be taken in the absence of the information.
(viii) Findings and Conclusions - These may be given either department-wise or in the order of
importance. All the facts and data pertaining to the situation should be assembled, classified
and analysed. Each conclusion and opinion should normally follow the findings. Tables or
graphs may be used for the presentation of statistical data in appendices.
(ix) Recommendations - An internal audit report usually includes recommendations for potential
improvements. In order to enable the management to accept and implement the
recommendations, the internal auditor should be able to convince the management that the
conclusions are logical and valid and the recommendations represent effective and feasible
ways of taking action.
(x) Auditee’s views - The auditee’s views about audit conclusions or recommendations may
also be included in the audit report in appropriate circumstances.
(xi) Summary - A summary of conclusions and recommendations may be given at the end. This
is particularly useful in long reports.
(xii) Supporting information - The internal auditor should supplement his report by such
documents and data which adequately and convincingly support the conclusions. Supporting
information may include the relevant standards or regulations.

(xiii) Draft Report - Before writing the final report, the internal auditor should prepare a draft report.
This would help him in finding out the most effective manner of presenting his reports. It would
also indicate whether there is any superfluous information or a gap in reasoning.
(xiv) Writing and issuing the Final Report - The final report should be written only when the
auditor is completely satisfied with the draft report. The head of the internal auditing
department, may review and approve the final report. Before issuing the final report, the
auditor should discuss conclusions and recommendations at appropriate levels of
management. The report should be duly signed.
5.2 Follow-up
The internal auditor should review whether follow-up action is taken by the management on the basis
of his report. If no action is taken within a reasonable time he should draw the management’s
attention to it.
Where the management has not acted upon his suggestions or not implemented his recom-
mendations, the internal auditor should ascertain the reasons therefor.
Where the management has accepted his recommendations and initiated the necessary action, the
internal auditor should periodically review the manner and the extent of implementation of the
recommendations and report to the management highlighting the recommendations which have not
been implemented fully or partly.
6. RELATIONSHIP BETWEEN INTERNAL AND EXTERNAL

AUDITORS
• The scope and objective of internal audit are dependent upon the size and structure of
the entity and the requirements of its management. As stated earlier the internal auditor
operates in various areas such as review of accounting system and internal control;
examination of financial and operating information for the benefit of management,
examination of the economy, efficiency and effectiveness of operations including non-
financial controls of various tangible assets of the entity. While operating in these areas,
there is lot of overlapping between the work of internal auditor and external auditor.
• The work done by internal auditor has an important bearing on the work performed by
the statutory auditor as evaluation done by the internal auditor in respect of internal
controls, reliability of financial information, verification of assets etc. is also required to
be done by the external auditor. The function of an internal auditor is an integral part of
the system of internal control.
• It is statutory requirement too as per section 138 of the Companies Act, 2013 where the
Audit Committee of the company or the Board shall, in consultation with the Internal
Auditor, formulate the scope, functioning, periodicity and methodology for conducting

the internal audit.

• However, it is obligatory for a statutory auditor to examine the scope and effectiveness
of the work carried out by the internal auditor. For the purpose, he should examine the
Internal Audit Department of the organisation, the strength of the internal audit staff,
their qualification and their powers.
• The extent of independence exhibited by the internal auditor in the discharge of his
duties and his status in the organisation are important factors for determining the
effectiveness of his audit.. But so far, the practice of audit being conducted jointly by
the internal auditors is of great assistance to statutory auditors.
• The external auditor should, as part of his audit, evaluate the internal audit function to
the extent he considers that it will be relevant in determining the nature, timing and
extent of his compliance and substantive procedures. Depending upon such evaluation,
the external auditor may be able to adopt less extensive procedures than would
otherwise be required.
Difference Between Internal & External Auditors

BASIS FOR INTERNAL AUDIT EXTERNAL AUDIT
COMPARISON
1. Meaning It refers to an ongoing audit It is an audit function performed by
function performed within an the independent body which is not
organization by a separate a part of the organization.
internal auditing department.
2. Examination Internal auditor examines the External auditor examines the
Operational efficiency of the Accuracy and Validity of Financial
organisation. Statements.
3. Appointment Internal auditor is appointed by External auditor is appointed by
the Management. the Members.
4. Users of Report User of internal audit report is User of external audit report is
Management. Stakeholders.
5. Period Internal audit is a Continuous External audit is done once in a
Process throughout the year. year.
6. Opinion Opinion is provided on the Opinion is provided on the
effectiveness of the operational truthfulness and fairness of the
activities of the organization. financial statement of the
company.
7. Status of Auditor Internal auditor is employee of External auditor is an independent
the company, thus, less person.
independent.
SA 610 “Using the work of an Internal Auditor” deals with the relationship between internal
and external auditors which is already discussed above.

6.1 Determining Whether, in Which Areas, and to What Extent the Work
of the Internal Audit Function Can Be Used
Evaluating the Internal Audit Function:
Evaluation of IA Scope of IA Objective of

Function includes: Function Evaluation of IA
• Appraisal activity. • Monitoring Internal Function
• Examining / Evaluating/ controls. • Assurance to
Monitoring adequacy / • Examination of financial & management.
effectiveness of internal Operating functions. • Evaluate & improve the
controls. • Review of regulatory effectiveness of Risk
Laws & Compliances. management.
6.2 Determining the Nature and Extent of Work of the Internal Audit
Function that Can Be Used
The external auditor shall not use the work of the internal audit function if the external auditor
determines that the function’s organizational status and relevant policies and procedures do not
adequately support the objectivity of internal auditors; the function lacks sufficient competence or
the function does not apply a systematic and disciplined approach, including quality control.
Determining the Nature & Extent of work of

Internal Audit function that can be used
The external auditor shall consider

Determine adequacy of Internal
Nature & scope of work done & its
Audit work for external auditors
relevance to overall Strategy & Audit
purpose
Plan
1. Objectivity of the internal audit functions.

2. Level of competence of internal audit function.
3. Whether a systematic & disciplined approach is applied
including quality control.

6.3 Determining Whether, in Which Areas, and to What Extent Internal

Auditors Can Be Used to Provide Direct Assistance
Amount of judgement wrt:

The E.A. a) Planning & performing relevant audit procedures
shall b) Evaluation of the audit evidence gathered.
Nature & consider
Extent of : Assessed risk of material misstatement
work that
can be Evaluation of existence & significance of threats .
assigned to
Internal Making significant judgements in the audit
auditors
providing The E.A. shall not Relate to higher assessed risks of material
Direct use internal misstatement where the judgement required is more
Assistance auditors to provide than limited.
direct assistance to
perform Relate to work which is reported to management or
procedures: TCWG by Internal audit function
Relate to decisions the E.A. makes in accordance
with SA .
6.4 If the External Auditor uses Internal Auditors to Provide Direct

Assistance on the Audit, the External Auditor shall include in the
Audit Documentation
(a) The evaluation of the existence and significance of threats to the objectivity of the internal
auditors, and the level of competence of the internal auditors used to provide direct
assistance;
(b) The basis for the decision regarding the nature and extent of the work performed by the
internal auditors;
(c) Who reviewed the work performed and the date and extent of that review in accordance with
SA 230 Audit Documentation;
(d) The written agreements obtained from an authorized representative of the entity and the
internal auditors; and
(e) The working papers prepared by the internal auditors who provided direct assistance on the
audit engagement.
Finally, in India even the statute has now recognised that internal audit is necessary for efficient
running of companies. Thus, a review of the internal audit function in specified companies has
become a statutory responsibility for the statutory auditor.
[Note: Student are advised to refer SA 610 Using the work of Internal Auditor for more details,
SA 610 is reproduced in Auditing Pronouncements.]

Illustration
The Managing Director of X Ltd is concerned about high employee attrition rate in his company. As
the internal auditor of the company he requests you to analyze the causes for the same. What factors
would you consider in such analysis?
Solution
The factors responsible for high employee attrition rate are as under:
(i) Job Stress & work life imbalance;
(ii) Wrong policies of the Management;
(iii) Unbearable behaviour of Senior Staff;
(iv) Safety factors;
(v) Limited opportunities for promotion;
(vi) Low monetary benefits;
(vii) Lack of labour welfare schemes;
(viii) Whether the organization has properly qualified and experienced personnel for the various
levels of works?
(ix) Is the number of people employed at various work centres excessive or inadequate?
(x) Does the organization provide facilities for staff training so that employees and workers keep
themselves abreast of current techniques and practices?
7. MANAGEMENT AUDIT
In recent years, the world has witnessed a rather new type of revolution viz. managerial revolution.
This revolution has considerably changed the composition and outlook of management. Auditing has
come to be viewed as an essential management tool, among others, for the efficient running of
business and other economic activities. When we speak of auditing as a management tool, we give
an extended coverage to the term auditing without, however, altering its basic concept. This
extended concept of auditing includes operational auditing.
The emphasis of auditing has been changing over the years According to T.G. Rose, “The
management audit would therefore concern itself with the
whole field of activities of the concern, from top to bottom,
starting, as always where management control is concerned,
from the top, because we are primarily concerned with
whether the general management is functioning smoothly and
satisfactorily. If it is not, it may be due to the functional
management being faulty and, therefore, we pass on to
examine that in its turn, in order to find the missing or faulty
link which is causing the trouble”. Fig.: Auditors & Management Audit ∗
∗
Source: Money Matters

7.1 Management and Operational Audit

The concept of operational audit is discussed in detail later in the chapter. Operational audit is an
audit for the management; it is undertaken at the instance of the management for providing it with
information and appraisal of operations and activities. A parallel development in auditing is getting
shaped as management audit. Management audit is an “audit of the management” also.
The scope and content of management audit. It should cover everything that we know as operational
audit and, in addition it should also include review of the adequacy and competence of the objectives,
plans, policies and decisions of the top management. However, as has been indicated above,
unanimity is lacking on this aspect and management audit has become a subject of debate. John C.
Burton, in the article “Management Auditing” (The Journal of Accountancy, May 1968) commented
as follows:
“In a management audit, the auditor will look to see whether management is getting information
relevant to the decisions and actions which it must take. This will require a much more intensive
analysis of information needs and the efficiency of the existing system in meeting them. The auditor
will not have to decide whether management is making the right strategic and operative decisions
but rather whether management has available to it and is using the relevant information and
techniques necessary to evaluate rationally the various alternatives that exist”. Management audits
are concerned with appraising management’s accomplishment of organisational objectives; the
management functions of planning, organising, directing, and controlling; and the adequacy of
management’s decisions and actions in moving towards its stated objectives. Hence, the accent is
on evaluating managers’ ability to manage.
Difference between Management Audit & Operational Audit
• Management audit is concerned with the “Quality of managing”, whereas operational
audit focuses on the “Quality of operations”.
• Management audit is the “Audit of management” while operational audit is the
“Audit for the management”.
• The basic difference between the two audits, then, is not in method, but in the level of
appraisal. In management audit, the auditor is to make his tests to the level of top
management, its formulation of objectives, plans and policies and its decision making.
It is not that he just verifies the operations of control and procedures and fulfilment of
plans in conformity with the prescribed policies.
7.2 Scope
From the authorities quoted above, it seems that the preponderant view about management audit is
that it is wider in scope compared to operational audit.
The Two Audits are Complementary and Supplementary to One Another: In management audit,
the auditor is to make his tests to the level of top management, its formulation of objectives, plans

and policies and its decision making. It is not that he just verifies the operations of control and
procedures and fulfilment of plans in conformity with the prescribed policies. He is to reach the root
i.e., the functions of top management which lay down objectives and policies, provide means and
procedures of implementation and control and which actually engage in direction and control on a
continuous basis.
In addition to what would normally be covered in an operational audit, management audit would also
encompass the relevance and effectiveness of the aims, duties and decisions of management at
various levels. Every aspect of the functions of Board of Directors should be in conformity with the
objects set out in the constituting document. Similarly the managing director, if any, should act not
only in accordance with the mandate he has received but he should ensure that the decisions he
takes are in conformity with the objects of the company and the policies formulated by the Board.
The effectiveness of management under the control of managing director and the various members
of the Board including those incharge of finance, production, sales etc., should be subject to review
of the management auditor.
From the point of view of the management auditor, knowledge about the following is essential:
(i) Purpose for which the organisation has been created.
For example, purpose of a steel mill in the state sector may include:
(a) production of steel to reduce imports of steel.
(b) creation of reasonable employment opportunities.
(c) development of backward areas.
(d) providing staff welfare consistent with the needs for a proper living.
It should not be understood that such steel mill will not work for profit. Profit being one of the
objects, should be properly balanced with other objects so that the purposes for which the
organisation was created can be achieved.
(ii) Management structure including delegation of authority, planning and budgeting.
(iii) Reports required for a proper management and the reports actually received.
(iv) Internal controls.
(v) Nature of production of the business concerned in the broad way so that he can understand
the flow and content of work leading to production and their mutual relationships. Some ideas
about the techniques, formulas, raw materials and personnel requirement would be of direct
assistance to the management auditor.
(vi) Production planning.
(vii) Factory layout, design and installed capacity.

(viii) Personnel policy and personnel management including requirements, training, welfare,
incentives and disincentives.
(ix) Materials management including sources of important raw materials, receipt of materials of
the quality and quantity needed, storage, supervision and safe custody, insurance and the
procedure for issue of materials.
(x) Sales management and sales planning including advertisement policy.
(xi) Decision making process.
(xii) Books and records including cost accounting records, cost accounting system and financial
accounting policies.
(xiii) Financial management of the organisation.
In view of the analysis made above which recognises management audit and operational audit as
two identifiable exercises having a large area of overlapping jurisdiction, it may be convenient to
consider them together to avoid duplication; and for this purpose the expression “management and
operational audit” may be acceptable as a management audit which includes within its scope all the
elements of operational auditing.
7.3 Desirability of Management Audit

Management Audit is a tool to improve management performance by recognising facts and
information about management presented after appropriate examination, verification and evaluation,
by professionally qualified and competent people. Management audit focuses attention on a
comprehensive and constructive examination of the organisational structure, its components such
as, divisions, departments, ventures, plans, policies, its financial control system, its method of
operation, its appropriate use of human, physical and financial resources.
The principal reason for undertaking a management audit is the need for detecting and
overcoming current managerial deficiencies (and resulting operational problems) in ongoing
operations. A management audit represents a more positive, forward-looking approach that
evaluates how well management accomplishes its stated organisational objectives; how
effective management is in planning, organising, directing, and controlling the organisation’s
activities; and how appropriate management’s decisions are for reaching stated organisation
objectives. This evaluation of managerial performance is achieved with the aid of a
management audit questionnaire.
In management audit, the managerial problems and related operational difficulties can be
spotted before the fact rather than after the fact as with a financial audit. This forward-looking
approach is analogous to the preventive maintenance concept found in production; that is,
periodic management audits can pinpoint problems as they are developing from a small scale.
In comparison, detecting the same problem at a later time, when they have generally
increased in scope, results in higher costs to the organisation.

The benefit of management auditing is that it represents another management tool to assist
the organisation in accomplishing desired objectives. The capability of the management audit
questionnaire to pinpoint important problem areas that are related to managing an
organisation is a real plus factor for its use.
Obviously, management auditing would be clearly helpful in the case of ailing industries, to
isolate the problems and account for their ailments. It is especially important if such industries
are either to be taken over by the government or to be heavily financed by financial institutions
with a view to bring back vigor in them. Before committing public funds, like government funds
or the institutional funds, it is important to properly diagnose the financial health and
possibilities of a business undertaking and know the specific reasons that have caused or
contributed to the decline of the business.
7.4 Organising the Management Audit

The establishment of a general programme for management audit requires management’s approval
to the plan. Unless the management’s full support is available for the proposal, there may be lot of
difficulties at later stages. Therefore, it is imperative to give consideration to a statement of policy
which indicates therein the objectives and which reflects a definite plan to achieve the objectives
while organising for management audit. The plan should also include the statement on personnel
requirements, establishment of staff training programmes to improve the effectiveness of work and
the basis of control over time and cost. These, being the basic features are discussed below at
length with related matters.
1. Devising the statement of policy –
• The management’s support must be reflected clearly and categorically in the
company’s highest policy statement. The policy statement should be quite specific.
• It should spell out clearly the scope and status of the management/operational auditing
within the enterprise, its authority to carry out audits, issue reports, make
recommendations, and evaluate corrective action.
• The statement of policy should lay down in clear terms the scope of activities to be
performed by the management auditor. The scope of activities is the most basic
requirement for building up a successful management audit programme both for small
as well as a large organisation.
• The statement must categorically say that the management auditor is capable of
reviewing administrative and management controls over any activity within the
company.
2. Location of audit function within the organisation –
• Some organisations depending upon their size and nature have established a separate
department of audit specialists where the head of the department reports directly to

the top executive. In certain cases, the audit group may be a part of the activities of
management services department, administrative control department or some other
unit of organisation.
• The more important question, however, is that the function should be as entirely
independent as possible of pressure from various groups in the enterprise. The greater
the independence, greater is the freedom to work effectively. Therefore, it is better to
place the auditing function quite high in the organisation.
3. Allocation of personnel –
• Whatever be the size of the enterprise, it is important that all persons selected and
assigned to audit, possess a good understanding of auditing theory, a thorough
knowledge of the fundamentals of both organisation and management, the principles
and effective methods of control, and the requirements for conducting scientific
appraisal. “General Guidelines on Internal Auditing” issued by the Institute also
emphasizes these qualifications for an auditor whose area extends beyond the review
of financial controls.
• As the management auditor is expected to evaluate operational performance and non-
monetary operational controls, he should possess basic knowledge of the technology
and commercial practices of the enterprise, an enquiring, analytical, pragmatic and
imaginative approach and a thorough understanding of the control system.
• The management auditor should also have a basic knowledge of commerce, law,
taxation, cost accounting, economics, quantitative methods and EDP systems.
4. Staff training programme –
• A continuous training programme is necessary to achieve quality in performing audit
assignments because the management auditor must keep of new ways to improve
auditing standards. An effective training programme enables staff to assume additional
responsibilities and advancements in the organisation. Thus, the programme acts as
an incentive for drawing capable people into the department and keeping them.
5. Time and other aspects –
• The time and cost will vary for each assignment, depending upon the nature of the
assignment, the number of auditors assigned to perform the work, and whether or not
more specialists in a particular field are required.
• An audit of a production planning and control department, for example because of its
size and other factors, could require an audit staff of several persons and, in addition,
a specialist in production planning and one in production control.

6. Frequency –
• Having specified various approaches to management audit, including its scope and its
staffing requirements the last item that should be considered before undertaking such
an audit is its frequency. Prime consideration should be given to the nature of the
organisation. Is the company in a fast-changing industry where there is great accent
on the latest technology in the company’s products and/or services?
• To get an idea of the optimum frequency of such an audit, it might be worthwhile to
look at financial audits. Customarily, financial audits are conducted annually. They are
highly programmed, since an internal control questionnaire is utilised to attest to
accounting methods and procedures.
• By contrast, a management audit should be considered from a longer time frame In no
case should the interval be allowed to exceed three years.
7.5 Conducting a Management Audit

Once top management has decided on the scope, the staffing, and the frequency of the management
audit, the next phase is the undertaking of actual audit. This involves investigating and analysing
the present facts through interviews as well as completing a management questionnaire so as to
determine the problems confronting the organisation.
1. Getting the facts through interviews –
• To avoid waste of time and effort, adequate preparation is necessary in management
auditing just as in financial auditing. The management auditors should know what
information is desired, and they should be prepared to ask a number of direct
questions to get the desired information. Reference can be made to the management
audit questionnaire for specific questions.
• In the interview itself, the auditors should begin by stating the purpose of the audit.
Emphasis should be placed on getting the facts that are essential to review and
appraise the functional area(s) under study. The exchange between auditor and
manager should be friendly and conducted in an open atmosphere so as to encourage
a free exchange of ideas.
2. Measuring performance through the Management Audit Questionnaire –
• During the interview, the management auditors make a careful inquiry into important
facts. The next step is to analyse this information, with the aim of measuring current
performance. The best way to perform such an analysis is to utilise the sections of the
management audit questionnaire that apply to the areas under study.
• By way of review, a management audit questionnaire aims at a comprehensive and
constructive examination of an organisation’s management and its assigned tasks.

• Overall, the questionnaire is concerned with the appraisal of management actions in

accomplishing organisation objectives. Its primary objective is to highlight weaknesses
and deficiencies of the organisation for possible improvements.
• Management audit questionnaire for this part of the audit not only serves as a
management tool to analyse the current situation; more importantly, it enables the
management auditors to synthesis those elements that are causing organisational
difficulties and deficiencies. (Management Audit Questionnaire is discussed in later
part of this chapter)
7.6 Concluding a Management Audit

The preparation of the management audit report that covers the details of the management auditor’s
findings and recommendations represents an important part of concluding an audit assignment.
∗
Figure: Management Audit and Audit Login Test
• To assist in the preparation of the final report, the management auditors normally meet
with management and other concerned personnel for the purpose of discussing freely any
aspect or finding of the audit.
• This approach assists the independent third party in bringing together the important
elements of audit as well as determining appropriate recommendations. It is far better to
discuss alternative recommendations and feel out the possible consequences of
∗
Source mssqltalks.wordpress.com

recommended action. However, it should be noted that the type of report required varies
with the level of investigation.
• Thus, a comprehensive investigation involves a report that is very broad in scope, while a smaller-
scale investigation of one or two functional areas will result in a less comprehensive report.
Oral recommendations for improvement - From the management viewpoint, the main focus of
audit is recommendations. Generally, there is an oral presentation of specific recommendations to
members of the top management team who approved the audit. In some cases, the approval may
have come from the board of directors, which then becomes the recipient of the auditors’ oral
recommendations. Upon completion of the presentation, oral recommendations become an integral
part of the final report- the subject matter for the next section.
The auditors should back these recommendations with a cost/benefit analysis that indicates the
expected return to the organisation from implementing them.
7.7 Management Audit Reports

The written report is the medium by which the comments, criticisms and recommendations of a
management audit department are conveyed to the Board, to functional directors and to
management in general. Management audit reports will inevitably cover a wide variety of subjects,
reflecting the many and ever increasing ramifications of management audit departments. Broadly,
however, reports may be divided into four main categories:
1. Reports prepared by the management audit staff after their visits to a unit.
2. Periodical reports prepared by senior members of management audit department which
summarise the main audit findings and recommendations for the period under consideration
and which afford a concise review of the department’s activities for that period.
3. Reports on the results of special investigations and inquiries.
4. An annual audit report.
Types of Reports - The reporting of results covers a wide spectrum of types. We can describe the
more important ones as follows:
1. Oral reports - In many situations, the reporting of results will be on an oral basis. To some
extent, this is inevitable since a part of the actual audit effort is carried on in conjunction with
company personnel. In other cases, it is a result of emergency action needs. It may also be
a prelude to more formal written reports. To some extent, there will always be oral reporting
as a means of later supplementing written reports, especially when individuals being served
have special needs.
Oral reporting therefore, serves a useful and legitimate purpose, specially the matters
covered by emergency oral reporting, should be followed up immediately by a written report
giving reference to oral reporting.

A management auditor, if he has come across any embezzlement, should

immediately inform the concerned management orally, so that steps may be
immediately taken to prevent further embezzlement.
2. Interim written reports - In situations where it is deemed advisable to inform management
of significant developments during the course of the audit, or at least preceding the release
of the regular report, there may be some kind of interim written report.
This report may pertain to especially significant problems where there is a need for early
consideration or the report may be of a progress nature. All in all, interim reports represent a
type of reporting which, when used with judgement, can be a good device to improve the total
reporting process.
3. Regular written reports - In the typical situation, the particular audit assignment will include
the preparation of a formal written report. The form and content of such written reports will
vary widely, both as between individual audit assignments and individual companies. They
may be short or long. They may be presented in many different ways, including the extent to
which quantitative or financial data are re-included. We will in the later pages discuss in more
detail the organisation and planning of this type of report.
4. Summary written reports - These summary reports are also referred to as ‘flash’ reports’.
In a number of companies the practice has developed of issuing an annual (or sometimes
more frequent) report summarising the various individual reports issued, and describing the
range of their content. These summary reports in some cases are primarily for audit
committees of Boards of Directors, but in other cases for higher level management. They are
especially useful to top level managers who do not actively review the individual reports. They
are also useful to the general auditor in seeing his total reporting effort with more perspective
and on an integrated basis.
Organisation of the Written Report -
Format - Though it is difficult to lay down a format applicable to all situations, yet the following
general guidelines may be observed:
(i) Title - The management audit report should have a short but descriptive title so that its subject
matter can be easily identified.
(ii) Objectives - The management auditor may describe the objectives of the audit assignment.
(iii) Scope - The management auditor may give a brief description of the activities audited by
him.
(iv) Findings, conclusions and opinions - These may be given either department wise or in the
order of importance. All the facts and data pertaining to the, situation should be assembled,
classified and analysed. Each finding should be discussed comprehensively and correlated

with other findings. Conclusions and opinions should normally follow the findings. Tables or
graphs may be used for the presentation of statistical data in appendices.
(v) Recommendations - A management audit report may include recommendations for potential
improvements. However, care should be taken in making recommendations in order that the
auditor’s own objectivity may not become subject matter of question. He may point out
defects and make recommendations in a broad manner on how to overcome them. He should
avoid providing detailed procedures in the capacity of an auditor. Normally specifying
procedures etc. should rest with consultants.
(vi) Auditee’s views - The auditee’s views about audit conclusions or recommendations may
also be included in the audit report in appropriate circumstances.
(vii) Summary - A summary of conclusions and recommendations may be given at the end. This
is particularly useful in long reports.
Brief Steps w.r.t Audit Report
Planning the Audit Report - Before starting the report, the auditor should ask himself, “What do I
want to tell the reader about this audit? The answer will enable him to communicate effectively.
Supporting information - The management auditor should supplement his report by such
documents and data which adequately and convincingly support the conclusions. Supporting
information may include the relevant standards or regulations.
Preparing draft report - Before writing the final report, the auditor should prepare a draft report.
This would help him in finding out the most effective manner of presenting his report. It would also
indicate whether there is any superfluous information or a gap in reasoning.
Writing and issuing the final report - The final report should be written only when the auditor is
completely satisfied with the draft report. The head of the management auditing department may
review and approve the final report. Before issuing the final report, the auditor should discuss
conclusions and recommendations at appropriate levels of management. The report should be
duly signed and dated.
Follow-up of the audit report - The management auditor should review whether follow-up action
is taken by management on the basis of his report. If no action is taken within a reasonable time,
he should draw management’s attention to it.
Action / Response of Management on Audit Report: Where management has not acted upon
his suggestions or not implemented his recommendations, the auditor should ascertain the reasons
therefor. In cases where he finds that non-implementation is due to a gap in communication, he
should initiate further discussions in that matter. It also reflects management’s attitude to audit. In
any case, the auditor to retain the usefulness of audit function should ascertain from the
management, preferably in writing, the reasons for non- implementation. It is possible that because
of change in circumstances, the audit observation did not require any action on the part of the
management.

7.8 Behavioral aspects encountered in a Management Audit

It has been experienced that one of the biggest difficulties involved during the course of management
audit is that people working in the organisation do not wish to accept any change. While at the time
of conducting interviews, it seems that people working in the organisation are amenable to change
but at the time of actual implementation they come up with stiff resistance to proposals on account
of various behavioural problems arising on this account. Such an unfortunate situation can be
avoided by building up a positive approach to management audit and involving the various
organisation personnel right from the initiation of the management audit.
Another fear which haunts executives working in the organisation is that the management auditors’
recommendations may lead to their removal or reshuffling in the process. This problem may also be
overcome by explaining to these executives that the management auditor is there to help them in
achieving the results rather acting against their interests. Various problems arising on account of
behavioural attitudes and solutions to overcome them during the process of management audit are
discussed in the following paragraphs.
Financial auditors deal mainly with figures. Management auditors deal mainly with people.
Management auditors in the normal discharge of their duty will come into contact with the following:
(a) Colleagues in their own department.

(b) Staff of the department whose functioning they audit.
(c) “Top management” who authorise them to perform audits.
Therefore, management auditors must develop and maintain good relations with auditees to gain
information and to ensure corrective action on audit findings.
In the following paragraphs, the nature and causes of behavioural problems that the management
auditor is likely to face in the discharge of the review function that is expected of him and possible
solutions to overcome these problems are discussed.
(1) Staff/line conflict - The staff/line relationship is inherently prone to conflict. Management
auditors are staff. And line people in the sense all members of other departments of the
organisation are likely to regard the management auditor the same way as they regard other
staff people. Management auditors being specialists in their field may think that their
approach and solutions are the only answers.
(2) Control - As the management auditor is expected to evaluate the effectiveness of controls,
there is an instinctive reaction from the auditee to have certain amount of fear that his actions
when reported are likely to cause adverse effect on those who receive the auditor’s report,
viz., top management. Therefore, the management auditor, being the part of control system
and thorough evaluation of controls, leads to breeding of antagonism on the part of the
auditees.

According to a research study, the causes of antagonism are as follows:
Hostile audit style - a

Insensitive audit
cold and distant aspect
practices -
is a lack of
Fear of reports which are
understanding of the
changes in overly critical,
auditee’s problems, an
Fear of day-today reports which
Punitive absence of empathy, an
criticism working focus on
action by air of smugness or
stemming habits deficiencies only,
superiors superiority, an excessive
from because of the air of mystery
prompted by concentration on
adverse changes cloaking some
reported insignificant errors, a
audit resulting audits, and the
deficiencies. prosecutional tone when
findings. from audit perception that
asking questions, and a
recommen auditors gain
greater concern with
dations. personally from
parading defects than
reporting
helping constructively to
deficiencies.
improve conditions.
(3) Resistance to Change: The other significant cause is that auditor’s study of existing systems
and procedures may give room for recommendations for changes of such systems. There is
a certain built-in resistance to change. When a change is recommended by the auditor the
resistance to change is transferred to the auditor’s recommendations and the auditor. The
auditor is looked upon as a likely instrument for recommending changes and auditees do not
welcome the visits of auditors and much less their studies and their reports thereafter.
Solution to behavioural problems - The auditors, if they were to adopt the role of accuser or secret
agency of the management to try upon the happenings of the auditee division, they would be
unwelcome. Relations between the auditor and the auditee may improve if the auditor acts and is
perceived as a professional advisor and consultant. In any event, there is a need to demonstrate to
the extent possible that:
1. the audit is part of an overall programme mandated by higher- level authority to meet higher-
level organisational needs for both protection and maximum constructive benefit.
2. the objective of the review is to provide maximum service in all feasible managerial
dimensions.
3. the review will be conducted with minimum interference with regular operations of the
operating personnel.

4. the responsible officers will be kept fully informed and have an opportunity to review findings
and recommendations before any audit report is formally released.
It is essential to create an atmosphere of trust and friendliness so that audit reports will be
understood in their proper perspective.
1. Constructive criticism - It is essential that the auditor should concentrate only on
constructive criticism. He should also make obvious in his report the value of his comments
in tangible terms. Only then would suggestions carry weight with the auditees and they will
feel convinced that the auditor has been objective in his remarks in the report.
2. Reporting methods - To achieve this objective, the auditor has to make a concerted effort
to convey effectively his role by adopting a friendly but firm tone in his report. It is always
possible to disagree without being disagreeable, to criticise without being critical. The reports
should concentrate on areas which need improvement rather than listing inefficiencies and
deficiencies in performance of the auditee.
3. Participative approach - It is well established that auditor’s reports have better acceptability
if the improvements suggested are discussed with those who have to implement them and
made to feel that they have participated in the recommendations made for improvements. On
the other hand, it has been observed that either oral or written appreciation of the auditee’s
achievements not only encourages the auditees to develop a friendly attitude towards the
auditors but look forward to their guidance in a more receptive fashion.
The participative approach to the internal audit process has proved to be success. Feelings
of hostility disappear giving room to feelings of mutual trust. Team spirit is developed.
Proposed recommendations are discussed with the auditee and such modifications as may
be mutually agreed upon are incorporated.
Three cases are given hereunder to illustrate the practical aspects of behavioural problems.
Case-1: Auditor objective: Auditee offensive: Management’s apathy - In Professional
Organisation Ltd., the Management Auditor as part of his duty was expected to perform the audit
function of the Consultancy Division of the organisation. The auditor in the normal functioning
discovered lack of control and a further study revealed suppression of information regarding illegal
procedures being followed by the department. His further in-depth examination of the books
revealed that the division has been overstating profits, to justify its existence. These facts which
had been in existence with the knowledge of manager of the Division had been left undetected.
The auditor was totally professional. His attitude was not one of “policing”. He had discussed the
contents of his proposed report with the auditee. The auditee had to be defensive and hence
decided to be offensive. Management had to face the predicament of appreciating the good job
done by the management audit department without openly decrying the Divisional Manager. There
was open “cold war” of hatred and hostility declared by the divisional Manager. The behavioural
problems arose in spite of auditor’s professional role. The auditee’s reaction was instinctive as a
corollary to being self-defensive. The management had a tough time. The problem was sorted out
and the atmosphere of ill-feeling and hatred generated by the auditee could be smoothened.

Case-2 Auditee progressive: Auditor cantankerous: Management indifferent - In a large

organisation, there was a long-standing problem of lack of coordination between marketing and
production. The pressures of day-to-day problem, made the situation worse. Production and
Marketing Managers were happy to have the services of the management, auditor to streamline
procedures and monitor the implementation. It would have been ideal for the auditor to evolve a
good system after a detailed study of the problems, have the key personnel of production and
marketing departments participate in the discussion and to have introduced the proposed system
with their co-operation. Instead the auditor took on his duty as a mission for fault finding and started
submitting secret reports on the malfunctioning of the Production and Marketing departments.
Management, having already the heavy load of coordination would seek explanations from
Production and Marketing departments. The auditor’s cantankerous behaviour and management’s
indifferent attitude inspite of auditee’s very co-operative approach gave room for a series of
behavioural problems. A participative approach, with the total curtailment of “policing” reports,
with the correct guidance from the management would have avoided all behavioural problems.
Case-3 Auditor progressive- Auditee appreciative: Management objective - In a large
organisation with operations spread all over the country the management faced sudden problems
of lack of financial control, inspite of high levels of production and remarkable market demand. The
organisation had an efficient and progressive management auditor with a good team. The auditees
were individuals with professional attitude. Management was progressive and dynamic.
Management called for meetings, explained the special assignment being given to management
auditor of aiding management to get a grip over the situation. The auditee welcomed the auditor
as an expert consultant. The auditor adopted an attitude of friendliness without descending to
levels of too much familiarity. There was coordinated effort between the auditor and auditee.
Management was kept informed of the problems and solutions being jointly worked out by the
auditors and the auditees. Within a very reasonable time, what seemed an “out of control” situation
was streamlined and the management got back the grip over the entire organisation.
8. OPERATIONAL AUDIT
Operational auditing is a systematic process involving logical, structured and organized series of
procedures.
8.1 Relationship between Internal Auditing and Operational Auditing

To understand what operational auditing is, it would be better if we first understand internal auditing.
It may be recalled that internal auditing is an activity carried on by the internal staff of an organisation
to meet the management requirements of information. Internal auditing is an independent appraisal
activity within an organisation for the review of operations as a service to organisation. Naturally,
when an auditor is concerned with the appraisal of operations, he becomes an operational auditor.
A function of internal auditing staff. According to the Institute of Internal Auditors, “the overall
objective of internal auditing is to assist all members of management in the objective discharge of

their responsibilities, by furnishing them with objective analysis, appraisals, recommendations and
pertinent comments, concerning the activities reviewed.
IIA publication defines operational auditing as - Operational auditing is a systematic process of
evaluating an organisation’s effectiveness, efficiency and economy of operations under
management’s control and reporting to appropriate persons the results of the evaluation along with
recommendations for improvement ∗.
On the basis of above definition operational auditing is a systematic process involving logical,
structured and organized series of procedures. Operational auditing concentrates on effectiveness,
efficiency and economy of operations and therefore it is future oriented. It does not end with the
reporting of the findings but also recommends the steps for improvement in future.
Illustration:
XYZ, a manufacturing unit does not accept the recommendations for improvements made by the
Operational Auditor. Suggest an alternative way to tackle the hostile management.
Solution
Alternative Way to Tackle the Hostile Management: While conducting the operational audit the
auditor has to come across many irregularities and areas where improvement can be made and
therefore he gives his suggestions and recommendations.
These suggestions and recommendations for improvements may not be accepted by the hostile
managers and in effect there may be cold war between the operational auditor and the managers.
This would defeat the very purpose of the operational audit.
The Participative Approach comes to the help of the auditor. In this approach the auditor discuses
the ideas for improvements with those managers that have to implement them and make them
feel that they have participated in the recommendations made for improvements. By soliciting the
views of the operating personnel, the operational audit becomes co-operative enterprise.
This participative approach encourages the auditee to develop a friendly attitude towards the
auditors and look forward to their guidance in a more receptive fashion. When participative method
is adopted then the resistance to change becomes minimal, feelings of hostility disappear and
gives room for feelings of mutual trust. Team spirit is developed. The auditors and the auditee
together try to achieve the common goal. The proposed recommendations are discussed with the
auditee and modifications as may be agreed upon are incorporated in the operational audit report.
With this attitude of the auditor it becomes absolutely easy to implement the proposed suggestions
as the auditee themselves take initiative for implementing and the auditor do not have to force
any change on the auditee.
Hence, Operational Auditor of XYZ manufacturing unit should adopt above mentioned participative
approach to tackle the hostile management of XYZ.
∗
Darwin J. Casler and James R. Crockett, operational Auditing. An Introduction (Altamonte Springs, FL: The
Institute of Internal Auditors, Inc., 1982). P 14.

Difference between Internal & Operational Audit: There probably may not be much of difference
in viewing operational audit as a review and appraisal of operations of an organisation carried on by
a competent independent person. Auditing whether carried on by an internal staff or by an external
person, should necessarily be an independent activity to maintain its objectivity and usefulness.
The difference in the approach of both these audits is illustrated below:
1. Perception - Traditionally, internal auditors have been engaged in a sort of protective
function, deriving their authority from the management. They view and examine internal
controls in the financial and accounting areas to ensure that possibilities of loss, wastage and
fraud are not there; they check the accounting books and records to see, whether the internal
checks are properly working and the resulting accounting data are reliable.
For example - when the auditor looks into the vouchers to see whether they corroborate the
entries in the cash book or physically examines the cash in hand he is doing his traditional
protective function. The moment be concerns himself to see whether customers’ complaints
are duly attended to or whether cash balance is excessive to the need, he comes to the
operational field.
Also he will review the operational control on cash to determine whether maximum possible
protection has been given to cash. Similarly, in the audit of stocks, he would be interested in
such matters as reorder policy, obsolescence policy and the overall inventory management
policy. In pure administrative areas on stock, he will see whether adequate security and
insurance arrangements exist for protection of stocks.
2. Issues - The basic difference that exists in conceptualisation of the technique of operational
auditing is in the auditor’s role in recommending corrections or in installing systems and
controls. According to Lindberg and Cohn, such a situation would be in conflict with the role
of operational auditor. In this connection, the views of the Institute of Internal Auditors, in the
context of internal audit are relevant. According to that Institute, “the internal auditor should
be free to review and appraise policies, plans, procedures and records; but his review and
appraisal does not in any way relieve other persons in the organisation of the responsibilities
assigned to them.
However, a further distinction should be observed between traditional internal auditing and
operational auditing - this lies in the attitude and approach to the whole auditing proposition.
Every aspect of operational auditing programme should be geared to management policies,
management objectives and management goals.
3. Objectives - The main objective of operational auditing is to verify the fulfilment of plans and
sound business requirements as also to focus on objectives and their achievement objectives;
the operational auditor should not only have a proper business sense, he should also be
equipped with a thorough knowledge of policies, procedures, systems and controls, he should

be intimately familiar with the business, its nature and problems and prospects and its
environment.
Above all, his mind should be open and active so as to be able to perceive problems and
prospects and grasp technical matters. In carrying out his work probably at every step he will
have to exercise judgement to evaluate evidence in connection with the situations and issues.
The norms and standards should be such as are generally acceptable or developed by the
company itself.
Performance yardsticks can be found in the management objectives, goals and plans,
budgets, records of past performance, policies and procedures. Industry standards can be
obtained from the statistics provided by industry, associations and government sources. It
should be appreciated that the standards may be relative depending upon the situation and
circumstances; the operational auditor may have to apply them with suitable adjustments.
The standards relating to objectives for a government company are quite different
from those of a private sector company. Similarly standards of performance of a
well equipped company which also adequately looks after the well-being of
employees may be significantly different from a company which offers scanty welfare facilities
or is ill-equipped.
Today, however, the concept of modern internal auditing suggests that there is no difference
in internal and operational auditing. In fact, the scope of internal auditing is broad enough to
embrace the areas covered by operational auditing as well. The modern internal auditing
performs both protective as well as constructive functions.
8.2 Qualities of Operational Auditor

The operational auditor should possess some very essential personal qualities to be effective in
his work:
1. In areas beyond accounting and finance, his knowledge ordinarily would be rather scanty
and this is a reason which should make him even more inquisitive.
2. He should ask the who, why, how of everything. He should try to visualise whether simpler
alternative means are available to do a particular work.
3. He should try to see everything as to whether that properly fits in the business frame and
organisational policy. He should be persistent and should possess an attitude of
skepticism.
4. He should not give up or feel satisfied easily. He should imbibe a constructive approach
rather than a fault-finding approach and should give a feeling that his efforts are to help
attaining an improved operation and not merely fault finding.
5. If the auditor succeeds in giving a feeling of help and assistance through constructive

criticism, he will be able to obtain co-operation of the persons who are involved in the
operations. This will itself be a tremendous achievement of the operational auditor. He
should try to develop a team comprised of people of different backgrounds. Involvement
of technical people in operational auditing is generally helpful.
8.3 Why Operational Audit?

The need for operational auditing has arisen due to the inadequacy of traditional sources of
information for an effective management of the company where the management is at a distance
from actual operations due to layers of delegation of responsibility, separating it from actualities in
the organisation.
Operational audit is considered as a specialised management information tool to fill the void that
conventional information sources fail to fill. Conventional sources of management information are
departmental managers, routine performance report, internal audit reports, and periodic special
investigation and survey. These conventional sources fail to provide information for the best direction
of the departments all of whose activities do not come under direct observation of managers. The
shortcomings of these sources can be stated as under:
(i) Executives and managers are too preoccupied with implementation of plans and achieving of
targets. They are left with very little time to collect information and locate problems. They may
come across problems that have come to surface but they are hardly aware of problems that
are brewing and potential.
(ii) Managers or their aides are generally relied upon for transmitting information than for booking
for information or for analysing situations.
(iii) The information that is transmitted by managers is not necessarily objective - often it may be
biased for various reasons.
(iv) Conventional internal audit reports are often routine and mechanical in character and have a
definite leaning towards accounting and financial information. They are also historical in
nature.
(v) Other performance reports contained in the annual audited accounts and the routine reports
prepared by the operating departments have their own limitations. The annual audited accounts
are good as far as an overall evaluation is concerned in monetary terms.
Sales may be shown at a higher monetary value compared to the previous year
and this may apparently suggest that the functioning of the sales department is
satisfactory. But this may have been caused by a number of factors inspite of a
really bad performance on the sales front. This fact may not be readily known unless one
cares to analyse the sales data by reference to notes and explanations to the accounts and
other related accounting data. Even a study of this nature may not fully reveal the weakness.
It is quite possible that the established market for sales has been lost partly while some
fortuitous sales have compensated the loss

The routine weekly production report may include production ‘that is subsequently
rejected by the quality control staff, or to avoid showing a bad production
performance; even the partly produced goods may also be included. Remember,
all this can happen inspite of specific management instructions about the basis on
which the production report is to be made out.
Another important point may be noticed in the matter of routine departmental reports.. The
busy management people, who can afford time only to glance over the performance reports,
cannot be expected to make an integrated reading of several reports or to undertake an
analysis of such reports. What they need is reliable, unmanipulated and objective report
which they would like to look into to understand the situation.
(vi) Operations of controls in a satisfactory manner cannot be relied upon to bring to light the
environmental conditions. Controls are specific and their satisfactory operation is related to
the specific situation under control. Also monitoring of the breakdown or non-operation of
controls is a periodic phenomenon.
(vii) Surveys and special investigations, no doubt, are very useful but these are at the best
occasional in character. Also, they are costly, time consuming and keep the departmental key
personnel busy during the period they are on. These are basically an attempt to carry out a
post-mortem rather than to enlighten the management about the ways on improvement or for
better performance or to give a signal for dangers and disasters to come.
8.4 Type of Operational Audits ∗

There are three broad categories of operational auditors: functional, organizational, and special
assignments. In case, part of the audit is likely to concern evaluating internal controls for efficiency
and effectiveness.
1. Functional Audits - Functions are a means of categorizing the activities of a business, such
as the billing function or production function. There are many ways to categorize and
subdivide functions.
For example, there is an accounting function, but there are also cash disbursements, cash
receipt, and payroll disbursement functions. There is a payroll function, but there are also
hiring, timekeeping, and payroll disbursement functions. As the name implies, a functional
audit deals with one or more functions in an organization. It could concern, for example, the
payroll function for a division or for the company as a whole.
A functional audit has the advantage of permitting specialization by auditors. Certain auditors
within an internal audit staff can develop considerable expertise in an area, such as
production engineering. They can more efficiently spend all their time auditing in that area. A
∗
Auditing and Assurance Services by Arens, Elder & Beasley; prentice hall publication, 2003 edition, page 740.

disadvantage of functional auditing is the failure to evaluate interrelated functions. The

production engineering function interacts with manufacturing and other functions in an
organization.
2. Organizational Audits - An operational audit of an organization deals with an entire
organizational unit, such as a department, branch, or subsidiary. An organizational audit
emphasizes how efficiently and effectively functions interact. The plan of organization and
the methods to coordinate activities are especially important in this type of audit.
3. Special Assignments - In operational auditing, special assignments arise at the request of
management. There are a wide variety of such audits. Examples include determining the
cause of an ineffective IT system, investigating the possibility of fraud in a division, and
making recommendations for reducing the cost of a manufactured product.
8.5 Objectives of Operational Audit

Like internal auditing, the scope and quality of operational auditing is predominantly dependent upon
management attitudes. An open minded management with broad vision can appreciate the need of
operational auditing and to give it the necessary freedom and sanction to perform what it is capable
of performing. Therefore, there is a possibility of operational auditing having different objectives to
fulfil in different organisations. Generally, operational audit objectives include:
(i) Appraisal of Controls: The most significant gain an organisation can derive from operational
auditing is probably in the area of appraisal of controls. Internal controls, because of their
unobtrusive omnipresence in the organisation, provide the essential hinges to ensure proper
performance in each functional or organisational area for accomplishing the desired
organisational objective. Similarly, if controls are weak or breaking down, however well-
equipped or well-manned the organisation may be, it will fail to operate effectively.
(ii) Evaluation of Performance: In the task of performance evaluation, an operational auditor is
heavily dependent upon availability of acceptable standards. Apart from this, the operational
auditor cannot be expected to possess technical background in so many diverse technical
fields obtaining even in one enterprise. Even when examining or appraising performance or
reports of performance, the operational auditor’s mind is invariably fixed on control aspects.
When he walks through the factory floor, amongst others, he observes whether
machines are idle or workmen not present in the post assigned to them or the
accumulation of stores on the floors All these have a bearing on the operation of
controls. He can then go into the reasons of the failure of controls and bring these to the
attention of the management for verification in the interest of proper working in future. He
reviews internal control reports to ascertain whether they bring the performance, qualitatively
and quantitatively to the notice of the management; also whether the organisation’s policies
and plans are being carried out.

(iii) Appraisal of Objectives and Plans: In performance appraisal, the operational auditor is basically
concerned not so much with how well technically the operations are going on, but with
accumulating information and evidence to measure the effectiveness, efficiency, and economy
with which the operations are being carried on. He prepares his evaluation programme in such a
manner that it will show how well or how poorly the department has fared by reference to
applicable standards, procedures, rules, policies and plans. The principal basis of performance
evaluation can be productivity, personnel, workload, cost and quality.
In the area of productivity, the operational auditor can undertake such tests as input-output
ratios for materials and labour in quantitative terms.
Personnel is perhaps the most important factor in performance evaluation. Unless the
organisation has a sound personnel policy consistent with its requirements, the facilities,
materials and equipment that are available in the organisation may not be utilised properly to
obtain optimum performance.
Work load measurement can be another significant area where operational auditor can be
of use because of ready availability of quantitative data. There can be measures like volume
or quantity of work handled and/or performed volume of new work, backlog of work, etc.
Quality of work is a matter which is not directly amenable to operational audit scrutiny.
Nevertheless, it is an important aspect of performance of an organisation. Therefore, some
quantitative measures are often devised to judge the quality of work. These can be number
of customers’ complaints, rejections by quality control department, number of workers’
grievances, number of errors in invoicing or recording transactions, quantity of scrap and
wastages, etc.
Cost is perhaps the most cogent indicator of performance. Costs are classified and recorded
for a proper assimilation of their implications on performance.
(iv) Appraisal of Organisational Structure: Organisational structure provides the line of
relationships and delegation of authority and tasks. This is an important element of the
internal control design. Therefore, this is also another important area for appraisal by the
operational auditor. In evaluating organisational structure, the aspects that may be
considered by the operational auditor may be as follows:
(i) Is the organisational structure in conformity with management objectives?
(ii) Whether the organisational structure is drawn up on the basis of matching of
responsibility and authority?
(iii) Whether the line of responsibility from the top to the bottom is clearly discernible from
the structure?
(iv) Whether the delegation of responsibility and authority at each stage is clear and
overlapping are avoided?

9. REVIEW OF SYSTEMS AND PROCEDURES

9.1 Systems
The word ‘system’ is commonly defined as “a set of objects, together with relationships between the
objects and their attributes, connected or related to each other and to their environment in such a
manner as to form an entire or integral whole”.
The definition can be better understood with reference to a complex biological system of human
beings which consists of various sub-systems, e.g. nervous system, digestive system, respiratory
system, blood circulation system, reproductive system, etc. Each sub-system in turn, may be treated
as a complete system in itself. For example, digestive system consists of various organs, say
stomach, esophagus, intestines, etc. which are interdependent and interrelated, so that failure of
any part will lead to failure of the digestive system. Thus, the essence of a system lies in the inter-
relationship and inter-dependence of various parts and processes. Unrelated and independent parts
can never constitute a system.
Similarly, it can be said that a business organisation also does not operate in a vacuum. Its various
operations-manufacturing, purchasing, marketing, accounting and finance, research and
development, personnel - comprise a system. These operations have to take into account and needs
and operating modes of all the people, enterprises and governments that make up the environments
in which it operates.
To accomplish an objective by means of a system entails three main steps:
1. Design a system to achieve the main objectives.
2. Operate the system.
3. Check that the system is operating and producing as intended by its design, i.e. that the
stated objective is being achieved.
9.2 Procedures
Procedures are the means by which policies are implemented. Most often, procedures entail the
use of documents in accordance with precise instructions or methods to be used. At lower levels in
an organisation, formalised and authorised procedures become more numerous and of specific
nature because of following factors:
1. There exists economic advantage of specifying precise uniform action to be taken by a large
number of people and for repetitive jobs.
2. The need for more precise control over employees’ activities which can only be achieved if
there are detailed prescriptions of how things are to be done.
3. The element of discretion has to be reduced as far as possible.

Standard procedures go a long way towards making sure that pertinent information flows to the
people who need it and that each person understands what he is to do with it.
9.3 Review of Systems and Procedures

The purpose of systems and procedures is to help management in the planning and accomplishment
of organisational purpose, in communicating their requirements, and in assisting the personnel in
carrying out the requirements. The review of systems and procedures is to improve the methods,
to get away from the old ways and traditional routines and to reduce the cost in completing and
processing the paper work - eliminating waste, duplication and inefficiencies. In reviewing any
system or procedure, the management auditor must concern himself with its purpose as well as its
design and then he must decide on its merits as the best serving the interests of the enterprise.
In the study of the systems and procedural functions, the auditor should ask himself:
1. Is the function properly located in the organisation?
2. Do the staff personnel have the necessary training and experience to perform the work?
3. Has a definite programme been established and has been taken for its attentive
accomplishment?
4. Is productivity satisfactory?
The evaluation of a system or a procedure actually includes three separate considerations. First, is
the system or procedure meeting all of the current requirements? Second, is it operating effectively?
And third, what is the degree of effectiveness? To determine whether system or procedure is
meeting current requirements, the following among other things, should be considered:
1. Is the system or procedure designed to promote achievement of the company’s objectives,
and is it accomplished effectively?
2. Does the system or procedure operate within the framework of the organisational structure?
3. Does the system or procedure adequately provide methods of control in order to obtain
maximum performance with the least expenditure of time and effort?
4. Do the routines designated in the system or procedures indicate performance in logical
sequence?
5. Does the system or procedure provide the means for effective coordination between one
department and another?
6. Have all required functions been established?
7. Has the necessary authority been designated to carry out responsibilities?
8. Can any changes be made to improve effectiveness?
The important thing is to make sure that the system or procedure is designed to meet the desired
results.

Differences between Financial and Operational Auditing - The major differences between
financial and operational auditing can be described as follows:
(i) Purpose - The financial auditing is basically concerned with the opinion that whether the
historical information recorded is correct or not, whereas the operational auditing emphasizes
on effectiveness and efficiency of operations for future performance.
(ii) Area - Financial audits are restricted to the matters directly affecting the appropriateness of
the presented financial statements but the operational auditing covers all the activities that
are related to efficiency and effectiveness of operations directed towards accomplishment of
objectives of organization.
(iii) Reporting -The financial audit report is sent to all stock holders, bankers and other persons
having stake in the Organisation. However the operational audit report is primarily for the
management.
(iv) End Task - The financial audit has reporting the findings to the persons getting the report as
its end objective, however, the operational auditing is not limited to reporting only but includes
suggestions for improvement also.
10. MANAGEMENT AUDIT QUESTIONNAIRE

A management audit questionnaire is an important tool for conducting the management audit. It is
through these questionnaires that the auditors make an inquiry into important facts by measuring
current performance. Such questionnaires aim at a comprehensive and constructive examination of
an organisation’s management and its assigned tasks. Overall it is concerned with the appraisal of
management actions in accomplishing the organisation’s objectives.
Management Audit Questionnaire
Its primary objective is to highlight weaknesses and deficiencies of the organisation. It includes a
review of how well or badly the management functions of planning, organising, directing and controlling
are being performed. The questionnaire provides a means for evaluating an organisation’s ongoing
operations by examining its major functional areas. There are three possible answers to the
management audit questions:
Yes No Not applicable
It indicates that the specific It indicates that

area, function or aspect It indicates unacceptable the question
under study is functioning in performance & should be doesnot apply.
an acceptable manner. No explained in writing.
written application is needed
in that case.
Thus, management audit questionnaire for this part of the audit not only serves as a management
tool to analyse the current situation; more importantly, it enables the management auditors to
synthesis those elements that are causing organisational difficulties and deficiencies.

APPENDIX
The following Standards on Internal Audit are recommendatory in nature. The Standards shall
become mandatory from such date as notified by the council:
SIA 1 : Planning an Internal Audit
SIA 2 : Basic Principles Governing Internal Audit
SIA 3 : Documentation.
SIA 4 : Reporting
SIA 5 : Sampling
SIA 6 : Analytical Procedures
SIA 7 : Quality Assurance in Internal Audit
SIA 8 : Terms of Internal Audit Engagement.
SIA 9 : Communication with Management
SIA 10 : Internal Audit Evidence
SIA 11 : Consideration of Fraud in an Internal Audit.
SIA 12 : Internal Control Evaluation
SIA 13 : Enterprise Risk Management
SIA 14 : Internal Audit in an Information Technology Environment
SIA 15 : Knowledge of the Entity and its Environment.
SIA 16 : Using the Work of an Expert.
SIA 17 : Consideration of Laws and Regulations in an Internal Audit.
SIA 18 : Related Parties.

TEST YOUR KNOWLEDGE

1. Write a short note on-Summary Written Report.
2. State the important aspects to be considered by the External auditor in the evaluation of
Internal Audit Function.
3. AB Pvt. Ltd. company having outstanding loans or borrowings from banks exceeding one
hundred crore rupees wants to appoint internal auditor. Please guide him for applicability of
the same and who can be appointed as internal auditor and what work would be reviewed by
him.

1. The Board of Directors of Young Ltd., a listed company, appointed Mr. Old, a Cost
Accountant (not in practice), to conduct internal audit of the functions and activities of the
company. The job of Mr. Old would be of an independent management function, involving a
continuous and critical appraisal of the functioning of the company with a view to suggest
improvements thereto and add value to and strengthen the overall governance mechanism
of the company, including the entity’s strategic risk management and internal control system.
However, some of the officers of the company are against the appointment of a Cost
Accountant who is not in practice as an internal auditor. State whether those officers are
correct or not in their view point by referring the provisions of the Companies Act, 2013?
(a) The view point of the officers are correct because as per section 138 of the Companies
Act, 2013, the internal auditor shall be a chartered accountant.
(b) The view point of the officers are correct because as per section 138 of the Companies
Act, 2013, the internal auditor shall a cost accountant in practice.
(c) The view point of the officers are correct because as per section 138 of the Companies
Act, 2013, the internal auditor shall be an employee of the company.
(d) The view point of the officers are not correct because as per section 138 of the
Companies Act, 2013, the internal auditor shall either be a chartered accountant or a
cost accountant (whether engaged in practice or not), or such other professional as
may be decided by the Board.
2. Employees of GIG Ltd. have to travel frequently for business purposes, so the company
entered into a contract with a Simony Travels Ltd. for managing booking, cancellation and
other services required by their employees. As per contract terms, Simony travels has to raise
its monthly bills for the tickets booked or cancelled during the period and the same are paid
by GIG Ltd. within 15 days of the bill date. The bills raised by Simony travels were of huge
amount, so the management of GIG Ltd. decided to get an audit conducted of the process

followed for booking/ cancellation of tickets and verify the accuracy of bills raised by the travel
agency. Which audit do you feel the management should opt for?
(a) Internal audit, as it relates to examine the operational efficiency of the organisation.
(b) Management audit, as it is an audit desired by the management.
(c) Performance audit so as to assess the performance of the Simony travels appointed
by the organisation.
(d) Operational audit, as it is the audit for the management and involves verifying the
effectiveness, efficiency and economy of operations done by the Simony travels for
the organisation.
Case Study Based MCQs

1. RS Ltd was set up by Raj and Shanti in 1992. Initially the name of the company was Rajeev
Private Limited. The company is currently into the business of aviation. The company has its
head office at Chennai. The company has been in the same business since its incorporation
but over the years had to shut down its business 3 times due to operational inefficiencies and
resultant losses.
In the year 2012, when the company restarted its operations after shutting that down third
time, the company got funding from foreign investors. The management of the company
increased its focus on the processes of the company and various checks and controls to
improve the efficiency of the operations. This gradually resulted in improving the overall
business culture of the company and gradually company started earning profits.
In the year 2016, the company got converted into public company and got its name changed
to RS Ltd. After that the company also tried to get listed on the New York Stock Exchange
but the market was not favourable and the company instead got listed in India.
The company kept increasing its focus on operational efficiencies which was also extended
to all other processes of the company, most importantly, financial reporting which was not
focused earlier by the management.
The company also appointed a large firm of Chartered Accountants, KB & Co, as its internal
auditors, who have had specialization in the same sector so that they can help the company
to fill the gaps in the processes, wherever required.
The company also appointed other consultants to improve on the operations and
management functions.

During the financial year ended 31 March 2018, the internal auditors of the company raised
some observations which were discussed in detail with the management, primarily because
the management was not agreeing to some of the points of the internal auditors.
Subsequently in the financial year ended 31 March 2019, the management decided to set up
its in-house internal audit function along with the CA firm, KB & Co. The idea was to do the
work in-house and over the period, KB & Co can move out once the management is confident
of the in-house internal audit function.
Considering the above mentioned facts, please provide your suggestions in respect of the
following:
(i) The Standard Operating Procedures (SOP) for logistics process was not defined from
the point of vehicle request received from the sales marketing department up to the
bills verification. The management explained that part of this process was developed
and remaining part was expected within next 3 months.
(a) This is more of a documentation and hence not relevant for the management.
(b) Auditor should highlight and report this matter in his report.
(c) The matter which is already under development should not be considered by
the auditor.
(d) Management needs to demonstrate the development process further and get
this issue closed.
(ii) It was noted that during a particular period, cash in hand balance was higher than
actual cash requirement at some locations. Ratio of cash expenses to closing cash
balance during that period ranged from 7 to 84 times. Further the insurance cover was
also not taken for the cash in hand kept at some locations. The management explained
that this occurred only during a specified period and the insurance coverage plan was
in place for the next year.
(a) Auditor should report this matter in his report.
(b) The management needs to explain the amount involved and if that is low then
the auditor should ignore this.
(c) The cash balance should not be looked at by the internal auditor as this is more
relevant from financial reporting.
(d) Internal auditor should only report about not availability of the insurance
coverage to the management.

(iii) On review of procurement process, it was observed that the system was not enabled
to show pending delivery of same material while raising a subsequent purchase order
and the guidelines were not defined for review of open purchase orders and long
pending orders.
Management explained that this was due to lead time, locking in quantity/price, lead
time to shipment, delays in delivery due to rake unavailability, failure of vendors to
supply material as per timelines or quality etc and they will explore how system driven
reporting can be done.
(a) This was an operational challenge and hence out of the purview of internal
auditor.
(b) This related to some system constraints and hence may be ignored by the
internal auditor.
(c) The internal auditor needs to highlight this in his report.
(d) The management should draw a proper plan to take care of this. In any case
there doesn’t appear to be any financial impact due eot this and hence the same
should be ignored.
(iv) It was observed that the credit limit assessment was not being performed for all the
customers which could result in possibility of credit being given to customers with weak
financial credibility leading to bad debts/ financial losses to the company.
Management replied that they started the process of updation of credit limit in their
ERP package which shall be completed in a month’s time for major customers and for
customers wherever temporary credit limit was defined. This would cover majority of
exposure.
(a) Since the management has already taken remedial action, the internal audit
should drop this point.
(b) Since this matter related to financials, this should be covered by the statutory
auditors and not the internal auditors.
(c) The management said that statutory auditors have also raised this point and
hence internal auditors should drop this.
(d) Internal auditors should report this irrespective of the fact whether statutory
auditors covered this or not.

(v) The management’s plan to phase out the CA firm by building up in-house internal audit
team has been questioned by the statutory auditors saying this is not acceptable.
(a) Statutory auditors are correct.
(b) Statutory auditors should observe this for a period and if that is working fine
then they should have no concern regarding this.
(c) The management has a discretion regarding this and hence statutory auditors
are not correct.
(d) The management should take approval from relevant authority like MCA and
then statutory auditors would have to accept this.

1. Refer Para 7.7.
2. Evaluation of Internal Audit Functions by External Auditor: The external auditor’s general
evaluation of the internal audit function will assist him in determining the extent to which he
can place reliance upon the work of the internal auditor. The external auditor should document
his evaluation and conclusions in this respect. The important aspects to be considered in this
context are:
(a) Organisational Status - Whether internal audit is undertaken by an outside agency
or by an internal audit department within the entity itself, the internal auditor reports to
the management. In an ideal situation his reports to the highest level of management
and is free of any other operating responsibility. Any constraints or restrictions placed
upon his work by management should be carefully evaluated. In particular, the internal
auditor should be free to communicate fully with the external auditor.
(b) Scope of Function - The external auditor should ascertain the nature and depth of
coverage of the assignment which the internal auditor discharges for management. He
should also ascertain to what extent the management considers, and where
appropriate, acts upon internal audit recommendations.
(c) Technical Competence - The external auditor should ascertain that internal audit
work is performed by persons having adequate technical training and proficiency. This
may be accomplished by reviewing the experience and professional qualifications of
the persons undertaking the internal audit work.
(d) Due Professional Care - The external auditor should ascertain whether internal audit
work appears to be properly planned, supervised, reviewed and documented. An

example of the exercise of due professional care by the internal auditor is the existence
of adequate audit manuals, audit programmes and working papers.
3. Applicability of Internal Audit: Section 138 of the Companies Act, 2013 states that every
private limited company is required to conduct internal audit if its outstanding loans or
borrowings from banks or public financial institutions exceeding one hundred crore rupees or
more at any point of time during the preceding financial year.
In view of above provisions, AB Pvt. Ltd. is under compulsion to conduct internal audit as its
loans or borrowings are falling under the prescribed limit.
Who can be appointed as Internal Auditor- The internal auditor shall either be a chartered
accountant or a cost accountant, whether engaged in practice or not, or such other
professional as may be decided by the Board to conduct internal audit of the functions and
activities of the companies.
The internal auditor may or may not be an employee of the company.
Work to be reviewed by Internal Auditor- Refer Para 2.

1. (d) 2. (d)
Answers to Case Study Based MCQs

1. (b) 2. (a) 3. (c) 4. (d) 5. (c)

16
DUE DILIGENCE, INVESTIGATION

& FORENSIC AUDIT
LEARNING OUTCOMES
 Know the concept of Due Diligence, Investigation and Forensic Audit.

 Differentiate between Audit and Investigation.
 Know the steps to be taken at the time of Investigation.
 Understand the purpose of Due diligence and content of its report

 Gain knowledge of Forensic Audit Techniques and content of its report.
CHAPTER OVERVIEW
Unit 1 : Due Diligence Unit 2 : Investigation Unit 3 : Forensic Audit
• Purpose • Steps in Investigation • Meaning

• Classification • Special Issues in • Fraud and Procedures
• Content of Due Investigations • Forensic Audit
Diligence Report • Audit V/s. Investigation Techniques

UNIT 1 : DUE DILIGENCE
1. OVERVIEW
Due Diligence is used to investigate and evaluate a business
opportunity. It implies a general duty to exercise care in any
transaction. Most legal definition of due diligence describe it
as a measure of prudence activity, or assiduity, as is properly
to be expected from, and ordinarily exercised by, a
reasonable and prudent person under the particular
circumstance, not measure by any absolute standard but
depends on the relative facts of the special case. Image: Due Diligence File ♣
Due diligence is a process of investigation, performed by investors, into the details of a potential
investment such as an examination of operations and management and the verification of material facts.
It entails conducting inquiries for the purpose of timely, sufficient and accurate disclosure of all material
statements/information or documents, which may influence the outcome of the transaction.
Due diligence involves an analysis carried out before acquiring a controlling interest in a company
to determine that the determine that the conditions of the business conform with what has been
presented about the target business. Also due diligence can apply to recommendation for an
investment or advancing a loan/credit.
Due Diligence may also required to be performed in cases of corporate restructuring, venture capital
financing, lending, leveraged buyouts, public offerings, disinvestment, corporatisation, etc.
Sometimes, in a restructuring exercise, while the unit may remain within a group, it may pass from
under the charge of one management team to that of another team. This situation also gives rise to
the need for a due diligence review.
2. DIFFERENCE BETWEEN DUE DILIGENCE AND AUDIT

It needs be underlined that due diligence is different from audit. Audit is an independent examination
and evaluation of the financial statements on an organization with a view to express an opinion thereon.
Whereas, due diligence refers to an examination of a potential investment to confirms all material facts
of the prospective business opportunity. It involves review of financial and non-financial records as
deemed relevant and material. Simply put, due diligence aims to take the care that a reasonable person
should take before entering into an agreement or a transaction with another party.
♣ Source: www.lyagency.co.ke

DUE DILIGENCE, INVESTIGATION & FORENSIC AUDIT 16.3
3. IMPORTANCE OF DUE DILIGENCE

When a business opportunity first arises, it continues throughout the talks, initial data collection and
evaluation commence. Thorough detailed due diligence is typically conducted after the parties
involved in a proposed transaction have agreed in principle that a deal should be pursued and after
a preliminary understanding has been reached, but prior to the signing of a binding contract.
There are many reasons for carrying out due diligence including:
To confirm that the business is what it appears to be;
To identify potential ‘deal killer’ defects in the target and avoid a bad business transaction;
To gain information that will be useful for valuing assets, defining representations and
warranties, and/or negotiating price concessions; and
To verify that the transaction complies with investment or acquisition criteria.
4. CLASSIFICATION OF DUE-DILIGENCE
The purpose of due diligence is to assist the purchaser or the investor in finding out all the
reasonably can about the business he is acquiring or investing in prior to completion of the
transaction including its critical
Commercial or success factors as well as its
Operational Due Diligence
strength and weaknesses.
Financial Due Diligence
In addition, it may expose problems
Tax Due Diligence or potential problems that can be
addressed in the price negotiations
Legal Due Diligence
or by dealing suitable clauses in the
Environmental Due
Diligence contractual documentation, in
particular, warranty and or
Personnel Due Diligence
indemnity provisions.
Due Diligence can be sub-classified into discipline-wise exercises in following manner:
(i) Commercial/Operational Due Diligence: It is generally performed by the concerned acquire
enterprise involving an evaluation from commercial, strategic and operational perspectives.
For example, whether proposed merger would create operational synergies.
(ii) Financial Due Diligence: It involves analysis of the books of accounts and other information
pertaining to financial matters of the entity. It should be performed after completion of
commercial due diligence.
(iii) Tax Due Diligence: It is a separate due diligence exercise but since it is an integral
component of the financial status of a company, it is generally included in the financial due
diligence. The accountant has to look at the tax effect of the merger or acquisition.

(iv) Information Systems Due Diligence: It pertains to all computer systems and related matter
of the entity.
(v) Legal Due Diligence: This may be required where legal aspects of functioning of the entity
are reviewed.
The legal aspects of property owned by the entity or compliance with various
statutory requirements under various laws.
(vi) Environmental Due Diligence: It is carried out in order to study the entity’s environment, its
flexibility and adaptiveness to the acquirer entity.
(vii) Personnel Due Diligence: It is carried out to ascertain that the entity’s personnel policies
are in line or can be changed to suit the requirements of the restructuring.
Financial Due Diligence

At times, the financial due diligence review is interpreted as complete due diligence review since it
is supposed to ascertain the financial implications of all the other due diligence reviews. This is,
however, not appropriate. The term 'financial due diligence' should be used with caution. Unless the
scope of financial due diligence to be performed is wide enough to cover all the aspects, it should
not be confused with overall due diligence review.
It can be understood from the foregoing that the role of financial due diligence commences after a
price has been agreed for the business. The initial price and other decisions are taken on the basis
of net worth as well as trend of profitability of the target company, with an assumption that all
contingent liabilities that may impact the future of the business have been recorded. The principal
objective of financial due diligence, therefore, is usually to look behind the veil of initial information
provided by the company and to assess the benefits and costs of the proposed acquisition/merger
by inquiring into all relevant aspects of the past, present and future of the business to be
acquired/merged with.
In order to achieve its objective, the due diligence process can include any or all of the
following objectives for individual areas of the verification:
♦ Brief description of the history of business
♦ The background of promoters
♦ Accounting policies and practices
♦ Management information systems
♦ Details of management structure
♦ Trading results both past and the recent past
♦ Assets and liabilities as per latest balance sheet

♦ Current status of Income tax assessments including appeals pending against tax liabilities
assessed by tax authority.
♦ Cash flow patterns
♦ The projection of future profitability
If a full fledged financial due diligence is conducted, it would include the following matters,
inter alia, in its scope:
(a) Brief history of the target and background of (b) Accounting policies;
its promoter;
(c) Review of financial statements; (d) Taxation;
(e) Cash flow; (f) Financial Projection;
(g) Management and employees; (h) Statutory Compliance.
(a) Brief history of the target and background of its promoters - The accountant should begin
the financial due diligence review by looking into the history of the company and the background of
the promoters.
The details of how the company was set up and who were the original promoters has to be gone
into, before verification of financial data in detail. An eye into the history of the target may reveal its
turning points, survival strategies adopted by the target from time to time, the market share enjoyed
by the target and changes therein, product life cycle and adequacy of resources. It could also help
the accountant in determining whether, in the past, any regulatory requirements have had an impact
on the business of the target. Broadly, the accountant should make relevant enquiries about the
history of target's business products, markets, suppliers, expenses, operations. This could, inter
alia, include the following:
♦ Nature of business(es)
Manufacturer, wholesaler,
financial services, import/export.
♦ Location of production facilities, warehouses, offices.
♦ Employment
By location, supply, wage levels, union contracts, pension commitments,
government regulation.
♦ Products or services and markets
Major customers and contracts, terms of payment, profit margins, market share,
competitors, exports, pricing policies, reputation of products, warranties, order
book, trends, marketing strategy and objectives, manufacturing processes.

♦ History of the business with important suppliers of goods and services

Long-term contracts, stability of supply, terms of payment, imports, methods of
delivery such as "just-in-time".
♦ Inventories
Locations,
Quantities.
♦ Franchises, licenses, patents.
♦ Important expense categories.
♦ Research and development.
♦ Foreign currency assets, liabilities and transactions.
♦ Legislation and regulation that significantly affect the entity.
♦ Information systems.
(b) Accounting policies - The accountant should study the accounting policies being followed
by the target and ascertain whether any accounting policy is inappropriate.
The accountant should also see the effects of the recent changes in the accounting policies. The
target might have changed its accounting policies in the recent past keeping in view its intention of
offering itself for sale.
The overall scope has to be based on the accounting policies adopted by the management. The
accountant has to look at the main effect of accounting policies on the overall profitability and their
correctness. It is reiterated that the accountant should mainly look at all material changes in
Accounting Policies in the period subjected to review very carefully.
The accountant's report should include a summary of significant accounting policies used by the
target, that changes that have been made to the accounting policies in the recent past, the areas in
which accounting policies followed by the target are different from those adopted by the acquiring
enterprise, the effect of such differences.
(c) Review of Financial Statements - Before commencing the review of each of the aspect
covered by the financial statements, the accountant should examine whether the financial
statements of the target have been prepared in accordance with the Statute governing the target,
Framework for Preparation and Presentation of the Financial Statements and the relevant
Accounting Standards. If not the accountant should record the deviations from the above and
consider whether it warrant an inclusion in the final report on due diligence.
After having an overall view of the financial statements, as mentioned in the above paragraphs, the
accountant should review the operating results of the target in great detail. It is important to make
an evaluation of the profit reported by the target. The reason being that the price of the target would
be largely based upon its operating results.

The accountant should consider the presence of an extraordinary item of income or expense that
might have affected the operating results of the target.
It is advisable to compare the actual figures with the budgeted figures for the period under review
and those of the previous accounting period. This comparison could lead the accountant to the
reasons behind the variations. It is important that the trading results for the past four to five years
are compared and the trend of normal operating profit arrived at.
The normal operating profits should further be benchmarked against other similar companies.
Besides the above, and based on the trend of operating results, the accountant has to advise the
acquiring enterprise, through due diligence report, on the indicative valuation of the business.
In the case of many enterprises, the valuation is mainly based on the value of net assets only. For
valuation of immovable properties and plant, if required, the assistance of expert valuers could also
to be taken. The exercise to evaluate the balance sheet of the target company has to take into
consideration the basis upon which assets have been valued and liabilities have been recognised.
The net worth of the business has to be arrived at by taking into account the impact of over/under
valuation of assets and liabilities. The accountant should pay particular attention to the valuation of
intangible assets.
The objective of the Due Diligence exercise will be to look specifically for any hidden
liabilities or over-valued assets.
Hidden Liabilities:
The company may not show any show cause notices which have not matured into demands,
as contingent liabilities. These may be material and important.
The company may have given “Letters of Comfort” to banks and Financial Institutions. Since
these are not “guarantees”, these may not be disclosed in the Balance sheet of the target
company.
The Company may have sold some subsidiaries/businesses and may have agreed to take
over and indemnify all liabilities and contingent liabilities of the same prior to the date of
transfer. These may not be reflected in the books of accounts of the company.
Product and other liability claims; warranty liabilities; product returns/discounts; liquidated
damages for late deliveries etc. and all litigation.
Tax liabilities under direct and indirect taxes.
Long pending sales tax assessments.
Pending final assessments of customs duty where provisional assessment only has been
completed.
Agreement to buy back shares sold at a stated price.

Future lease liabilities.

Environmental problems/claims/third party claims.
Unfunded gratuity/superannuation/leave salary liabilities; incorrect gratuity valuations.Huge
labour claims under negotiation when the labour wage agreement has already expired.
Over-Valued Assets :
Uncollected/uncollectable receivables.
Obsolete, slow non-moving inventories or inventories valued above NRV; huge inventories of
packing materials etc. with name of company.
Underused or obsolete Plant and Machinery and their spares; asset values which have been
impaired due to sudden fall in market value etc.
Assets carried at much more than current market value due to capitalization of
expenditure/foreign exchange fluctuation, or capitalization of expenditure mainly in the nature
of revenue.
Litigated assets and property.
Investments carried at cost though realizable value is much lower.
Investments carrying a very low rate of income / return.
Infructuous project expenditure/deferred revenue expenditure etc.
Group Company balances under reconciliation etc.
Intangibles of no value.
(d) Taxation - Tax due diligence is a separate due diligence exercise but since it is an integral
component of the financial status of a company, it is generally included in the financial due diligence.
It is important to check if the company is regular in paying various taxes to the Government. The
accountant has to also look at the tax effects of the merger or acquisition.
(e) Cash Flow - A review of historical cash flows and their pattern would reflect the cash generating
abilities of the target company and should highlight the major trends. It is important to know if the
company is able to meet its cash requirements through internal accruals or does it have to seek
external help from time to time.
It is necessary to check that:
(a) Is the company able to honour its commitments to its trade payables, to the banks, to
government and other stakeholders?
(b) How well is the company able to turn its trade receivables and inventories?
(c) How well does it deploy its funds?

(d) Are there any funds lying idle or is the company able to reap maximum benefits out of
the available funds?
(f) Financial Projections - The accountant should obtain from the target company the projections
for the next five years with detailed assumptions and workings. He should ask the target to give
projections on optimistic, pessimistic and most likely bases.
The accountant evaluates the appropriateness of assumption used in the preparation and
presentation of financial projections. If, the accountant is of the opinion that as assumption
used by the target is unrealistic, the accountant should consider its impact on the overall
valuation of the company. He should offer his comments on all the assumption, highlighting those
which, in his opinion are not inappropriate. In case he feels the projections provided by the target
are not achievable or aggressive he has to mention this in his report. He should thoroughly check
the arithmetic of the calculations made for financial projections.
(g) Management and Employees - In most of the companies which are available for take over
the problem of excess work force is often witnessed. It is important to work out how much of the
labour force has to be retained. It is also important to judge the job profile of the administrative and
managerial staff to gauge which of these match the requirements of the new incumbents. Due to
complex set of labour laws applicable to them, companies often have to face protracted litigation
from its workforce and it is important to gauge the likely impact of such litigation.
It is important to see if all employee benefits like Provident Fund (P.F.), Employees State
Insurance (E.S.I.), Gratuity, leave and Superannuation have been properly paid/ provided
for/funded. In case of un-funded Gratuity, an actuarial valuation of the liability has to be
obtained from a reputed actuary.
The assumptions regarding increase in salaries, interest rate, retirement etc. have to be gone into
to see if they are reasonable. It is also necessary to see if the basic salary /wage considered for the
valuation is correct and includes all elements subject to payment of Gratuity. In the case of PF, ESI
etc. the accountant has to see if all eligible employees have been covered.
It is very important to consider the pay packages of the key employees as this can be a crucial factor
in future costs. One has to carefully look at Employees Stock Option Plans; deferred compensation
plans; Economic Value Addition and other performance linked pay; sales incentives that have been
promised etc. It is also important to identify the key employees who will not continue after the
acquisition either because they are not willing to continue or because they are to be transferred to
another company within the 'group' of the target company.
(h) Statutory Compliance - During a due diligence this is one aspect that has to be investigated
in detail. It is important therefore, to make a list of laws that are applicable to the entity as well as to
make a checklist of compliance required from the company under those laws. If the company has
not been regular in its legal compliance it could lead to punitive charges under the law. These may
have to be quantified and factored into the financial results of the company.

5. WORK APPROACH TO DUE DILIGENCE

The purchase of business in many instances is the largest and most expensive assets purchase in
life time and therefore some caution should be exercised through the due diligence process.
Therefore, assessing the businesses fair value passes through.
Reviewing and reporting on the Assessing the business first

financials submitted by the hand by a site visit (if
target company. applicable).
Working through the

Helping prepare an
due diligence process
offer based on
with the acquisitioning
completion of due
company or investor by
diligence.
defining the key areas.
Discovering the correct strategy is always challenging, and even more so during challenging
economic circumstances. Each situation is unique. The variables are numerous, including factors
such as company age, markets, geography, price levels, competitive dynamics, to name but a few.
But when a company and its products are turned to match market needs and expectations-that is,
the decision markers and influencers involved in purchase decision-exceptional changes in
performance can occur. However, comprehensive model that describes this approach to the work
is illustrated in the figure below:
Diagnose
Define Defend
Discover Delivery
Design
Figure : Six Dimensional Process Framework

6. HOW TO CONDUCT DUE DILIGENCE
Image : Due Diligence Process ∗

Start with an open mind. Do not assume that anything wrong will be found and look for it.
What needs to be done is to identify trouble spots and ask for explanations.
Get the best team of people. If you do not have a group of people inside your firm that can
do the task (e.g. lack of staff, lack of people who know the new business because you are
acquiring a business in an unrelated areas, etc.), there are due diligence experts that you
can hire. When hiring such professionals, look for their experience record in the industry.
Get help in all areas like finance, tax accounting, legal, marketing, technology, and any others
relevant to the assignment so that you get a 360-degree view of the acquisition candidate.
Talk to customers, suppliers, business partners, and employees are great resources.
Take a risk management approach. So, while you want to do your research, you also want
to make sure that you do not antagonise the team of people of the target company by bogging
them down with loads of questions.
Prepare a comprehensive report detailing the compliances and substantive risks/issues.
∗
Source: Mazars.sg

7. CONTENTS OF A DUE DILIGENCE REPORT

The contents of a due diligence report will always vary with individual circumstances. Following
headings are illustrative:
Example of Headings of a Due Diligence Report
♦ Executive Summary
♦ Introduction
♦ Background of Target
♦ Objective of due diligence
♦ Terms of reference and scope of verification
♦ Brief history of the company
♦ Share holding pattern
♦ Observations on the review
♦ Assessment of management structure
♦ Assessment of financial liabilities
♦ Assessment of valuation of assets
♦ Comments on properties, terms of leases, lien and encumbrances.
♦ Assessment of operating results
♦ Assessment of taxation and statutory liabilities
♦ Assessment of possible liabilities on account of litigation and legal proceedings against
the company
♦ Assessment of net worth
♦ Interlocking investments and financial obligations with group / associates companies,
amounts receivables subject to litigation, any other likely liability which is not provided for
in the books of account
♦ SWOT Analysis
♦ Comments on future projections
♦ Status of charges, liens, mortgages, assets and properties of the company
♦ Suggestion on ways and means including affidavits, indemnities, to be executed to cover
unforeseen and undetected contingent liabilities
♦ Suggestions on various aspects to be taken care of before and after the proposed
merger/acquisition.

UNIT 2 : INVESTIGATION
1. OVERVIEW
The term investigation implies a systematic and in-
depth examination or inquiry to establish a fact or to
evaluate a specific situation. In other words,
investigation means inquiry into facts". Professional
accountants are often required to investigate the
accounts or the related matters and records of the
enterprise. The term investigation may be defined as
an examination of books and records preliminary to
financing or for any other specified purpose,
sometimes differing in scope from the ordinary audit.
Thus, investigation covers areas of financing
decisions, investment decisions, fraud or profitability
determination or cost determination etc.
2. AUDIT VERSUS INVESTIGATION

Investigation differs substantially from an audit assignment. Audit aims at collection of sufficient
appropriate audit evidence to enable the auditor to form a judgement and express an opinion on the
financial statements or other data under examination. An investigation, on the other hand, requires
special in-depth examination of the particular records or transaction with the objective of establishing
a part or happening or assessing a particular situation. The scope of audit is broad based and
general in nature whereas investigation is narrow and specific.
The difference is tabulated below:
Basis of Difference Investigation Audit

(i) Objective An investigation aims at The main objective of an audit is
establishing a fact or a to verify whether the financial
happening or at assessing a statements display a true and fair
particular situation. view of the state of affairs and the
working results of an entity.
(ii) Scope The scope of investigation may The scope of audit is wide and in
be governed by statute or it case of statutory audit the scope
may be non- statutory. of work is determined by the

provisions of relevant law.

(iii) Periodicity The work is not limited by rigid The audit is carried on either
time frame. It may cover quarterly, half-yearly or yearly.
several years, as the outcome
of the same is not certain.
(iv) Nature Requires a detailed study and Involves tests checking or sample
examination of facts and technique to draw evidences for
figures. forming a judgement and
expression of opinion.
(v) Inherent Limitations No inherent limitation owing to Audit suffers from inherent
its nature of engagement. limitation.
(vi) Evidence It seeks conclusive evidence. Audit is mainly concerned with
prima- facie evidence.
(vii) Observance of It is analytical in nature and Is governed by compliance with
Accounting Principles requires a thorough mind, generally accepted accounting
capable of observing, principles, audit procedures and
collecting and evaluating facts. disclosure requirements.
(viii) Reporting The outcome is reported to the The outcome is reported to the
person(s) on whose behalf owners of the business entity.
investigation is carried out.
The approach to an investigation is different from that followed in an audit. An investigation involves
a more detailed examination of the selected areas than what is required in an audit. An investigation
seeks substantive and in some case even conclusive evidence as compared to audit which mainly
relies on persuasive evidence.
An investigator does not accept a stated fact as correct until it is substantiated. An auditor, in the
absence of suspicious circumstances, relies on stated facts or figures. An auditor has to see whether
the method of valuation and other accounting policies have been properly made in the financial
statements or not. An investigator, however, is not by accounting conventions, policies and
disclosure requirements. An auditor does not suspect unless circumstances are there to arouse
suspicion, while an investigator approaches the work with a frame of mind to suspect, verify and
satisfy.
The auditor seeks to report what he finds in the normal course of examination of the accounts
adopting generally followed techniques unless circumstances call for a special probe: fraud, error,
irregularity, whatever comes to the auditor’s notice in the usual course of checking, are all looked
into in depth and sometimes investigation results from the prima facie findings of the auditor.

3. STEPS IN INVESTIGATION
As investigation involves a variety of situations, it is not possible to lay down any standardised
procedure. However, usually, an investigation requires the following steps in order of sequence:
1. Determination of 3. Examination and

2. Formulation of the
objectives and study of various records
investigation
establishment of scope by reference to
programme.
of investigation. appropriate evidence.
4. Analysis, processing 5. Preparation of report

and interpretation of and drawing up of
findings. conclusions.
Diagram showing Sequence of Steps for Investigation
Step 1: Determination of objectives and establishment of scope of investigation

At the stage of acceptance of the assignment, the investigator should be absolutely clear about what
is sought to be achieved by the investigation. If instructions from the client leave matters vague and
non-specific, it would be proper for the investigator to have the matters discussed and obtain clearly
written instructions covering the object and the scope of investigations and the issues incidental
thereto.
The period which the investigation should cover should be clearly specified. The results of
investigation are often seriously affected owing to change in circumstances which have occurred
since it was contemplated, e.g., devaluation, import restrictions, starting of a new division, etc.
Therefore, the purpose of the investigation should be borne in mind while determining the period
which an investigation should cover.
Step 2: Formulation of the investigation programme

It is not possible to draw up one programme to serve different types of investigations which a
professional accountant is called upon to carry out, for their scope and content have to be
determined on a consideration of circumstances peculiar to each business or situation. The
investigation programme should be drawn up having regard to the nature of the business, the
structure of business, the instructions from the client embodying the objectives, the consequent
scope and depth and the necessity to extend the investigation into books and records belonging to

others. The programme should also be flexible so that knowledge gained with the progress of work
can be used to extend, reduce or modify the extent and areas of checking.
In programming the verification, the investigator should concentrate on areas considered relevant
rather than to undertake a wide-ranging verification.
In case of an investigation on suspected payment of wages to ghost workers, the investigator
should scan the areas having a bearing on the determination of wages and payments
thereof. He should concentrate on time and job cards, appointment and termination of
workers, attendance records, internal controls, internal checks, and preparation of wage sheets,
withdrawal of money from bank for payment of wages and the actual disbursement of wages.
A conscious effort in investigation programming should be devoted to localise the enquiry into the
relevant areas and, for that purpose, the initial wider base of inquiry should be gradually narrowed
and fixed at a level that is meaningful. Matters not found to have a bearing on the subject matter of
investigation should be gradually and progressively eliminated. This procedure alone will enable an
in-depth examination of the matters relevant to the investigation.
Step 3: Collection of Evidence

Through examination, the investigator would be gathering relevant evidence connected with the
matters to be investigated. In the course of examination of the documents and records, the
investigator may require to obtain oral explanations from various personnel of the concerned
business. In case his client is a person external to the business, it may be necessary for the
investigator to get the matter formally agreed to by the business through the client. The investigator
should look for the most convincing evidence; he should seek and examine all the available evidence
and by a process of elimination and corroboration, should endeavour to reach at the truth of the
matter. He, unlike the auditor, is not to restrict himself to prima facie evidence ordinarily available.
He should examine it and if circumstances demand should try to obtain evidence that may have to
be specifically procured.
In the matter of valuation of land, he should definitely have regard to the available
evidence as per records of the business and records of any bid received for the land. In
addition, he should have regard to the prices at which land was sold or purchased in the
neighbourhood around the same time. This may require him to obtain evidence even by going to
the land registration office. He may also call for the report of experts in land valuation.
Step 4: Analysis and Interpretation of Findings

Careful analysis and correlation of facts and figures will be necessary before the investigator can
reach his conclusion. The conclusion should be well reasoned and backed by established facts and
data. He must analyse the data objectively on the basis of evidence gathered by him and should not
draw conclusions according to pre-conceived notions. While interpreting the figures, the investigator
must keep in mind various factors e.g. the political and economic considerations, competition faced
by the business, historical pattern of the data, nature of the business, etc.

Step 5: Reporting of findings

Like all other work of an accountant, an investigation results in a report. It is submitted and
addressed to the party at whose instance the investigation has been carried out. The nature of the
report is governed mainly by two factors. First, the instructions given by the client as regards the
special aspects of the business which are required to be investigated; and second, the findings of
the investigating accountant.
The important issues to be kept in mind by the investigator while preparing his report
are as follows:
(i) The report should not contain anything which is not relevant either to highlight the nature
of the investigation or the final outcome thereof.
(ii) Every word or expression used should be properly considered so that the possibility of
arriving at a different meaning or interpretation other than the one intended by the
investigator can be minimized.
(iii) Relevant facts and conclusions should be properly linked.
(iv) Bases and assumptions made should be explicitly stated. Reasonableness of the bases
and assumptions made should be well examined and care should be taken to see that
none of the bases and assumptions can be considered to be in conflict with the objective
of the investigation. For example, in an investigation into over-stocking of raw materials,
inventories and spares etc. it should not be assumed that the ordering levels indicated
on bin cards provide fair guidance about acquisition of further materials. Also, since
investigation is a fact finding assignment, assumptions should be made only when it is
unavoidably necessary.
(v) The report should clearly spell out the nature and objective of the assignment accepted
its scope and limitations, if any.
(vi) The report should be made in paragraph form with headings for the paragraphs. Any
detailed data and figures supporting any finding may be given in Annexures.
(vii) The report should also state restrictions or limitations, if any, imposed on the instructions
given by the client. Preferably the reasons for placing such restrictions and their impact
on the final result should also be stated.
(viii) The opinion of the investigator should appear in the final paragraph of the report.
Due to non-availability of standardised procedure and lack of professional guidance, investigation
calls for extreme care, caution and circumspection on the part of the investigator in exercising his
judgement and discretion. Investigation often has a characteristic of very intimate and direct
involvement of parties whose interest may be affected. Therefore, unlike auditing, chances of one
or the other of the parties challenging the finding of the investigation are far greater.

4. SPECIAL ISSUES IN INVESTIGATIONS

Investigations broadly range between two extremes; on the one hand there are those in respect of
which complete accounts, documents, records and other information are available, and on the other,
those in respect of which little information, besides published accounts and statistical data, is
available. Then again, investigation may cover the whole of accounting or may relate to only a part
or parts of accounting as may be specified. Some more issues often arise in investigation. They are
stated below:
(a) Whether an investigator is required to undertake a cent per cent verification approach
or whether he can adopt selective verification - The answer to this question depends on
the exact circumstances of the case under investigation. If the investigator has to establish
the amount of cash defalcated by the cashier, he has probably no option but to carefully
examine all the cash vouchers and related transactions. On the other hand, if he is to arrive
at the profitability of a concern, he may verify constituent transactions on a selective basis
taking extreme care to see that no material transaction that affects profit has remained
concealed from his eyes. In investigation, it is always safer to go by statistically recognised
sampling methods than to depend on the so-called “test checks” where circumstances permit
selective verification.
(b) Whether the investigator can put reliance on the already audited statement of account
- Here also no dogmatic views are possible. If the investigation has been launched because
of some doubt in the audited statement of account, no question of reliance on the audited
statement of account arises. However, if the investigator has been requested to establish
value of a business or a share or the amount of goodwill payable by an incoming partner,
ordinarily the investigator would be entitled to put reliance on audited materials made
available to him unless, in the course of his test verification, he finds the audit to have been
carried on very casually or unless his terms of appointment clearly require to test everything
afresh.
It was held in the case of Short & Compton v. Brackert (1904) that an accountant, when
making an investigation for an incoming partner, was entitled to assume that the figures
appearing in the books were correct.
In another case, Mead v. Ball Baker & Co. (1911), it was held that an accountant, when acting
as an adviser to a proposed investor in a limited company, was not expected to check errors
in stock sheets and the omission of liabilities.
These cases were decided long time ago. Therefore, much reliance cannot be placed on
them. It is, therefore, desirable for the investigator to ascertain from the client, in advance,
in writing, whether the audited statements of account produced to him should be taken as
correct.

If the statements of account produced before the investigator were not audited by a qualified
accountant, then of course there arises a natural duty to get the figures in the accounts
properly checked and verified. However, when the accounts produced to the investigator have
been specially prepared by a professional accountant, who knows or ought to have known
that these were prepared for purposes of the investigation, he could accept them as correct
relying on the principle of liability to third parties settled in the famous Hedley Byrne’s case.
Nevertheless, it would be prudent to see first that such accounts were prepared with
objectivity and that no bias has crept in to give advantage to the person on whose behalf
these were prepared.
(c) Whether an investigator necessarily requires assistance of expert - Often an investigator
may feel the necessity of obtaining views and opinions of experts in various fields to properly
conduct the investigation. It would be therefore, proper for the investigator to get the written
general consent of his client, to refer special matters for views of different experts; at the
beginning it and he should settle the question of costs for obtaining the views and other
related implications.
(d) Investigation out of disputes and conflicting claims - Cases for investigation sometimes
arise out of disputes and conflicting claims. It is needless to emphasise that the investigator
should remain above disputes or conflicting claims and be alert to the possibilities of the
information or documents made available to him to be prejudiced. Even the client, overtly or
covertly, may try to influence his reports. A seller of a business or controlling shares may
request him to see that he gets the most favourable price. Similarly, if he is appointed by the
buyer, he may be requested to deliberately depress the value. The investigator should keep
him scrupulously professional and should keep the interest of all the involved parties in view.
This is a challenging task and probably no other professional work offers this much of
challenge. This work is exciting too and requires not only the best of skill but of a high degree
of maturity and experience.
(e) Basis of opinion of an investor- The investigator should refrain from issuing speculative
opinion. He should confine his opinion to the established facts and nothing more. If the facts,
as conveyed through the books, records, papers and other evidence, are not capable of being
properly established, he should not express an opinion or, if at all he expresses any opinion,
he should qualify the opinion appropriately. This problem may particularly arise in cases
where incomplete books and records are produced for investigation.
(f) Whether an investigator can make futuristic statements - The investigator should refuse
to be futuristic. He may assume that the established trend in the business will continue in the
near future, in the absence of any contrary evidence, in arriving at the present value of a
business. He, however, should not project the trend into any future years to establish a value.
(g) Whether to retain working papers or not - Another important precaution is that the
investigating accountant should retain, on his files full notes of the work carried out, copies

of schedules and all working papers, record of conversations and the like. Also, the working
papers should link up the figures shown by the books of business with the final figures
produced by the accountant. In the absence thereof, he would not be able to explain the
figures when he is called upon to give evidence in a court of law to support his figures; for
quite often the conclusions of the accountant are challenged by parties whose interest is
adversely affected by his findings, for example, when the value of shares of a company taken
over by the Government has been determined by him. This will also be of immense help to
the investigator in correlating facts and events and later in drafting the report.
5. SPECIAL ASPECTS IN CONNECTION WITH BUSINESS

INVESTIGATIONS
We discuss below the factors to be considered by a professional accountant while carrying out the
investigation for attaining satisfactory results:
(a) Studying the overall picture - In such a business investigation, it is of utmost importance first
to have an overall picture of the position of the business which is being investigated before the
details are gone into. This is because figures are only symbols; and it is impossible to interpret them
intelligently without knowledge of the background in which they have emerged.
For investigating the accounts of a group of companies, it would not be possible to know
the manner in which the profits had emerged in the past unless a chart is prepared,
showing the relationship of different companies comprising the group; whether as
subsidiaries or not, the nature of transactions entered into by one unit in the group with another or
others and the terms on which this has been done. Further, it is important to know whether the
business is engaged in the manufacture of one or two important lines of products, is principally
processing materials or is concerned only with the sale of a single product. Also, whether it is a
business which depends for its success on imported raw materials or supply of parts and
components from ancillary businesses or uses indigenous materials and parts which are
manufactured locally.
If the business is labour - intensive, its future profitability would be dependent on
availability of skilled labour and relations of the management with the trade unions. Labour
relations thus can affect the future profitability of the business. The method of distribution
of products, either through wholesalers or retailers also must be examined. Apart from these
preliminary enquiries, the investigating accountant should study:
(i) the character of management;
(ii) the economic and political forces to which the business is subject; and
(iii) the position it enjoys in trade.

At times, political or economic factors also may affect the fortunes of a business; for example, labour
disturbances, changes in government policies in the matter of levy of excise and custom duties,
imports, etc. It is, therefore necessary that the impact of all these factors should be studied and their
effect on the business judged on a consideration of the profits in the past. For studying the economic
and financial position of the business, the following should be considered:
(i) The adequacy or otherwise of fixed and working capital. Are these sufficient for the growth of
the business?
(ii) What will be the trend of the sales and profits in the future? Establishing the trend of sales,
product-wise and area-wise will ordinarily help in drawing a conclusion on whether the trend
will be maintained in the future.
(iii) Whether the profit which the business could be expected to maintain in the future would yield
an adequate return on the capital employed?
(b) Statement of Profit and Loss - To study the Statement of Profit and Loss of a concern, it is
necessary to consider each item, included therein, in relation to the corresponding items in the
Statement of Profit and Loss of the previous years. It is therefore, necessary that a summary, in a
columnar form, should be prepared of the balances included in the Statement of Profit and Loss of
the business for a period, say of 5 to 7 years.
In the foregoing summary, in the place of figures of opening and closing inventories, the figures of
inventory consumed in different years should be entered. It should also be verified that the
inventories have been valued on a consistent basis throughout the period under review. If there has
been a change, the values of inventories should be adjusted. Further, in the summary, the gross
profit ratios and the ratios showing the relationship between various items of expenses and sales
should be entered. The trend of these ratios should be examined and, if there is a wide divergence
in them, an explanation for the same should be sought. In the preparation of the summary attention
should also be paid to the following matters:
Turnover - The figures of sales should be broken down between the various products sold to show
variations in turnover of individual products from year to year. In this way, it would be possible to
find out the products the sales of which have been increasing and those the sales of which have
been falling.
By reference to the list of customers, in the Order Books, it should be ascertained whether the
business has a very large turnover with a few customers or a small turnover with several customers.
The Order Books should also be examined to find out if fictitious sales have been entered in any
year to boost up profits. If so, the figures of sales of the year or years should be adjusted.
If the business consists of activities which are dissimilar in operation, like manufacturing and agency,
then apart from splitting the income between the two sources, expenses should also be apportioned
between them to separately arrive at the figures of profit from each of the activities.

Wage structure - The method of computing wages and the rates of wages should be examined. On
occasions a business may have to pay higher wages than those prevailing in other business in the
same neighbourhood in pursuance of an industrial award. Another factor which is important to
consider in this connection is the relationship of the business with its workers. A business which has
suffered several industrial disputes, strikes, etc. and has had its working interrupted by them
frequently cannot be expected to prosper unless a proper settlement is reached with workers’ unions.
Depreciation - The charge on account of depreciation and maintenance of machinery and other
assets included in the accounts of different years should be compared to verify that depreciation has
been provided from year to year on a consistent basis and that it is adequate. Also, the necessary
adjustment in the depreciation charge should be made if it is the practice of the company to write off
the assets on a renewal basis.
Further, if assets have been revalued, it should be confirmed that depreciation on the increased
valuation has been adjusted.
Generally, with age, the cost of maintenance of assets should increase. If it has not, the reason
thereof should be ascertained.
In case of leasehold property, it should be ascertained whether an adequate provision has been
made for the dilapidation charge which may be payable at the end of the lease.
Further, compliance of relevant AS should also be verified.
Managerial Remuneration - It should be verified that the remuneration payable to various members
of managerial personnel is not excessive in relation to the profits of the business after taking into
account the time devoted by each of them. However, it could also be that no or only a nominal
remuneration has been charged in the accounts. In either case, an adjustment should be made to
arrive at true profitability of the concern. Further, in case of company, requirement of relevant section
of Companies Act, 2013 is to be seen. It has to be assured that calculation of profit for arriving at
the remuneration is correct.
Exceptional and non-recurring items - It is customary to adjust exceptional items in the summary
of Statement of Profit and Loss in order that they may not obscure the trend of the profits. In the
matter of non-recurring items, it is necessary to remember that adjustments are to be made in
respect of exceptional items which do not recur from year to year or can be considered exceptional
having regard to their materiality or periodicity.
In this connection, it is worthwhile to examine the income tax assessment orders of the business to
find out the items which have been treated as revenue but have been regarded by the taxing
authority as inadmissible. Where the effect of these has been abnormal on the tax paid by the
company from year to year, suitable adjustments should be made in the figures of taxes paid, as
well as in the assets amounts. Likewise, adjustments should be made in respect of exceptional
profits and losses.

Repairs and maintenance - It is one of the recurring expenses of a business. Occasionally it is

noticed that this expenditure is unduly heavy in some of the years, while quite low in some others.
Generally, companies, as a matter of routine undertake major repairs, overhauls and maintenance
programme at an interval of 3 or 4 years while running repairs and maintenance continue in the
usual manner which gives rise to fluctuating charges in the accounts unless periodic major expenses
are treated as deferred expenditure.
Besides, due to wrong allocation of expenses between capital and revenue, repair charges may
appear to be heavy or low. If fluctuating and abnormal charges for repairs is noticed, it would be the
duty of the investigating accountant to scrutinise this head thoroughly to establish correct and normal
charge for repairs.
Unusual year - A company’s record of profitability may show a trend of increasing or decreasing
profit or loss or it may be highly erratic and fluctuating. Where a definite trend is discernible, the job
of the investigating accountant is somewhat simplified. He can adopt recent years’ record of
profitability as the basis for estimating future maintainable profit having regard to the inflationary
state in the economy. But if the same is fluctuating, there would be more demand on judgement of
the accountant in selecting the period to be covered for estimation of profitability. In such cases it
may even be necessary to take into consideration results of past 9 to 10 years with a view to iron
out the fluctuation. If, however, it is noticed that results of one or more years under scrutiny were
materially vitiated by exceptional factors like a long term industrial dispute, natural calamities, fire,
war, ravage etc., the investigating accountant should eliminate such year / years from consideration
altogether since they do not reflect the results obtained through normal business.
(c) Balance Sheet - Fixed Assets - Fixed assets, usually, are shown in accounts at cost less
depreciation but the accounts do not show the ages of different assets. It is desirable, therefore, to
obtain age analysis of various items of fixed assets. Assets which are old or are obsolete would
naturally have to be replaced. It should be seen that their values are not in excess of the value of
service that they could be expected to render to the business during the balance period of their
active life and the amount they would fetch on sale as scrap.
In addition, from a study of the maintenance expenses incurred from year to year, it should be judged
whether the assets have been properly maintained. If not, it might be necessary to incur heavy
expenditure on repairs to put them in a proper working order. In such a case, an allowance for this
factor should be made in the value of assets. More particularly, it should be seen that if assets have
been revalued, the increased depreciation charge has been adjusted against profit. Further,
investigator has to assure whether assets whose recoverable amount is less than carrying amount
are impaired and requirement of AS 28, “Impairment of Asset”, has been complied.
Investments -Investments should be broadly classified into long term investments and current
investments. A current investment is by its nature readily realisable and is intended to be held for
not more than one year. All other investments are long term investments.

Current investments are valued on the basis of lower of cost and fair value determined either on an
individual investment basis or by category of investment but not on an overall basis.
Long-term investments are usually carried at cost. However, when there is a permanent decline in
the value of long-term investments, the carrying amount should be reduced to recognise the decline.
The carrying amount of long term investments is determined on an individual investment basis.
Interest, dividends and rentals receivable in connection with investment are generally regarded as
income. However in some cases, such receipts represent recovery of cost and should therefore be
reduced from, the cost of investment (e.g. dividend out of pre-acquisition profits).
Inventories - It should be seen that inventories have been valued consistently and that the basis of
valuation was such that the value placed on inventories did not include any element of profit. Also,
there should be due allowance for damaged, obsolete and slow moving inventories.
Trade Receivables - In assessing their value, the following should be taken into account:
(i) Whether bad debts have been adjusted in the years in which the relevant sales took place
instead of in the year in which they have been written off. Normally, such an adjustment
should be made but not when debts have had to be written off on account of a slump or a fall
in international prices, during a period subsequent to the period in which sales had taken
place.
(ii) The length of the credit period allowed throughout the period under investigation, to determine
whether it has been necessary to increase continually the credit period in order to effect the
sales. If it has been so, it would indicate that the demand for the goods manufactured by the
concern in the market has been diminishing gradually.
(iii) Debts should be classified according to their age. This would disclose the character of the
parties with whom the company trades and the amount of working capital that will be
necessarily blocked on this account in the course of business.
Other liquid assets - It should be ascertained that the assets so described are readily realisable.
Money with a bank in liquidation should be taken only to the extent guaranteed by Deposit Insurance
Scheme.
Idle assets -On a scrutiny, it may appear that certain assets are remaining idle and are not being
properly applied in the business. These may come from all sections of assets. For example, certain
plant and machinery may have been put to use after a considerable period of time after acquisition.
Some of the fixed assets may be awaiting installation even at the valuation time. The company may
hold large cash and bank balances, not warranted by the need of the business. Then again, there
may be instances of obsolete and slow moving inventories of large value in the accounts of the
company. It would be the duty of the investigating accountant to eliminate these idle assets, if any,
after proper identification from the net worth of the business. However, proper value of these assets
may be separately added to the value of the business.

Liabilities - The important matter to investigate in this regard is whether those are stated fully or
understated or overstated. In other words, whether the profits of the business have been inflated by
suppression of liabilities or there are any free reserves included in the liabilities. In either case, an
adjustment would be necessary. Secondly, it should be ascertained that liabilities are not unduly
large or are not outstanding for a long time, in such cases, it would be necessary to pay off some of
them which would cause a drain on the liquid resources of the concern. The fact should be stated in
the report.
Taxation - Orders in respect of assessments completed should be studied and it should be verified
that an adequate provision has been made in respect of liabilities for taxes which have not been
assessed. Also, it should be seen that in the past there has been no reopening of assessments. If
so, the company may be liable for an undisclosed sum of taxes plus penalties. Any temporary tax
benefit should also be disregarded.
Capital - In this regard, it is necessary to ascertain:
(i) Whether the capital is well balanced. This would not be the case if the amount of debentures
and preference share capital are disproportionately large as compared to the equity capital,
for this would be a handicap to the company in raising further equity capital, on favourable
terms for financing the business or to pay off capital commitment. Further, when the capital
is highly geared, it would affect the value of the equity capital;
(ii) That the amount of capital is reasonable compared to the value of fixed assets and the
amount of working capital required. The terms associated with the issue of the capital should
also be studied; restriction on transferability of shares usually depresses the value of share
and of the business.
(d) Interpretation of figures - Fixed Assets - The amount of capital expenditure which would
be necessary in the future for the continuation of the business, in its existing stage, should be
assessed having regard to the under-mentioned factors:
(i) the amount required for the replacement of assets when these would become worn out or
obsolete;
(ii) the expenditure which will be necessary to replace obsolete machinery by more sophisticated
machinery for manufacturing different types of goods for which there is demand.
Turnover - In assessing the turnover which the business would be able to maintain in the future, the
following factors should be taken into account:
(i) Trend: Whether in the past sales have been increasing consistently or they have been
fluctuating. A proper study of this phenomenon should be made.

(ii) Marketability: Is it possible to extend the sales into new markets or that these have been
fully exploited? Product wise estimation should be made.
(iii) Political and economic considerations: Are the policies pursued by the Government likely to
promote the extension of the market for goods to other countries? Whether the sales in the
home market are likely to increase or decrease as a result of various emerging economic
trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the same
field or if products which would sell in competition are placed on the market at cheaper price?
Is the demand for competing products increasing? Is the company’s share in the total trade
constant or has it been fluctuating?
Working Capital - In making assessment of the working capital requirements in the future, the
following matters should be taken into account:
(i) Has the ratio of inventory to turnover been increasing and if so, is it a continuing or only a
temporary trend?
(ii) Are the trade payables being paid promptly or is there a backlog which will have to be dealt
with?
(iii) What will be the effect on inventory, trade receivables and trade payables, if the turnover is
increased or if new products are introduced?
Estimating Future Maintainable Profits - Fluctuations in profits during the years under review
should be examined after adjusting the profits for extraneous factors, if any, that had given rise to
fluctuations to determine whether the factors responsible for the fluctuations were temporary or was
likely to recur in future. A statement should be prepared showing separately the profits after
depreciation earned in each of the years during the period under review, after making adjustments
therein, if considered necessary, as regards factors which have been responsible for any
extraordinary increase in profits. If the percentage of profits before taxation to capital has been
stable or has been increasing, it would indicate that the business would continue to earn the same
rate of profit as it has done in the past. If, on the other hand, the percentage has been falling, and
there is no evidence that the factors responsible therefore have ceased to operate, investment of
further capital in the business would not be commercially advisable.

6. TYPES OF INVESTIGATION
The different types of investigation that a chartered accountant is usually called upon to carry out
are given hereunder:
Types of Investigation
Statutory Non-statutory
Investigation on behalf of an incoming

Investigation of ownership partner
Investigation into the
affairs of a company of a company (Section
216) Investigation for valuation of shares in
private companies
By inspector through an order of
the Central Government (Section
Investigation on behalf of a bank
210)
proposing to advance loan to a company
By Serious Fraud Investigation

Office (Section 212) Investigation of frauds
Other cases Investigation on behalf of an individual or a

(Section 213) firm proposing to buy a business
Investigation in connection with review of

profit / financial forecast
Statutory - By an inspector under Sections 210, 212, 213 and 216 of the Companies Act, 2013.
Non-statutory - These are listed as under:
(a) Investigation on behalf of an incoming partner.

(b) Investigation for valuation of shares in private companies.
(c) Investigation on behalf of a bank proposing to advance loan to a company.
(d) Investigation of frauds.
(e) Investigation on behalf of an individual or a firm proposing to buy a business.
(f) Investigation in connection with review of profit/financial forecast.

6.1 Investigation under the Companies Act, 2013

Investigation under the Companies Act, 2013 may broadly be classified into:
Investigation Investigation
into the of
affairs of a ownership
company; of a
and company.
(A) Investigation into the affairs of a company: This may further be divided into three parts:
(1) Investigation into the affairs of a company by inspector through an order of the Central
Government as envisaged under Section 210.
(2) Investigation into the affairs of a company by Serious Fraud Investigation Office as
prescribed under Section 212.
(3) Investigation into the affairs of a company in other cases as provided under Section
213.
(1) Investigation into the affairs of a company as envisaged under Section 210:
Where the Central Government is of the opinion, that it is necessary to investigate into
the affairs of a company-
(a) on the receipt of a report of the Registrar or inspector;
(b) on intimation of a special resolution passed by a company that the affairs of
the company ought to be investigated; or
(c) in public interest,
it may order an investigation into the affairs of the company.
Further, where an order is passed by a court; or the Tribunal requiring investigation,
the Central Government shall order an investigation into the affairs of that company.
For the above purposes, the Central Government would appoint one or more persons
as inspectors to investigate into the affairs of the company and to report thereon in
such manner as the Central Government may direct.
(2) Investigation into the affairs of a company by Serious Fraud Investigation Office
under Section 212: The Central Government may, by an order, assign the
investigation, into the affairs of the company, to the Serious Fraud Investigation Office,
when it considers necessary to investigate into the affairs of the company, on receipt

of a report of the Registrar or inspector; or on intimation of a special resolution passed

by a company; or in public interest; or on request from the Department of the Central
Government, or a State Government.
Where the Central Government assign any case to the Serious Fraud Investigation
Office for investigation under this Act, no other investigating agency of Central
Government or any State Government shall proceed with investigation in such case.
The Serious Fraud Investigation Office shall follow the manner and procedure as
provided and submit its report to the Central Government. The Central Government
may also direct to submit an interim report.
Where the report states that fraud has taken place in a company and due to such
fraud any director, key managerial personnel, other officer of the company or
any other person or entity, has taken undue advantage or benefit, whether in the
form of any asset, property or cash or in any other manner, the Central
Government may file an application before the Tribunal for appropriate orders
with regard to disgorgement of such asset, property or cash and also for holding
such director, key managerial personnel, other officer or any other person liable
personally without any limitation of liability.
(3) Investigation into the affairs of a company in other cases as provided under
Section 213: The Tribunal may order investigation into affairs of the company, on an
application received by specified number of members and supported by such
evidence; or on an application made to it by any other person or otherwise, if it is
satisfied that there are circumstances like, the business of the company is being
conducted with intent to defraud its creditors, or that the company was formed for any
fraudulent or unlawful purpose, or the members of the company have not been given
all the information with respect to its affairs, etc. The investigation may be ordered,
after giving a reasonable opportunity of being heard to the parties concerned.
It may be noted that if after investigation it is proved that—
(i) the business of the company is being conducted with intent to defraud its
creditors, members or any other persons or otherwise for a fraudulent or
unlawful purpose, or that the company was formed for any fraudulent or
unlawful purpose; or
(ii) any person concerned in the formation of the company or the management
of its affairs have in connection therewith been guilty of fraud, misfeasance
or other misconduct,
then, every officer of the company who is in default and the person or persons
concerned in the formation of the company or the management of its affairs shall be
punishable for fraud.

Who can be appointed as an Inspector - A firm, body corporate or other association

cannot be appointed as an inspector. Thus, a firm of professional accountant cannot
be appointed as inspector but an individual accountant can be so appointed.
Power of Inspector to conduct investigation into the affairs of related companies
etc.-Section 219 of the Companies Act, 2013 provides that an inspector appointed
under section 210 or section 212 or section 213 to investigate into the affairs of a
company may also investigate, subject to approval of the Central Government, into
the affairs of—
(a) any other body corporate which is, or has at any relevant time been the company’s
subsidiary company or holding company, or a subsidiary company of its holding
company;
(b) any other body corporate which is, or has at any relevant time been managed by
any person as managing director or as manager, who is, or was, at the relevant
time, the managing director or the manager of the company;
(c) any other body corporate whose Board of Directors comprises nominees of the
company or is accustomed to act in accordance with the directions or instructions
of the company or any of its directors; or
(d) any person who is or has at any relevant time been the company’s managing
director or manager or employee.
It may be noted that he shall, subject to the prior approval of the Central Government,
investigate into and report on the affairs of the other body corporate or of the managing
director or manager, in so far as he considers that the results of his investigation are
relevant to the investigation of the affairs of the company for which he is appointed.
The objective of these investigations, fundamentally, is to determine whether any
provision of the Act has been violated or there has been a breach of duty on the part
of a director or an officer of the company resulting in a loss to shareholders or a class
of them. It has been held in the case Narayanlal Bansilal v. Maneck Phiroze Mistry
and another (1960 comp. Cases, p. 62) that an investigation into the affairs of a
company under the Companies Act was not a criminal proceeding. It was also held
that the report of the inspector is just an expression of his opinion in the manner in
which affairs of the company was conducted.
The term “affairs of a company” was considered in R.V. Board of Trade Ex. parte St.
Martin Preserving Company Ltd. (1964 E.R. 561). It was held that it can cover
investigations into all aspects of its business; its assets including goodwill, profits and
losses, contracts and transactions, investments and rather property interests and
control of subsidiary companies and transactions of a receiver and manager of a
company.

PROCEDURE, POWERS ETC. OF INSPECTORS – Section 217 of the Companies

Act, 2013 states the procedures, powers of the Inspectors as follows:
(1) Duty of officers and employees of the company towards inspector: It
shall be the duty of all officers and other employees and agents including the
former officers, employees and agents of a company which is under
investigation to preserve and to produce to an inspector or any person
authorised by him, all books and papers relating to the company or the
person; and to provide assistance in connection with the investigation which
they are reasonably able to give.
(2) Inspector may ask information from any body corporate: The inspector
may require any body corporate, other than a body corporate referred to in
point(1), to furnish such information to, or produce such books and papers
before him as he may consider necessary.
(3) Not to keep Books and Papers in custody for more than 180 days: The
inspector shall not keep in his custody any books and papers produced for
more than 180 days and return the same to those by whom the books and
papers were produced.
The inspector may call the books and papers again, if needed, for a further
period of 180 days by an order in writing.
(4) Examine on oath: The inspector may examine on oath any of the persons
referred above; and with the prior approval of the Central Government, any
other person in relation to the affairs of the company, or other body corporate
or person, as the case may be.
(5) Inspector to possess all the Powers of Civil Court: The inspector, being
an officer of the Central Government, making an investigation shall have all
the powers as are vested in a civil court under the Code of Civil Procedure,
while trying a suit in respect of specified matters.
(6) Assistance of Officers of Government to Inspector: The officers of the
Central Government, State Government, police or statutory authority shall
provide necessary assistance to the inspector for the purpose of inspection,
investigation etc.
(7) Evidence from place outside India: If in the course of an investigation into
the affairs of the company, an application is made to the competent court in
India by the inspector stating that evidence may be available in a country or
place outside India, such court may issue a letter of request to a court or an
authority in such country or place for seeking such evidence.

It may be noted that the letter of request shall be transmitted in such manner as the
Central Government may specify in this behalf.
INSPECTOR’S REPORT - Under Section 223 of the Companies Act, 2013, an
inspector shall, if so directed by the Central Government, submit interim reports to that
Government, and on the conclusion of the investigation, shall submit a final report to
the Central Government. Every report made shall be in writing or printed as directed
by the Central Government. A copy of the report may be obtained by members,
creditors or any other person whose interest is likely to be affected by making an
application to the Central Government.
Section 224 of the Companies Act, 2013, deal with follow-up of the inspector’s report
and gives power to the central government to launch prosecution; apply for winding up
of the company etc.
GENERAL APPROACH FOR INVESTIGATION - The general approach for
investigation under Sections 210, 212 and 213 of the Companies Act, 2013 is
conditioned by the legal requirements in these regards. From the foregoing
requirements of law, it is apparent that investigations under these requirements may
encompass a wide field.
The affairs of the company may include everything such as goodwill, profit and loss,
contracts, investments, assets, shareholding in subsidiaries, decision making, etc.
Also the specific circumstances mentioned in these sections like fraud,
mismanagement, oppression of any shareholder etc. come within the term “affairs of
the company.”
Investigation under Sections 210 and 213 do not call for any special approach.
Approach/Steps for pursuing the investigation are:
(i) Clarity of Terms of Reference: The approach to any investigation is
determined on a consideration of the nature of the investigation and the
terms of reference. However, the inspector should ensure that the terms of
reference are clear, unambiguous and in writing. If he has any doubt about
any item in the terms, he should obtain clarification in writing. It should also
be, seen that the terms of reference are not too general, because that may
frustrate the whole objective of the investigation; the scope of the
investigation will become unwieldy and ill defined. An investigation order to
investigate into the affairs of the company would be an instance at point.
Therefore, the inspector should ask for reframing of the order specifying the
exact matters to be investigated. He should also take into consideration the
possible effect of limitations, if any, put in the terms of reference and should
keep the Central Government informed in writing about their effect on the
investigation.

(ii) Scope of Investigation: The next point for consideration of the inspector would
be the determination of the scope of the investigation on the basis of the terms
of reference. At this stage, it may be useful for the inspector to go into the history
of the company and its affiliates or associates. He should evaluate the terms of
reference in sketching the scope of investigation; this will enable him to locate
the limitation, if any, in the terms of reference, not clearly mentioned. For a
purposeful investigation, he may need to stretch his inquiry into the books and
records of allied and associated persons and concerns and may require to arm
himself with the powers given under the Companies Act.
(iii) Period for investigation: He should also have regard to the period over which
the investigation should stretch. The evaluation of terms of reference and the
consequential determination of the scope of investigation are the twin props on
which the entire investigation would rest and, therefore, the inspector appointed
under Sections 210 and 213 should devote careful attention to these.
(iv) Framing of Programme: The next step is the investigator/inspector should
frame his programme for investigation in a systematic manner. He should
keep adequate working notes and papers with references and cross
references in a proper and methodical way to aid him in the preparation of
the report. The actual process of investigation would be essentially an
evidence gathering procedure and, at every step, he should have regard to
the procedures laid down in these sections regarding production of
documents and evidence, examination on oath and seizure of documents.
He should also keep his mind open to the revelations he comes across in
the process of evidence collection and should assess whether the
programme of investigation needs amendment or modification.
(v) Using the work of Experts: He should also consider whether assistance of
other experts like engineers, lawyers, etc., is necessary in the interest of a
comprehensive and full proof examination of the documents and information.
(vi) Legal requirements and investigation Report: Only after he has
completed the steps in the investigation programme and has marshaled all
the information that he needed should he prepare his report. He, however,
can also make interim report as provided under Section 223 of the
Companies Act. The findings should be completed and exhaustive. Before
he makes his final report he should obtain and keep on record the evidences
relied upon by him. By the nature of things, such evidence should be as
conclusive as possible depending on circumstances of the case. He should
make his report in accordance with the provisions of the section 223 of the
Companies Act, 2013.
The general approach for investigations under Sections 210 and 213 should, therefore,
be formulated having regard to the terms of reference, scope, the period, the
programme and procedure of the investigation and the attending legal requirements
specified above.

(B) INVESTIGATION OF OWNERSHIP OF A COMPANY: According to Section 216 of the

Companies Act, 2013, where it appears to the Central Government that there is a reason so
to do, it may appoint one or more inspectors to investigate and report on matters relating to
the company, and its membership for the purpose of determining the true persons, who are
or have been financially interested in the success or failure, whether real or apparent, of the
company; or who are or have been able to control or to materially influence the policy of the
company; or who have or had beneficial interest in shares of a company or who are or
have been beneficial owners or significant beneficial owner of a company.
In case, if the Tribunal, in the course of any proceeding before it, directs by an order that the
affairs of the company ought to be investigated as regards the membership of the company
and other matters relating to the company discussed above, the Central Government shall
appoint one or more inspectors.
While appointing an inspector, the Central Government may define the scope of the
investigation as respects the matters or the period to which it is to extend. It may limit the
investigation to matters connected with particular shares or debentures. Powers of inspectors
shall extend to the investigation of any circumstances suggesting the existence of any
arrangement or understanding.
Scope and extent of investigation - When a chartered accountant is appointed to carry out
an investigation under any of the aforementioned provisions, the extent of enquiry, the
objective of the investigation and the various matters referred to for investigation are specified
in the order of investigation issued by the appointing authority.
On a consideration thereof, the investigating accountant should determine the areas of
accounts which require investigation and the extent to which the enquiry is to be made as
well as his general approach to the enquiry.
In case, if the allegation is that certain transactions have been entered into in
contravention of the provisions of the Companies Act, the nature of transactions,
the persons who were parties thereto, the amount or amounts involved and the
circumstances under which these were entered into must be examined. If the contravention
was deliberate and willful and was made with some ulterior motive, it would attract greater
penalty as compared to the one which was inadvertent. The enquiry therefore should show
the motive, if any, of the contravention. If the loss suffered by the company has given rise to
a gain by a director and other managerial personnel or its associates, the manner in which
the benefit has accrued and the amount thereof shall have to be investigated.
In case of a company having subsidiaries or where one or more directors are interested in
one or more concerns, all the dealings with these concerns should be examined for these
may have been entered into with the intention of transferring profit. Generally, all sales and
purchases of goods and assets from directors and their associated concerns should be
scrutinized since these also can be a vehicle of illicit transferring of profits.

Any breach of duty or abdication of responsibility for purposes of investigation would be

material only if it has resulted in a loss to the company. In such a case, the factors responsible
for the loss or losses, besides the amount thereof, shall have to be investigated. Negligence
would be culpable only if it was in relation to a duty cast by the Act, Articles of Association or
by a resolution of the shareholders or that of the Board of Directors.
Any negligence in the discharge of duty of a director or any other managerial personnel must
be construed very broadly, for apart from being the agents of the company, they are trustees
of its property. As such, it is their duty to safeguard the property of the company and protect
the interest of the shareholders. It must be remembered, however, that it is not the duty of a
director to attend to the business of a company continuously and, therefore, so long as the
decisions of the Board at which the director was present were taken on a proper consideration
of the evidence available and in the best interest of the company, he would not be responsible
for any losses suffered by the company.
It may be necessary for an investigator to interrogate directors, officers, agents, and others
concerned with matters under his enquiry. Before drawing up his brief in this regard as well as for
framing his conclusions, he should, if necessary, take legal assistance. If the Investigating
accountant is required to report on the efficiency of the management, he should be discreet in
expressing his opinion. Usually, it is sufficient if he merely indicates the general limitations of the
management. The inspector must ensure that the persons who figure in the investigation get the
fullest opportunity to explain their action and conduct. However, the inspector cannot hold out any
assurance to anybody except the assurance of fairness implicit in the job.
6.2 Investigation on behalf of an Incoming Partner

The general approach of the investigating accountant in this type of investigation would be more or less
similar, irrespective of the nature of business of the firm-manufacturing, trading or rendering a service.
Primarily, an incoming partner would be interested to know whether the terms offered to him are
reasonable having regard to the nature of the business, profit records, capital distribution, personal
capability of the existing partners, socio-economic setting, etc., and whether he would be capable of
deriving continuing benefit in the shape of return on capital to be contributed and remuneration for
services to be rendered, which can be justified by the overall economic conditions prevailing and other
considerations considering his own personality and achievements. In addition, he would be interested to
ascertain whether the capital to be contributed by him would be safe and applied usefully.
Broadly, the steps involved are the following:
(a) Ascertainment of the history of the inception and growth of the firm.
(b) Study of the provisions of the deed of partnership, particularly for composition of partners,
their capital contribution, drawing rights, retirement benefits, job allocation, financial
management, goodwill, etc.

(c) Scrutiny of the record of profitability of the firm’s business over a suitable number of years,
with usual adjustments that are necessary in ascertaining the true record of business
profits. Particular attention should, however, be paid to the nature of partners’
remuneration, which may be excessive or inadequate in relation to the nature and
profitability of the business, qualification and expertise of the partners and such other
factors as may be relevant.
(d) Examination of the asset and liability position to determine the tangible asset backing for
the partner’s investment, appraisal of the value of intangibles like goodwill, know how,
patents, etc. impending liabilities including contingent liabilities and those for pending tax
assessment. In case of firms rendering services, the question of tangible asset backing
usually is not important, provided the firm’s profit record, business coverage and standing
of the partners are of the acceptable order.
(e) Position of orders at hand and the range and quality of clientele should be thoroughly
examined, which the firm is presently operating.
(f) Position and terms of loan finance would call for careful scrutiny to assess its usefulness and
implication for the overall financial position; reason for its absence should be studied.
(g) It would be interesting to study the composition and quality of key personnel employed
by the firm and any likelihood of their leaving the organisation in the near future.
(h) Various important contractual and legal obligations should be ascertained and their nature
studied. It may be the case that the firm has standing agreement with the employees as
regards salary and wages, bonus, gratuity and other incidental benefits. Full import of such
standing agreements would be gauged before a final decision is reached.
(i) Reasons for the offer of admission to a new partner should be ascertained and it should
be determined whether the same synchronises with the retirement of any senior partner
whose association may have had considerable bearing on the firm’s success.
(j) Appraisal of the record of capital employed and the rate of return. It is necessary to have
a comparison with alternative business avenues for investments and evaluation of
possible results on a changed capital and organisation structure, if any, envisaged along
with the admission of the partner.
(k) It would be useful to have a firsthand knowledge about the specialisation, if any, attained
by the firm in any of its activities.
(l) Manner of computation of goodwill on admission as also on retirement, if any, should be
ascertained.
(m) Whether any special clause exists in the deed of partnership to allow admission in future
of a new partner, who may be specified, on concessional terms.
(n) Whether the incomplete contracts which will be transferred to the reconstituted firm will
be a liability or a loss.
It would always be worthwhile to remember that, in a partnership, personal considerations count
predominantly over other considerations and assessment of standing of the firm, standing and
reliability of other partners, their personal reputation and the goodwill enjoyed by the
products/services are important.

On the basis of the broad frame of considerations as given above, the investigating accountant
should devise his own considerations in each case which may be quite diverse. Additional
considerations may come up in the case of service-rendering firms where profit and business record,
goodwill of the firm and of individual partners would assume greater significance.
Again, in the case of industrial firms, the network of customers, their scatter, size, etc., would be
relevant for consideration.
6.3 Investigation for Valuation of Shares in Private Companies

The importance should be given on various purposes for which such a valuation is necessary, the
different bases on which valuation is possible and the variety of economic factors, on a consideration
whereof the price so determined needs to be adjusted.
The necessity for valuation of shares of a private company arises, for under the Companies Act, a
private company must restrict the transfer of its shares. In consequence, the shares of a private
company do not have a free market in which their prices could be determined by interaction of the
forces of supply and demand.
In respect of equity shares, there are two main methods of valuation. According to the first method,
value is determined on the basis of net worth of the company. The amount of net worth is divided by
the number of shares comprising the equity capital to arrive at the value for one share. When this
method is followed, goodwill of the business, based on the estimated future maintainable profit, is
included among the assets to arrive at the amount of net worth. According to the second method,
the average profit earned by the business during the preceding 5 to 7 years is computed. Afterwards,
on the assumption that the same would continue to be earned in the future, the value of business is
calculated by capitalising it at a reasonable rate of interest. If the rate assumed is high, the value of
the business would be smaller. Correspondingly, it would be high if the rate of interest applied is
low. A provision of the risk factor and restriction on transfers in the value of shares is made by
varying the rate of interest applied. The rate of return that an investor expects to earn in a business
of the type in which the company is engaged, is ascertained from the prices of the shares of
companies engaged in a similar business quoted on the stock exchange.
The value of preference shares is estimated on the basis of the yield on preference shares of
companies engaged in a similar trade or industry after making allowance for factors like restriction
on transferability, average rate of earnings as compared to the rate of dividend, etc.
Special features -
Net worth basis
(a) Each asset should be revalued on taking into account its utility to the business as a going
concern. The value of different assets, on a revaluation, may be either more or less in
comparison to their book values.

The book value of safes and furniture in the case of a bank is usually much less
as compared to their utility. On the other hand, the book value of intangible
assets, e.g., leasehold rights, patents, goodwill, etc., in case of an industrial concern may
be higher in comparison with the advantage which accrues to it from these assets. In both
the cases, the assets should be revalued at their replacement cost i.e., the cost of similar
assets at the prevailing market price, reduced by the amount of depreciation which they
would have suffered, if they were in use during the period that the corresponding assets
have been in use. But the cost adopted, in cash, should be the cost of the assets as were
originally purchased or that of their substitutes considered more suitable in the
circumstances of the case.
(b) The value of goodwill of a business is primarily dependent on its capacity to earn super-profit
and the period over which these are expected to arise. The super profits that the business
would earn in the future are estimated on the basis of profits earned in the past, after making
an allowance therein for the continuation or otherwise of favourable factors, which in the past
had enabled the business to earn super-profits. This is usually a difficult matter since, for the
purpose, it is necessary to analyse the trend of economic, social and political forces which
have an impact on the profitability of the business.
The installed capacity must be viewed against future national requirements on
taking into account the government’s licensing policy. Again, government policies
like controls over selling price or advantages of marketing through its own organisations
will have to be considered since any change therein might seriously affect the profit
structure. Therefore, to determine the impact of these factors, the accountant must have
knowledge of the company’s working and experience of the business in general.
Yield basis
(a) The value of shares on yield basis is arrived at on the basis of present value of the right to
receive dividends in the future. Since dividends can be paid only out of profits, in this case
also, it is necessary to determine the amounts of profits which the company would be earning
in future as well as the amounts thereof which would be distributed as dividend from year to
year. In short, it is an exercise in projecting the trend to profits and predicting the policy that
the company might follow in the matter of declaration of dividends.
(b) The rate at which the amount of dividends should be capitalised is decided on taking into
account the risk that shareholders are taking in the matter of declaration of dividends being
continued in future, assessed in the background of past history of the company, the amount
of reserves the company possesses, both secret and those disclosed in its books, future
prospects of the line of manufacture or trade in which the company is engaged and the impact
of various social and political factors that are likely to emerge on the company’s profitability.
Since the effect of these factors is reflected in the prices at which the shares of companies
engaged in similar trades and businesses are quoted on the Stock Exchange, the
investigating accountant should consider them. These would show to him the rate at which
their dividends were being capitalised. He should adopt the average rate of return expected

by investors in the shares of such companies but it should be applied only after making due
allowance for the factors peculiar to the case, such as restrictions on transfer of shares,
majority holding, etc. In any valuation of shares, with the transfer of shares control is also to
pass, a separate value should be ascertained for the control and added to the value otherwise
obtained either on net worth basis or yield basis.
6.4 Investigation on behalf of a Bank Proposing to Advance Loan to a

Company
A bank is primarily interested in knowing the purpose for which a loan is required, the sources from
which it would be repaid and the security that would be available to it, if the borrower fails to pay
back the loan. On these considerations, the investigating accountant, in the course of his
enquiry, should attempt to collect information on the under-mentioned points:
(i) The purpose for which the loan is required and the manner in which the borrower proposes
to invest the amount of the loan.
(ii) The schedule of repayment of loan submitted by the borrower, particularly the
assumptions made therein as regards amounts of profits that will be earned in cash and
the amount of cash that would be available for the repayment of loan to confirm that they
are reasonable and valid in the circumstances of the case. Institutional lenders now-a-
days rely more for payment of loans on the reliability of annual profits and loss on the
values of assets mortgaged to them.
(iii) The financial standing and reputation for business integrity enjoyed by directors and
officers of the company.
(iv) Whether the company is authorised by the Memorandum or the Articles of Association to
borrow money for the purpose for which the loan will be used.
(v) The history of growth and development of the company and its performance during the
past 5 years.
(vi) How the economic position of the company would be affected by economic, political and
social changes that are likely to take place during the period of loan.
To investigate the profitability of the business for judging the accuracy of the schedule of
repayment furnished by the borrower, as well as the value of the security in the form of assets
of the business already possessed and those which will be created out of the loan, the
investigating accountant should take the under-mentioned steps:
(a) Prepare a condensed income statement from the Statement of Profit and Loss for the
previous five years, showing separately therein various items of income and expenses, the
amounts of gross and net profits earned and taxes paid annually during each of the five years.
The amount of maintainable profits determined on the basis of foregoing statement should be
increased by the amount by which these would increase on the investment of borrowed funds.

(b) Compute the under-mentioned ratios separately and then include them in the statement to
show the trend as well as changes that have taken place in the financial position of the
company:
(i) Sales to Average Inventories held.
(ii) Sales to Fixed Assets.
(iii) Equity to Fixed Assets.
(iv) Current Assets to Current Liabilities.
(v) Quick Assets (the current assets that are readily realisable) to Quick Liabilities.
(vi) Equity to Long Term Loans.
(vii) Sales to Book Debts.
(viii) Return on Capital Employed.
(c) Enter in a separate part of the statement the break-up of annual sales product-wise to show
their trend.
Steps involved in the verification of assets and liabilities included in the Balance Sheet of the
borrower company which has been furnished to the Bank - The investigating accountant should
prepare schedules of assets and liabilities of the borrower and include in the particulars stated below:
(a) Fixed assets - A full description of each item, its gross value, the rate at which depreciation
has been charged and the total depreciation written off. In case the rate at which depreciation
has been adjusted is inadequate, the fact should be stated. In case any asset is encumbered,
the amount of the charge and its nature should be disclosed. In case an asset has been
revalued recently, the amount by which the value of the asset has been decreased or
increased on revaluation should be stated along with the date of revaluation. If considered
necessary, he may also comment on the revaluation and its basis.
(b) Inventory - The value of different types of inventories held (raw materials, work-in-progress
and finished goods) and the basis on which these have been valued.
Details as regards the nature and composition of finished goods should be disclosed. Slow-
moving or obsolete items should be separately stated along with the amounts of allowances,
if any, made in their valuation. For assessing redundancy, the changes that have occurred in
important items of inventory subsequent to the date of the Balance Sheet, either due to
conversion into finished goods or sale, should be considered.
If any inventory has been pledged as a security for a loan the amount of loan should be
disclosed.
(c) Trade Receivables, including bills receivable - Their composition should be disclosed to
indicate the nature of different types of debts that are outstanding for recovery; also whether
the debts were being collected within the period of credit as well as the fact whether any
debts are considered bad or doubtful and the provision if any, that has been made against
them.

Further, the total amount outstanding at the close of the period should be segregated as
follows:
(i) debts due in respect of which the period of credit has not expired;
(ii) debts due within six months; and
(iii) debts due but not recovered for over six months.
If any debts are due from directors or other officers or employees of the company, the
particulars thereof should be stated. Amounts due from subsidiary and affiliated concerns, as
well as those considered abnormal should be disclosed. The recoveries out of various debts
subsequent to the date of the Balance sheet should be stated.
(d) Investments - The schedule of investments should be prepared. It should disclose the date
of purchase, cost and the nominal and market value of each investment. If any investment is
pledged as security for a loan, full particulars of the loan should be given.
(e) Secured Loans - Debentures and other loans should be included together in a separate
schedule. Against the debentures and each secured loan, the amounts outstanding for
payments along with due dates of payment should be shown. In case any debentures have
been issued as a collateral security, the fact should be stated. Particulars of assets pledged
or those on which a charge has been created for re-payment of a liability should be disclosed.
(f) Provision of Taxation - The previous years up to which taxes have been assessed should
be ascertained. If provision for taxes not assessed appears in be inadequate, the fact should
be stated along with the extent of the shortfall.
(g) Other Liabilities - It should be stated whether all the liabilities, actual and contingent, are
correctly disclosed. Also, an analysis according to ages of trade payables should be given to
show that the company has been meeting its obligations in time and has not been depending
on trade credit for its working capital requirements.
(h) Insurance - A schedule of insurance policies giving details of risks covered, the date of
payment of last premiums and their value should be attached as an annexure to the
statements of assets, together with a report as to whether or not the insurance-cover appears
to be adequate, having regard to the value of assets.
(i) Contingent Liabilities - By making direct enquiries from the borrower company, from
members of its staff, perusal of the files of parties to whom any loan has been advanced
those of machinery suppliers and the legal adviser, for example, the investigating accountant
should ascertain particulars of any contingent liabilities which have not been disclosed. In
case, there are any, these should be included in a schedule and attached to the report.
Finally, the investigating accountant should ascertain whether any application for loan to
another bank or any other party has been made. If so, the result thereof should be examined.

6.5 Investigation of Frauds

In the Companies Act, 2013 meaning of fraud has been considered in two specific sections viz.
Section 143(10), where the SAs specified by the ICAI are deemed to be the auditing standards for
purposes of the Act, which, inter alia, define fraud, and in Section 447, where punishment for fraud
has been prescribed.
Fraud has been defined in paragraph 11(a) of SA 240, “The Auditor’s responsibilities Relating to
Fraud in an Audit of Financial Statements” as ‘an intentional act by one or more individuals among
management, those charged with governance, employees, or third parties, involving the use of
deception to obtain an unjust or illegal advantage.’
In the context of stating the provisions for punishment for fraud, Section 447 of the Act has explained
the term ‘fraud’ as “fraud in relation to affairs of a company or any body corporate, includes any act,
omission, concealment of fact or abuse of position committed by any person or any other person
with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure
the interests of, the company or its shareholders or its creditors or any other person, whether or not
there is any wrongful gain or wrongful loss.”
This Section further explains the terms ‘wrongful gain’ and ‘wrongful loss’ to mean the gain by
unlawful means of property to which the person gaining is not legally entitled; and the loss by
unlawful means of property to which the person losing is legally entitled, respectively.
Note : Students are also advised to refer Chapter 5 of this study material given in Module I and
Chapter 5 Fraud and the Responsibilities of the Auditor in this regard of Auditing and Assurance
study material of Intermediate level for detailed provisions w.r.t to Fraud Reporting.
6.5.1. Types of Frauds

Frauds may broadly be categorized as –
Fraudulent Financial Reporting – Mis-appropriation of Assets –
Alteration or falsification of records & Embezzlement of receipts in respect of
documents written-off accounts
Misrepresentation in or intentional Stealing physical assets or intellectual
omission of events, transactions or properties
information Introduction of fictitious vendors
Intentional misapplication of accounting Payment of factitious employees
principles
Using entities assets for personal use.
Fictitious Journal Entries
Adjusting assumptions and changing
Judgments
Omitting, advancing or delaying the
recognition of events or transactions.

Fraudulent Entries - Sales Frauds - Collection Frauds – Expenses Frauds –
• Late entry • Price enhancement • Defalcation of • Entering ineligible

• No entry • Omission to make receipt contributions to charity discount
of sale of scrap. funds • Overcharging expenses
• Part entry • Crediting donation to loan
• Billing and sales reversals • Falsification of documents
• Inserting wrong entries to in amusement parks. accounts
divert attention • Untimely payment
• Food production yield ratio • Introduction of fictitious
in hotels and suppression vendor
of Revenue.
• Using or hiring assets of
the company in lean
period
• Omission in preparation of
dispatch note for sale
• Sale of Assets recorded
as Income
Payroll Frauds – Data Frauds –

•Extra number of employees • Change in computer data
•Extra hours • Destroy, suppress or insert records
•Calculation of net pay by transferring • Using open fields in computerized
rounding off amount to personal account. accounting system
•Not deactivating the retired employees’ IDs
Technology related Frauds – Banking related Frauds - Others –
• Employing hostile Software • Forged Signatures • Teaming and Lading

Programs or malware attacks • Cheque Frauds - Alteration in • Process houses mixing inferior
• Phishing mails amounts, Alteration in accounts quality material to sale good
• Vishing – Voice Mail titles, Kite flying quality material
• SMSishing - Text messages • Cash lending during working • Pilferage and theft in super
• Whaling – Targeted phishing on hours markets
high network individuals • Missing notes in bundles • Selling classified information,
• Card duplications • Use of same notes bundles by • Withholding information from
• Stealing confidential data two branches customer about free product
• Wrong posting in other accounts schemes, discount and
• Misuse of sensitive stationery concession.
• ATM transaction misuse • Enhancement of performance
• Using PINs of debit card/credit • Taking advantage of disaster or
card holder natural calamity.
• Advances - Car, Xerox Machine, • Trust FDs
inflated stock statements, • Fictitious journal entries to inflate
inflated projections, expenses or income.
forged/duplicate land
documents, L/Cs

Frauds may be classified as defalcations involving misappropriation, either of money or that of

goods, and manipulation of accounts not involving a defalcation. The detections of manipulations of
accounts being one of the objects of an audit, for the detection of frauds perpetrated for
misappropriating either money or goods, knowledge of the various circumstances under which these
may be committed and that of different forms they take is essential. On this account, a brief
description thereof at different level is given below:
1. Fraud for Personal GainS
Bribery: Money, gift or other favours offered to procure (often illegal or dishonest) action or
decision in favour of the giver. These are also relatable to contract fraud or procurement fraud
and are, generally, out of books transactions. The auditor normally conducts a propriety audit
over the veracity of the transactions and review of any undue favours to vendors.
2. Corporate Frauds/ Irregularities
(i) Advance Billing: Advance billing is a situation where the company officials indulge in
booking fictitious sales in anticipation of actual sales. This results in misrepresentation
of revenue in the books thereby misleading financers and stakeholders. When the
management treats borrowings from money lenders as customer advances in the
books against sale orders or for adjusting bills receivables, the fraudulent act gets
unnoticed for an extended period. This situation results in a death knell for the
corporation as the company is dragged into an irredeemable debt trap.
Use of Shell Company, false vendors, purchases of personal nature booked as official
expenses enable falsification of accounts and diversion of funds for purposes other
than an intended purpose. These could also be mechanism for employees or cartel of
employees engaging in personal gain at the cost of the company. In the former incident
this could be termed as management fraud.
(ii) Shell/ Dummy Company Schemes: Generally, represents a fictitious company or a
‘paper company’ to transfer profits or funds from the main company. This could also
involve fictitious bills (mostly for services rendered or consultancy charges that cannot
be corroborated) which are used in the name of dummy companies diverting the funds
taken from banks and financial institutions.
The books could be falsified by wrong classification of expenses, inflating the expense
claims, fictitious expenses or multiple reimbursements. A review of controls, normally,
leads to the uncovering of expense booking that are prima facie not incurred.
(iii) Money Laundering Activities: As per the Prevention of Money Laundering Act, 2002
whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly
is a party or is actually involved in any process or activity connected with the proceeds
of crime and projecting it as untainted property shall be guilty of offence of money
laundering.”

The person indulging in money laundering looks for avenues with weak banking
controls for converting illegal money into the banking system. Any excess credit in the
bank accounts that does not belong to the customer or is parked for a temporary period
should raise suspicion of such activities. This person indulging in money laundering
activity looks for avenues to enter into ‘benami’ (could be called `proxy’ name lending)
transactions. Companies with extensive cash handling and inadequate identification
process of source of money or about the remitter are susceptible to money laundering
activities.
3. Fraud at Operational Level Employees
(i) Tampering of Cheques/Drafts/On-line payments/receipts: Tampering of cheques,
payee name being altered, or preparation of cheques without issue of the cheques to
payee, etc., are methods that may also lead to falsification of accounts.
On-line payments generally are considered a transparent mechanism to prevent the
above frauds. The ATM is a popular technological advancement that has inherent
control gaps. For example, credit cards once swiped the transaction is put through in
the system without the need for a signature of the payer. Similarly, unauthorised
credits in bank accounts through ATMs are an immense source of threat to recipients
including bribery allegations, unless they lodge a complaint with the bankers or the
regulatory authorities in a prompt manner of such unauthorised credits to their
accounts/or company bank accounts.
Care should be taken that the name of the payee in the payment transactions in books
and cheque issued therein for payment is not fabricated to wrongly codify and book
against an improper account head.
(ii) Off Book Frauds: In off book frauds, the fraud perpetrator misappropriates the cash
before these are recorded in the books or before the sale is recorded in the books.
These frauds are difficult to unearth as the cash or collection is taken off before the
accounting entries are made in the books. This situation arises especially in
unorganized markets and in rural economies where banking habits are relatively under
developed. These are difficult to establish due to absence of audit trails and are more
prevalent in businesses that have extensive cash dealings. These are difficult to
uncover as the means adopted could include printing of receipts/ bills outside the
system.
The above fraudulent schemes can be established based on circumstantial evidence
or validation through external sources such as, customer balance confirmations
(where feasible) and customer copy of the receipts or other documents that are
retained by them. These are also further supplemented by external evidence in the
form of background checks and surveillance mechanism.

(iii) Cash Misappropriation: Cash is misappropriated after the accounting entries are
already passed in the books. These are identified through surprise checks and through
shortages in cash balances. These occur when there are delays in accounting of cash
collections and there are no laid down cash flow controls. Unaccounted money in any
form in an entity is a serious red flag in uncovering of irregularities. Improper daily fund
monitoring mechanism is another factor that results in creating unauthorised float by
employees in their personal account or in fictitious surrogate (proxy) entities by
fraudsters.
(iv) Teeming and Lading: This is also achieved through cash deposits or cheques
collected from customers being overlapped with the collections from subsequent
customers and the amount collected is diverted to personal account. The ageing of
receivables is not a constant, and, therefore, this makes the task of identifying the
leakage of collections unless all the customer accounts are reconciled at a single point
of time.
(v) Fraudulent Disbursements: Fraudulent disbursements or reimbursements take
place either by issuing or submission of false bills, or personal expense bills being
converted into official expenses bills. The other method that is resorted to by the
perpetrator of fraud is to inflate the refunds due to a customer and skim the excess
refunds.
(vi) Expense Reimbursement Schemes: These fraudulent schemes involve employees
resorting to treating their personal expenses as incurred for business purpose and
claiming reimbursement. In some cases, employees may get reimbursed by third
parties (such as distributors) as well as by claiming these expenses from the company.
Multiple expense claims based on duplicate bills or photostat copies.
(vii) Payroll Fraud: The payroll fraud could include payment to non-existent employees or
in a contractual arrangement inflating of the manpower resources than those actually
deployed while billing the client. It may also include showing higher pay than actual
disbursement to employees/ workers, etc. The process would require a detailed review
of statutory declarations/filings under various labour law statutes including disclosures
in financial statements of retirement benefits such as P.F, Gratuity and
Superannuation benefits from an evidence gathering perspective.
(viii) Commission Schemes: The salesman exaggerates the sales through fictitious
billings to earn higher commission or alter the sales prices of the products sold from
those stipulated by the company or share the sales volumes achieved with other
employees to share higher commission. Commission schemes in mega deals backed
by legal documents are often tools used to camouflage kickbacks. These are often
difficult to uncover and would need to be supplemented by the monetary trails across
entities and geographies.

Procedure for Investigation of Fraud: Before proceeding to investigate frauds of the

type afore-mentioned, the investigating accountant should ascertain the exact duties
of the person concerned who is suspected to have committed a fraud; his relationship
to the general routine of the office, and the circumstances in which any known
instances of defalcation have come to light. Such an enquiry would give a clue to
promising avenues of investigation. Greater the authority of the individual suspected
of a fraud, wider would be the field which would have to be covered by the
investigation. At times, an accountant is called upon to investigate a suspected fraud,
the details or the nature whereof is not known. In such a case, for localising the source
of the fraud, the investigating accountant will have to study the financial and
accounting structure of the organisation. As a first step, he should examine the line of
responsibility between the various members of the staff. He should have a look at the
system of internal control in operation for spotting out the weaknesses, if any, that may
exist in it. Relying on the above study, he should direct his enquiry towards those
aspects of the business where there has been excessive control in the hands of single
persons, without any supervision by any other person or any other inherent weakness
that may be in existence in the system.
Some of the situations in which money may be embezzled and the various forms that such
frauds usually take place alongwith their investigation procedure include the following:
(a) Cash receipts - In cases like holding back cash sales, collections by travelling salesmen,
V.P.P receipts, or casual receipts, e.g., sales of scrap, recoveries out of debts written off
earlier, etc., the amount or amounts of receipts embezzled may be subsequently covered up
by the perpetrator adopting one or other of the under-mentioned devices:
(i) Issuing a receipt to the payee for the full amount collected and entering only a part of
the amount on the counterfoil.
(ii) Showing a larger cash discount than actually allowed.
(iii) Adjusting a fictitious credit in the account of a customer for the value of goods returned
by him.
(iv) Adjusting a cash sale as a credit sale, and raising a debit in the account of the
customer.
(v) Writing off a good debt as bad and irrecoverable to cover up the amount collected
which has been misappropriated.
(vi) Short-debiting the customer’s account in the ledger with an intention to withdraw the
difference when the full amount payable by him is collected.
(vii) Under-casting the receipts side of the Cash Book or over-casting the payment side;
carrying over a shorter total of the receipts from one page of the Cash Book to the
next or over-carrying the total of the payment from one page of the Cash Book to the

next with a view to covering up misappropriation; either short banking of cash

collection or apart of the amount withdrawal from the bank.
Verification of Cash Receipts: On the assumption that some of these may have been
diverted before being entered in the books, evidence as regards income received from
different sources should be scrutinised, e.g., inventory, sales summaries, rental registers,
correspondence with customers, advices of travelling salesmen and counterfoils or receipts.
Carbon copies of receipts marked ‘duplicate’, should be scrutinised to confirm that they are
in fact copies of receipts issued earlier. In addition, by recalling paying-in-slips from the bank
the details of cash deposited on each day should be compared with those shown in the Cash
Book. The record of sales of scrap of waste paper, that of collection of rents from labourers
temporarily accommodated in the company’s quarters, that of refunds of amounts deposited
with the electric supply co., and other Government authorities should be examined for finding
out if any of these amounts have been misappropriated. Cash sales should be vouched in
detail. Recoveries from customers and sundry parties should be checked with the copies of
receipts issued to them; deductions made on account of cash discounts should be reviewed.
All withdrawals from the bank should be checked by reference to corresponding entries in the
bank pass book.
(b) Inflating cash payment -
(i) Making double payment of an invoice or paying a false invoice.
(ii) Paying personal expenses out of the business by falsifying details. e.g., showing
betting losses as advertisement charges.
(iii) Withdrawing unclaimed credit balances of customers or amounts falsely credited in
the accounts of parties.
(iv) Falsely adjusting a refund in the account of a customer and withdrawing the credit
balance.
(v) Wrong totalling of the wage sheets and misappropriating the excess amount withdrawn
from the bank for payment of wages.
Verification of Cash Payments: All the evidence as regards cash payments made, including
acknowledgement by parties for payments shown to have been made to them, should be
carefully scrutinised. In the case where a figure appears to have been erased or altered on
the receipts issued by the party, on reference to the party concerned, the actual amount paid
to him should be confirmed. The same procedure should be adopted in respect of amounts
acknowledged on blank papers. All payments by bearer cheques should be examined. The
system of recording of wages should be reviewed, specially as regards possible over-totalling
of wage sheets, and entries in them of dummy workmen. The system of ordering and receiving
goods should be reviewed so as to confirm that no payment has been made in respect of

supplies which have not been received. Confirmations should be obtained from partners or
Directors in respect of amounts shown to have been paid to them.
The Petty Cash Book should be vouched and totaled. Special attention should be paid to
payments made on account of salaries and wages; confirmation should be obtained from the
management that all payments of such salaries and wages were made to persons who were
actually in the service of the company. All the withdrawals from the bank should be checked
by reference to entries in the bank’s pass book. All the bills receivable or payable should be
checked by reference to the Bills Books.
(c) Frauds through suppliers’ ledger -
(i) Adjusting fictitious or duplicate invoices as purchases in the accounts of suppliers and
subsequently misappropriating the amounts when payments are made to the suppliers
in respect of these invoices.
(ii) Suppressing the Credit Notes issued by suppliers and withdrawing the corresponding
amounts not claimed by them.
(iii) Withdrawing amounts unclaimed by suppliers, for one reason or another by showing
that the same have been paid to them.
(iv) Accepting purchase invoices at prices considerably higher than their market prices
and collecting the excess amount, paid in cash, from the suppliers.
Verification of balances in suppliers’ ledger - The Bought Journal should be vouched by
reference to entries in the Goods Inward Book and the suppliers’ invoices to confirm that
amounts credited to the accounts of suppliers were in respect of goods, which were duly
received and the suppliers’ accounts had been credited correctly. All the suppliers should be
requested to furnish statements of their accounts to see whether or not any balance is
outstanding or due so as to confirm that allowances and rebates given by them have been
correctly adjusted.
(d) Customers’ ledger -
(i) By the ‘teeming and lading’ method, i.e., misappropriating the amount collected from
a customer and crediting his account by the amount paid by him only when an amount
is subsequently collected from another customer; repeating this practice with several
items collected and depositing back the amount or amounts so misappropriated before
the close of the year.
(ii) Misappropriating the amount collected from a customer and subsequently adjusting
his account by crediting the amount on account of allowance or a rebate for excess
price charged.
(iii) Crediting the amount received from a customer to the account of another customer
and subsequently withdrawing the amount wrongly credited.

Verification of balances in customers’ ledger: Special attention should be paid to

allowances adjusted on account of goods returned or difference in price or on any other
account as well as to amounts written off as bad debts. To confirm that the accounts of
customers have been debited in respect of goods supplied to them, entries in the Order Book
should be tested with those in the Sales Day Book where one is kept. The investigating
accountant should obtain confirmation of customers in respect of the amounts standing in
their accounts. Those of them who have no balance in their accounts should be requested to
confirm the statement of their account (which should be sent to them) for ascertaining that
the entries shown therein were genuine.
(e) Inventory frauds-Inventory frauds are many and varied but here we are concerned with
misappropriation of goods and their concealment.
(i) Employees may simply remove goods from the premises.
(ii) Theft of goods may be concealed by writing them off as damaged goods, etc.
(iii) Inventory records may be manipulated by employees who have committed theft so that
book quantities tally with the actual quantities of inventories in hand.
Verification Procedure for Defalcation of inventory - It may be of trading stock, raw
materials, manufacturing stores, tools or of other similar items (readily) capable of conversion
into cash. The loss may be the result of a theft by an employee once or repeatedly over a
long period, when the same have not been detected. Such thefts usually are possible through
collusion among a number of persons. Therefore, for their detection, the entire system of
receipts, storage and despatch of all goods, etc. should be reviewed to localise the weakness
in the system.
The determination of factors which have been responsible for the theft and the establishment
of guilt would be difficult in the absence of: (a) a system of inventory control, and existence
of detailed record of the movement of inventory, or (b) availability of sufficient data from which
such a record can be constructed. The first step in such an investigation is to establish the
different items of inventory defalcated and their quantities by checking physically the
quantities in inventory held and those shown by the Inventory Book.
Afterwards, all the receipts and issues of inventory recorded in the Inventory Book should be
verified by reference to entries in the Goods Inward and Outward Registers and the
documentary evidence as regards purchases and sales. This would reveal the particulars of
inventory not received but paid for as well as that issued but not charged to customers.
Further, entries in respect of returns, both inward and outward, recorded in the financial books
should be checked with corresponding entries in the Inventory Book. Also, the totals of the
Inventory Book should be checked. Finally, the shortages observed on physical verification
of inventory should be reconciled with the discrepancies observed on checking the books in
the manner mentioned above. In the case of an industrial concern, issue of raw materials,

stores and tools to the factory and receipts of manufactured goods in the godown also should
be verified with relative source documents.
Defalcations of inventory, sometimes, also are committed by the management, by diverting a
part of production and the consequent shortages in production being adjusted by inflating the
wastage in production; similar defalcations of inventories and stores are covered up by
inflating quantities issued for production. For detecting such shortages, the investigating
accountant should take assistance of an engineer. For that he will be more conversant with
factors which are responsible for shortage in production and thus will be able to correctly
determine the extent to which the shortage in production has been inflated. In this regard,
guidance can also be taken from past records showing the extent of wastage in production in
the past. Similarly, he would be able to better judge whether the material issued for production
was excessive and, if so to what extent. The per hour capacity of the machine and the time
that it took to complete one cycle of production, also would show whether the issues have
been larger than those required.
6.5.2 Indicators of Fraud

Several indications of possible frauds can be listed as follows :-
i. Discrepancies in Accounting Records including non-recording or partial recording or
incorrect recording or delayed recording of amounts, misclassifications, etc.
ii. Conflicting or missing evidence including missing documents, altered documents,
significant unexplained items in reconciliations, discrepancies between entity’s records
and confirmations received etc.
iii. Unacceptable management responses such as – denial of access to
records/facilities/employees, undue time pressure to resolve complex issues, unusual
delays in providing requested information, denial for use of Computer Assisted Audit
Techniques, unwillingness to address identified deficiencies in internal control etc.
iv. Other indications such as – Accounting Policies in variance with Industry Norms, Frequent
changes in accounting estimates etc.
6.5.3 Responses to Fraud

SA 330 states the auditor’s responses to assessed risks. It requires auditor to assign and supervise
personnel taking into account of the knowledge, skill and ability of the individuals, evaluation of
selection and application of accounting policies by the entity and incorporation of an element of
unpredictability in the selection of the nature, timing and extent of audit procedure.
Response to the risks related to management override of controls includes Testing the
appropriateness of journal entries and other adjustments made in preparation of the Financial
Statements, review of accounting estimates for biases and also review the significant transactions
that are outside the normal course of business for the entity or that otherwise appear to be unusual.

Auditor need to assessed fraud risk factors for material misstatement or misappropriation of assets
due to fraud, such as incentive / pressures, opportunities and attitudes /rationalizations.
The responses to fraud will include communications to management and with those charged with
governance, communication to regulatory and enforcement authorities and appropriate
documentation on his assessment of the risks of material misstatement.
Auditor’s ability to detect fraud depends on factors such as –
- the skillfulness of the perpetrator
- the frequency & extent of manipulation
- the degree of collusion involved
- the relative size of Individual amounts manipulated; and
- the seniority of those individuals involved.
Detection of Fraud depends upon effectiveness of Audit Procedure. Detection risk, however, can
only be reduced, not eliminated.
6.6 Investigation on behalf of an Individual or Firm Proposing to Buy a

Business
Scope of investigation - The objective of such an investigation is to collect such information as
would enable the purchaser to decide whether it is worthwhile to buy the business and if so, for what
amount. The investigation should proceed broadly on the same lines as for valuation of shares.
Additional matters which must receive the attention of the investigating accountant on which, if
appropriate, information to the client should be given.
(A) In case of proprietary concerns or partnerships -
(i) Reasons for the sale of the business and the effect on turnover and profits that there
would be on retirement of the present proprietor (or partners).
(ii) The length of lease under which the premises are held; the prospects of its renewal or
extension.
(iii) The unexpired period of any patents owned by the vendors.
(iv) The age of the present managerial staff and the prospects of continuing in service
under the new proprietorship and the possible liability, not already provided for that
would arise as regards payment of pensions or gratuities in case of old and aged
employees and those retrenched.
(v) If the bulk of sales are made to customers whose number is small, the profitability of
the business would be greatly shaken on withdrawing their support. This would be an
element of weakness which should be investigated as it might affect future profitability.

(vi) The valuation that could be placed on goodwill to determine whether that appearing in
the book is less or more; if none is included to determine the amount that should be
included, if at all.
(B) If the business belongs to a limited company -The vendors’ interest in this case will be
purchased by the acquisition of shares. On that account, the following additional matters
would also require consideration:
(i) The authorised and issued capital of the company.
(ii) Whether there is any uncalled liability on the shares.
(iii) If the capital is divided into different classes of shares - the rights that are attached to
each class.
(iv) Particulars of dividends paid in the past and the amounts thereof which are in arrear
(on cumulative preference shares).
(v) If there are any mortgages created on the assets appearing in the company’s books,
a search should be made in the Register of Charges in the office of the Registrar of
Companies.
(vi) The price at which the shares are being offered. If the company is a public company,
the price will usually be in excess of market price quoted on the Stock Exchange, but
in the case of unquoted shares particularly where the company whose shares are
being acquired is a private company, a valuation will have to be placed on the shares
for the purpose of purchase.
6.7 Investigation in connection with review of Profit/Financial

Forecasts
There are many investigations which involve an examination of future profits. Profit reports can be
required as part of a general investigation into the purchase of a business or by banks and financial
institutions with regard to project cash flow and profitability statements for appraisal of loan
applications submitted by the intending borrowers. All forecasts depend, to a large extent, on the
nature of the business with its numerous and substantial uncertainties. Therefore, such forecasts
are not capable of verification by the reporting accountants in the same way as financial statements
which present the results of a completed accounting period. Normally, such situations involve special
review as these depart from the auditor’s traditional role of expressing an opinion in relation to past
events.

UNIT 3 : FORENSIC AUDIT
1. OVERVIEW
The number of fraudulent activities and ambiguous financial activities have been accelerating all
over the world. Consequently, businesses are
exposed to risks of fraudulent activities. With all
of the recent corporate accounting scandals at
Parmalat, Xerox Corporation, and Satyam
Computer Services, and all the high profile
corporate frauds at Enron, WorldCom, and
HealthSouth followed by Bernie Madoff’s
colossal ponzi scheme, the media has made
Forensic Accounting and Forensic Auditing into
a growth industry. Image : Forensic Audit ∗
Forensic Auditing has established itself as dynamic and strategic tool in combating corruption,
financial crimes and frauds through investigations and resolving allegations of fraud and
embezzlement. Thus, a new area of auditing, known as Forensic Audit, was needed to detect the
frauds in companies that suspected fraudulent transactions.
“Forensic” means “suitable for use in the court of law”. Bologna said that it is the
application of financial skills and investigative mentality to unresolved issues, conducted
within the context of the rules of evidence. As an emerging discipline, it encompasses
financial expertise, fraud knowledge and a sound knowledge and understanding of
business reality and the working of legal system.
However, the definition of Forensic Auditing keeps on changing in response to the growing needs of
corporations. Simply stated, Forensic Auditing includes the use of accounting, auditing and
investigative skills to assist in legal matters.
Important Definitions:
Forensic: The word forensic comes from the Latin word forensis, meaning "of or before the
forum." It is -
Relating to, used in, or appropriate for courts of law or for public discussion or
argumentation.
∗
Source : Shutterstock

Relating to the use of science or technology in the investigation and establishment of

facts or evidence in a court of law.
Forensic Accounting: The integration of accounting, auditing and investigative skills yields the
specialty known as Forensic Accounting. It is the study and interpretation of accounting evidence.
It is the application of accounting methods to the tracking and collection of forensic evidence, usually
for investigation and prosecution of criminal acts such as embezzlement or fraud.
Forensic Accounting can sometimes be referred to as Forensic Auditing.
Forensic Investigation: Also known as forensic audit is the examination of documents and the
interviewing of people to extract evidence. Forensic Accounting examines individual or
company financial records as an investigative measure that attempts to derive evidence
suitable for use in litigation.
Fraud Auditing: In a fraud audit one searches for the point where the numbers and/or financial
statements to do mesh. It is a meticulous review of financial documents conducted when fraud
is suspected. Some entities do them as a precaution to prevent fraud from happening and to
catch it before the loss magnifies. A Fraud Audit however is not an Investigation. Fraud auditing
is used to identify fraudulent transactions, not to figure out how they were created. Fraud
auditors often go outside the books of accounts to find fraudulent transactions.
Red Flag: Red flags are sign or warning of any impending danger or inappropriate behavior.
Red flag do not necessarily indicate the existence of fraud however are indicators that caution
needs to be exercised while investigating the situations. Red flags are classified in categories
such as financial performance red flag, accounting system red flags, operational red flags and
behavioral red flags.
Forensic audit can be conducted in order to prosecute a party for fraud, embezzlement or other
financial claims. In addition, an audit may be conducted to determine negligence in addition, an audit
may be conducted to determine negligence.
2. AUDIT V/S. FORENSIC ACCOUNTING/FORENSIC AUDIT

How is a forensic accounting analysis different from an audit?
The general public believes that a financial auditor would detect a fraud if one were being perpetrated
during the financial auditor's audit. The truth, however, is that the procedures for financial audits are
designed to detect material misstatements, not immaterial frauds. While it is true that many of the
financial statements and frauds could have, perhaps should have, been detected by financial
auditors, the vast majority of frauds could not be detected with the use of financial audits. Reasons
include the dependence of financial auditors on a sample and the auditors' reliance on examining
the audit trail versus examining the events' and activities behind the documents. The latter is simply

resource prohibitive in terms of costs and time.

There are some basic differences today between the procedures of forensic auditors and those of
financial auditors. In comparison, forensic accounting and audit differ in specific ways, as shown
below:
*In response to an event

Forensic *Financial investigation
Accounting *Finding used as evidence in court or to resolve disputes
*Mandatory
*Measures compliance with reporting standards
•Obtain reasonable assurance that financial statements are free of
material misstatement In practice, there are difference in mind set
Audit between forensic accounting and audit:
•"Investigative mentality" vs. "professional scepticism". A forensic
accountant will often require more extensive corroboration.
•A forensic accountant may focus more on seemingly immaterial
transactions.
A forensic accountant will often look for indications of fraud that are not subject to the scope of a
financial statement audit.
Sr. No. Particulars Other Audits Forensic Audit
1. Objectives Express an opinion as to Whether fraud has taken
‘True & Fair’ presentation place in books
2. Techniques Substantive & Compliance. Investigative, substantive or
Sample based in depth checking
3. Period Normally for a particulars No such limitations
accounting period.
4. Verification of stock, Relies on the management Independent/verification of
Estimation certificate/Management suspected/selected items
realisable value of Representation where misappropriation in
assets, provisions, suspected
liability etc.
5. Off balance sheet Used to vouch the arithmetic Regulatory & propriety of
items (like contracts accuracy & compliance with these transactions/contracts
etc.) procedures. are examined.
6. Adverse findings if Negative opinion or qualified Legal determination of fraud
any opinion expressed impact and identification of
with/without quantification perpetrators depending on
scope.

3. FORENSIC AUDITOR
A Forensic Auditor is often retained to analyze, interpret, summarize and present complex financial
and business related issues in a manner which is both understandable and properly supported.
Forensic Accountants are trained to look beyond the numbers and deal with the business reality of
the situation.
A Forensic Auditor must initially consider whether his/her firm has the necessary skills and
experience to accept the work. Forensic audits are highly specialized, and the work requires detailed
knowledge of fraud investigation techniques and the legal framework.
Forensic Auditors can be engaged in public practice or employed by insurance companies, banks,
police forces, government agencies and other organizations.
3.1 A Forensic Auditor is often involved in:
Fraud Providing Expert

Computer Testimony:
Fraud Detection: Forensics: Prevention:
Investigating and Developing Either reviewing internal Assisting in legal

analyzing financial computerized controls to verify their proceedings, including
evidence, detecting applications to assist adequacy or providing testifying in court as an
financial frauds and in the recovery, consultation in the expert witness and
tracing analysis and development and preparing visual aids to
misappropriated presentation of implementation of an support trial evidence.
funds financial evidence; internal control
framework aligned to an
organization's risk profile
In order to properly perform these services a Forensic Auditor must be familiar with legal concepts
and procedures and have expertise in the use of IT tools and techniques that facilitate data recovery
and analysis. In addition, a Forensic Auditor must be able to identify substance over form when
dealing with an issue.

3.2 Who retains Forensic Auditors?

Business
Lawyers Courts and
Community
Police Forces Banks
Insurance Government Regulatory

Companies Bodies and Agencies
3.3 Importance of Forensic Auditors

They can resolve the matters by combining accounting knowledge & experience with respect to:
Fraud Prevention Fraud Detection Risk Management
Filing requirements Court systems Investigative methodologies
Internal Controls Implementation and Review Compliance and Regulatory Functions
Evidence Collection and Analysis Assignments with regulatory agencies like
SEBI, RBI. EOW etc.,
Professional body to provide expertise and literature in this fast growing field
Communicating with audiences from attorneys & judges to victims & suspects
3.4 Services rendered by Forensic Auditors

Crafting questions to be posed
Responding to questions posed
Identifying documents to be requested and/or subpoenaed
Identifying individuals to be most knowledgeable of facts
Conducting research relevant to facts of the case
Identifying and preserving key evidence
Evaluating produced documentation and information for completeness
Analyzing produced records and other information for facts
Identifying alternative means to obtain key facts and information
Providing questions for deposition and cross examination of fact and expert witnesses

The services rendered by the forensic accountants are in great demand in the following areas:
• Matters relating to financial implications the services of the forensic

accountants are availed of. The report of the accountants is
Criminal considered in preparing and presentation as evidence.
Investigation :
• Professional negligence cases are taken up by the forensic accountants. Non-

conformation to Generally Accepted Accounting Standards (GAAS) or non-
Professional compliance to auditing practices or ethical codes of any profession they are needed
Negligence to measure the loss due to such professional negligence or shortage in services.
Cases :
• Forensic accountants render arbitration and mediation services for the business
community. Their expertise in data collection and evidence presentation makes
Arbitration them sought after in this specialized practice area.
service:
• Forensic accountants render such services both when called upon to investigate
Fraud specific cases as well for a review of or for implementation of Internal Controls.
Investigation Another area of significance is Risk Assessment and Risk Mitigation.
and
Risk/Control
Reviews:
• Insurance companies engage forensic accountants to have an accurate

assessment of claims to be settled.
• In case of policyholders seek the help of a forensic accountant when they need to
challenge the claim settlement as worked out by the insurance companies. A
Settlement of forensic accountant handles the claims relating to consequential loss policy,
insurance property loss due to various risks, fidelity insurance and other types of insurance
claims: claims.
• Business firms engage forensic accountants to handle contract disputes,

Dispute construction claims, product liability claims, infringement of patent and trade marks
settlement: cases, liability arising from breach of contracts and so on.

Characteristics- Forensic Auditor Skills - Forensic Auditor should possess

Out of the Box Thinking Auditing standards, procedures and
Strong Visualization and Imagination related methodologies
Curiosity Accounting & Business reporting
systems
Persistence
Information Technology
Detail-oriented
Data Analytics
Inquisitiveness
Criminology
Creativity
Legal Framework
Discretion
Litigation processes & procedures
Skepticism
Investigative Techniques
Confidence and
Evidence gathering
Sound professional judgement.
Network of professional contacts in
related fields' viz. enforcement,
regulatory bodies, law, industry, peers
etc.
A forensic accountant should possess not only the broad knowledge of accounting principles,
practice and standards but also the knowledge of insurance, banking civil and criminal law and
human psychology.
A Forensic Auditor must be open to consider all alternatives, scrutinize the details and at the same
time see the big picture. In addition, a Forensic Auditor must be able to listen effectively and
communicate clearly and concisely in a timely manner.
4. PROCESS OF FORENSIC ACCOUNTING

Each Forensic Accounting assignment is unique. Accordingly, the actual approach adopted and the
procedures performed will be specific to it. However, in general, many Forensic Accounting
assignments will include the steps detailed below.
Court
Reporting Proceedings
• Step 6
Perform • Step 5
Obtain Analysis
Relevant • Step 4
Develop
the Plan Evidence
Initialization
• Step 3
• Step 1 • Step 2

Step 1. Initialization
It is vital to clarify and remove all doubts as to the real motive, purpose and utility of the assignment.
It is helpful to meet the client to obtain an understanding of the important facts, players and issues
at hand. A conflict check should be carried out as soon as the relevant parties are established. It is
often useful to carry out a preliminary investigation prior to the development of a detailed plan of
action. This will allow subsequent planning to be based upon a more complete understanding of the
issues.
Step 2. Develop Plan
This plan will take into account the knowledge gained by meeting with the client and carrying out the
initial investigation and will set out the objectives to be achieved and the methodology to be utilized
to accomplish them.
Step 3. Obtain Relevant Evidence
Depending on the nature of the case, this may involve locating documents, economic information,
assets, a person or company, another expert or proof of the occurrence of an event. In order to
gather detailed evidence, the investigator must understand the specific type of fraud that has been
carried out, and how the fraud has been committed. The evidence should be sufficient to ultimately
prove the identity of the fraudster(s), the mechanics of the fraud scheme, and the amount of financial
loss suffered. It is important that the investigating team is skilled in collecting evidence that can be
used in a court case, and in keeping a clear chain of custody until the evidence is presented in court.
If any evidence is inconclusive or there are gaps in the chain of custody, then the evidence may be
challenged in court, or even become inadmissible. Investigators must be alert to documents being
falsified, damaged or destroyed by the suspect(s).
Step 4. Perform the analysis
The actual analysis performed will be dependent upon the nature of the assignment and may involve:
• calculating economic damages;
• summarizing a large number of transactions;
• performing a tracing of assets;
• performing present value calculations utilizing appropriate discount rates;
• performing a regression or sensitivity analysis;
• utilizing a computerized application such as a spread sheet, data base or computer
model; and
• utilizing charts and graphics to explain the analysis.

Step 5. Reporting
Issuing an audit report is the final step of a fraud audit. Auditors will include information detailing the
fraudulent activity, if any has been found. The client will expect a report containing the findings of
the investigation, including a summary of evidence and a conclusion as to the amount of loss
suffered as a result of the fraud. The report may include sections on the nature of the assignment,
scope of the investigation, approach utilized, limitations of scope and findings and/or opinions. The
report will include schedules and graphics necessary to properly support and explain the findings.
The report will also discuss how the fraudster set up the fraud scheme, and which controls, if any,
were circumvented. It is also likely that the investigative team will recommend improvements to
controls within the organization to prevent any similar frauds occurring in the future.
The forensic auditor should have active listening skills which will enable him to summarize the facts
in the report. It should be kept in mind that the report should be based on the facts assimilated during
the process and not on the opinion of the person writing the report.
Step 6. Court proceedings
The investigation is likely to lead to legal proceedings against the suspect, and members of the
investigative team will probably be involved in any resultant court case. The evidence gathered
during the investigation will need to be presented at court, and team members may be called to court
to describe the evidence they have gathered and to explain how the suspect was identified.
5. FORENSIC AUDIT TECHNIQUES

Detecting fraud is difficult, especially frauds involving material financial statement misstatements,
which occur only in about 2 percent of all financial statements. Fraud is generally concealed and
often occurs through collusion. Normally, the documents supporting omitted transactions are not
kept in company files. False documentation is often created or legitimate documents are altered to
support fictitious transactions. While fraud detection techniques will not identify all fraud, the use of
sound techniques can increase the likelihood that misstatements or defalcations will be discovered
on a timely basis.
Some of the techniques that a forensic auditor may use are listed below:
(I) General Audit Techniques:
• Testing defenses: A good initial forensic audit technique is to attempt to circumvent
these defenses yourself. The weaknesses you find within the organizations control will
most probably guide you down the sea path taken by suspected perpetrators. This
technique requires you to attempt to put yourself in the shoes and think like your
suspect.
(II) Statistical & Mathematical Techniques:
• Trend Analysis: Businesses have cycles and seasons much akin to nature itself. An
expense or event within a business that would be analogous to a snowy day in the
middle of summer is worth investigating. Careful review of your subject organization's
historical norms is necessary in order for you to be able to discern the outlier event
should it arise within your investigation.
• Ratio Analysis: Another useful fraud detection technique is the calculation of data
analysis ratios for key numeric fields. Like financial ratios that give indications of the
financial health of a company, data analysis ratios report on the fraud health by
identifying possible symptoms of fraud.
(III) Technology based /Digital Forensics Techniques: Every transaction leaves a digital footprint
in today's computer-driven society. Close scrutiny of relevant emails, accounting records, phone
logs and target hard drives is a requisite facet of any modern forensic audit. Before taking steps
such as obtaining data from email etc. the forensic auditor should take appropriate legal advice
so that it doesn’t amount to invasion of privacy. Digital investigations can become quite complex
and require support from trained digital investigators. However, many open-source digital
forensics tools are now available to assist you in this phase of the investigation.
Cross Drive Analysis EnCase

Live Analysis MD5
Deleted Files Tracking Log Files
Stochastic Forensics PC System Log
Steganography Free Log Tools

(IV) Computer Assisted Auditing Techniques (CAATs): Changing patterns of businesses,

regulatory framework, scarcity of resources at auditors’ disposal on one side and the ever
increasing mountainous data on other hand is making audit a complex process. Use of
CAATTs is, thus, indispensable to the Auditors and forensic auditors. Computer-assisted
audit techniques (CAATs) or computer-assisted audit tools and techniques (CAATTs) are
computer programs that the auditors use as part of the audit procedures to process data of
audit significance contained in a client’s information systems, without depending on him.
(V) Generalised Audit Software (GAS): Generalized Audit Software (GAS) is a class of CAATs
that allows auditors to undertake data extraction, querying, manipulation, summarization and
analytical tasks. GAS focuses on the fully exploiting the data available in the entity’s
application systems in the pursuit of audit objectives. GAS support auditors by allowing them
to examine the entity’s data easily, flexibly, independently and interactively in data based
auditing.
Using GAS, an auditor can formulate a range of alternative hypotheses for a particular
potential misstatement in the subject matter and then test those hypotheses immediately.
“What if” scenarios can be developed with the results and the auditors can examine the
generated report rapidly. Currently, the latest versions of GAS include the Audit Command
Language (ACL), Interactive Data Extraction and Analysis (IDEA) and Panaudit.
(VI) Common Software Tool (CST): Due to shortcomings of GASs, CSTs have become popular
over a period. Spreadsheets (like MS Excel, Lotus, etc.), RDBMS (like MS Access, etc.) and
Report writers (like Crystal reports, etc.) are few examples of CSTs. Their widespread
acceptability is due to its instant availability and lower costs. While spreadsheets may be
extremely easy to use due to its simplicity and versatility, other CSTs may need some
practice.
Whether one uses GAS or CST, it is imperative that the auditor is aware about the manner
and processes that have led to the data generation, the control environment revolving around
the data and the source from where the data samples are imported into the GAS/CST.
(VII) Data Mining Techniques: It is a set of assisted techniques designed to automatically mine
large volumes of data for new, hidden or unexpected information or patterns.
Data mining techniques are categorized in three ways: Discovery, Predictive modeling and
Deviation and Link analysis. It discovers the usual knowledge or patterns in data, without a
predefined idea or hypothesis about what the pattern may be, i.e. without any prior knowledge
of fraud. It explains various affinities, association, trends and variations in the form of
conditional logic.

(VIII) Laboratory Analysis of Physical and Electronic Evidences:

Computer Forensics Protection/Validation of Evidence
hard disk imaging Federal Rules of Evidence
E-mail analysis Chain of Custody
search for erased files Altered & Fictitious Documents
analyze use & possible misuse physical examination
computer software to analyze fingerprint analysis
data forgeries
ink sampling
document dating
6. FORENSIC AUDIT REPORT

A Report is a statement of collected & considered facts, so drawn up as to give clear and concise
information to persons who are not already in possession of the full facts of the subject matter of the
report.
The Forensic Audit Report is nothing but statements
of observation gathered & considered while proving
conclusive evidence. It is a medium through which
an auditor expresses his opinion under audit. It is
an important part of the audit as it provides the
results of the audit conducted by the auditor.
Points to keep in mind while reporting:
Clear thinking:  To whom the report is directed
 Purpose and aim
 Cool and calm thinking to have logical and coherent
presentation
 Pattern of presentation
Keep the reader uppermost in  Translate technical matters to layman's language
mind
 To visualize the reader's viewpoint
Unbiased approach  To mention the view point of the auditee

Impact of the report  What be the probable reaction to reporting whether

action or decision will follow in quickest possible time
or to be treated as of academic interest only.
 To remember the universal saying - "don't jump to
conclusions"
Facts and figures to be in proper sequences
The main factors to be considered for the various ways of presentations of written reports are:
Extent of
Nature of Purpose Managem Forensic details
Nature of For whom
business for which ent auditor's required
subject or the report
of the the report attitude, approach by auditee
aspect is
organizat- is directives and and
appraised intended
ion prepared and needs calibre manage-
ment.
Sample Table of Contents of a Forensic Audit Report may include the following:
1. EXECUTIVE SUMMARY
1.0 Background
1.1 Origin of the Audit
1.2 Audit Objective
1.3 Proposed Audit Outputs
1.4 Audit Implementation Approach
2. RISK ANALYSIS
2.1 Internal Environment Risk 2.2 External Environment Forces
2.1.1 Financial Management 2.2.1 Influence of Economics and
relevant Market
2.1.2 Customers, Products and Competitors
2.2.2 Political and Legal Scenario
2.1.3 Information technology
2.2.3 Technology in the Sector
2.1.4 Business Process
2.1.5 Human Resource Management

3. AUDIT PROCESS
3.1. Preliminary understanding of scope and incident coverage
(i) Identification of all related data elements
(ii) Preparation of a List of "persons of interest" for interview
(iii) Obtain management approval for scope
3.2. Collect Evidence
3.3. Conduct Interviews
3.4. Analyze findings
3.5. Validate Inferences and conclusions
4. EVIDENCE OF RISK EVENTS
4.1 Conflicts of interest
4.2 Bribery
4.3 Extortion
4.4 Theft
4.5 Fraudulent transactions
4.6 Inventory frauds
4.7 Misuse of assets
4.8 Financial Statement frauds
5. AUDIT RECOMMENDATIONS
5.1 Logical Framework Approach
5.2 Preconditions and Risks
6. GOVERNANCE ON RECOMMENDATION IMPLEMENTATION
6.1 Stakeholders
6.2 Budget Considerations
LIST OF ANNEXURES
Annex 1: Members of the Interviews
Annex 2: Organization Chart of Auditee organization
Annex 3: Financial Performance (YYYY to YYYY)
Annex 4: Audit Recommendation Logical Framework
Annex 5: Analysis of Key Risk Events

TEST YOUR KNOWLEDGE

1. Sri Rajan is above 80 years old and wishes to sell his proprietary business of manufacture of
specialty chemicals. Ceta Ltd. wants to buy the business and appoints you to carry out a due
diligence audit to decide whether it would be worthwhile to acquire the business.
What procedures you would adopt before you could render any advice to Ceta Ltd.?
2. An American Company engaged in the business of manufacturing and distribution of industrial
gases, is interested in acquiring a listed Indian Company having a market share of more than
65% of the industrial gas business in India. It requests you to conduct a “Due Diligence” of
this Indian Company and submit your Report. List out the contents of your Due Diligence
Review Report that you will submit to your USA based Client.
3. A nationalised bank received an application from an export company seeking sanction of a
term loan to expand the existing sea food processing plant. In this connection, the General
Manager, who is in charge of Advances, approaches you to conduct a thorough investigation
of this limited company and submit a confidential report based on which he will decide
whether to sanction this loan or not.
List out the points you will cover in your investigation before submitting your report to the
General Manager.
4. What are the important steps involved while conducting Investigation on behalf of an Incoming
Partner?
5. Mr. Clean who proposes to buy the proprietary business of Mr. Perfect, engages you as
investigating accountant. Specify the areas which you will cover in your investigation.
6. In a Company, it is suspected that there has been embezzlement in cash receipts. As an
investigator, what are the areas that you would verify?
7. J Ltd. is interested in acquiring S Ltd. The valuation of S Ltd. is dependent on future
maintainable sales. As the person entrusted to value S Ltd., what factors would you consider
in assessing the future maintainable turnover?
8. Briefly mentioned the forensic audit techniques name.
9. Forensic audit is unlike other audits. Explain
10. Enumerate the steps to be undertaken in case of forensic audit process.

1. IMIR Inc is a major technology, engineering, manufacturing and financial services
conglomerate, with global operations having its registered office in US. The Company’s

manufacturing footprint extends across eight countries in addition to US. It has several
international offices and a supply chain that extends around the globe.
HIN Private Limited is a medium-sized Fast Moving Electrical Goods (FMEG) company and
is also involved in power distribution equipment manufacturing. This company is based in
India and enjoys a good market share in a wide spectrum of products like Industrial &
Domestic Circuit Protection Devices, Cables & Wires, Fans, Commercial and Industrial
Applications.
IMIR Inc (Acquirer) is currently in talks to acquire HIN Pvt Ltd (Target). The initial price has
been agreed for the acquisition of business based on net worth and profitability of the target
company with an assumption that all contingent liabilities of the target impacting its future
business have been considered. The acquirer appointed a firm to carry out the financial due
diligence review of the target company and advised that the firm should strictly work as per
the scope.
The firm during the course of its review found some showcause notices (which have not
matured into demands) being issued against the target company. The firm also found that
there could be a potential high value labour claim which may arise out of the negotiation
which was ongoing between the target company and the labour union and the labour wage
agreement was already expired.
The firm discussed all these matters with the management of the target company. The target
company confirmed that these matters are under discussion and was confident that these
matters would not result into any liability and hence it did not consider the same in the initial
price. The firm after its discussion with the target reported these matters to the acquirer.
In the given situation, please suggest which one of the following should be correct?
(a) In the given case, the initial price between the target and the acquirer is already set
which includes the impact of contingent liabilities. Hence the above mentioned matters
relating to showcause notice and labour claim should be ignored by the firm.
(b) In the given case, the initial price between the target and the acquirer is already set
which includes the impact of contingent liabilities. However, since these matters have
not been considered by the target company in the initial price, it would be appropriate
to consider the impact of matter related to labour claim as that may result in liability in
future but the matter related to showcause notice should be ignored by the firm.
(c) In the given case, the firm has gone beyond its scope of financial due diligence review.
Financial due diligence review covers review of trading results, assets and liabilities
and accounting policies and practices of the target company. The management of the
target company should talk to acquirer so that the acquirer can ask the firm to limit its
work as per the scope agreed.

(d) In the given case, even though the initial price between the target and the acquirer is
already set but still the firm needs to look at any hidden liabilities which may arise in
the two cases – show cause notices and labour claim. Accordingly, the firm has done
the right thing by reporting these matters to the acquirer.
2. FTA Renewables S.p.A, is based in Europe and has operations in renewable energy. The
company’s operations are spread out in many countries. The company is also looking for
various acquisitions.
VAS Private Limited is a company based in Pune having operations into solar energy. The
company’s management projected that its operations should increase significantly and it
should become one of the largest companies in the sector in the next five years on the basis
of the management plan. However, due to some unforeseen circumstances, the promoters of
the company are looking to sell their business.
FTA Renewables S.p.A (acquirer) is interested in acquisition of VAS Private Ltd (target) and
has started the discussions with the target company for the same.
The due diligence of the target company is in process and the reviewer has come up with
following observations so far:
(i) The target company has certain balances with its related companies which are under
reconciliation for long time.
(ii) The target company had certain demands in respect of taxation matters on which
the court has given a stay.
(iii) The target company has some assets which are carried in its books at more than
their current market value due to capitalization of foreign exchange loss as the same
was permitted in Indian GAAP.
(iv) The target company had two properties which were under litigation.
(v) The target company had given guarantees which were not appearing the financial
statements.
Reviewer needs your advise that which of the above mentioned observations should be
reported by him to the acquirer?
(a) i, ii, iv and v.
(b) ii, iii, iv and v.
(c) i, ii, iii, iv and v.
(d) i, iii, iv and v.

3. ARA & Associates is a partnership firm and has been in existence for the last 15 years. The
firm is engaged in consultancy business related to various areas and has built a good name
for itself over the period.
Some of the clients of the firm are very old who have been continuing since its existence. The
business of the firm has gone through various phases some of them were very bad. But
currently the business is going very well and the firm is looking to expand its operations into
different geographies. For this, the firm’s management decided that some of its senior
partners will move to new offices and new partners would be inducted.
A team of new partners is in discussion with the senior old partners regarding their joining
the firm.
The new partners would be interested to know whether the terms offered to them are
reasonable having regard to the nature of the business, profit records, capital distribution,
personal capacity of the existing partners, socio-economic setting etc. and whether they
would be able to derive continuing benefits in the shape of return of capital to be contributed
and remuneration of services to be offered. In addition, they also want to ascertain whether
the capital to be contributed by them would be safe and applied usefully or not.
For this purpose, an investigation of the business of the firm was set up on behalf of these
new partners.
At the time of scrutiny of the record of profitability of the firm’s business, the investigating
accountant picked up records of last 4-5 years wherein he observed 2 years which were
unusual because the profits during those 2 years were highly erratic and fluctuating. The
investigating accountant, therefore, went into the profits of last 7-8 years to iron out the
fluctuation. He also examined the provisions of the partnership deed particularly the
composition of partners, their capital contribution, drawing rights, retirement benefits and
goodwill. He also asked for details of jobs/ contracts in hand and the range of current clientele
of the firm for his examination. Some of these procedures of the investigating accountant
were not found appropriate by the senior partners of the firm and they advised the
investigating accountant not to go beyond his scope.
Please advise which of the above mentioned procedures of investigating accountant is/are
not appropriate and what improvements/ changes are required in his approach.
(a) The investigating accountant should not have asked for the records of the profits of
last 7-8 years as that would be too much of the information for his review. Also the
details of jobs/ contracts in hand and the range of current clientele of the firm are
confidential and hence does not get covered in his scope.
(b) After finding 2 years which were unusual because the profits during those 2 years were
highly erratic and fluctuating, the investigating accountant should have reported the
matter to the new partners instead of asking for more details related to the profits of

last 7-8 years. Also he is not required to examine the provisions of the partnership
deed as these details would have already been discussed with the new partners and
they would have checked that.
(c) The procedures of the investigating accountant looks completely reasonable
considering his scope of work. Further, no changes are required in his work approach.
(d) At the outset, it can be said that investigation in the given case was not required.
However, even if the new partners decided to carry out the investigation it should have
been limited to mainly inquiry procedures by the investigating accountant. The
investigating accountant could have also reviewed the manner of computation of
goodwill which doesn’t seem to have been performed on the basis of the above
mentioned facts.
Case Study Based MCQs

Karma Ltd got incorporated in 1980’s as a private limited company and started its business into two
segments – retail and construction. The two business activities were completely different but those
were managed very well and the company grew significantly over a period of time. In year 2001, the
company got converted into a public company and in 2008, the company also got listed on Bombay
Stock Exchange.
The turnover of the company was increasing, however, the margins were not increasing as per the
expectations of the management and the management analysed this aspect and realized that the
margins were not so high in case of retail segment.
The company decided to focus more on construction business and include infrastructure in its line
of business. This was also because of the fact that the government policies were favourable towards
this sector. For this the company decided to sell its retail segment in 2015.
The new investor for the retail segment carried out a due-diligence of the business involving various
aspects and the company sold this segment in January 2016.
Since the business of the company was infrastructure and it involved transactions with government
officials also, the management suspected certain suspicious transactions for which it decided to
carry out a forensic audit in the financial year 2016-17. Certain transactions were identified as per
this audit on which the management worked and set up certain new processes and stringent controls
so that the business can function in an efficient manner.
In the financial year ended 31 March 2019, an investigation was set up against the company which
impacted the company significantly in terms of its reputation and business. The company lost some
significant contracts during the process of investigation itself.

In the light of the above mentioned facts, you are required to comment on the following:
1. At the time of due diligence, the reviewer assessed the business feasibility also which
included the assessment whether business would be more beneficial at its current location or
not. The management of Karma Ltd did not understand this perspective. The management
argued that the reviewer should not have this assessment as part of his scope as the company
has been doing this business for many years at that location.
(a) The contention of the management was correct.
(b) Reviewer was correct as due diligence covers assessment of business feasibility as
well.
(c) Reviewer was correct as due diligence covers assessment of business feasibility as
well, however, considering the company was doing this business for decades it should
not have been carried out by the reviewer.
(d) Management was correct, however, the same thing should have been discussed with
the investor as part of the sale contract.
2. The due diligence reviewer was given audited financial statement of the company for his
financial review. However, the reviewer asked for certain documents pertaining to the year
which was already audited by the statutory auditors of the company and the management of
the company declined this request.
(a) The management is correct.
(b) Reviewer can ask for documents even for the period for which audit is completed.
(c) Reviewer can ask for documents for the period for which audit is completed but he
cannot give any assessment on that. That can be given for his documentation purpose
only as per the requirements of the auditing standards.
(d) Reviewer cannot ask for documents for the period for which audit is completed.
However, if the same document is required for further period for which audit is not
completed, then the management should give him that document.
3. The company has various litigations going on including those related to matter of taxation.
The company had taken consultations in respect of those litigations from some renowned
legal/ tax consultants. The reviewer for due diligence reviewed these consultation documents
and also asked for the documents related to these matters. Further he also suggested that
the positions taken by the company in some matters was not correct.
(a) The reviewer needs to have independent assessment of legal/ tax cases and any
outcome needs to be discussed with the management.
(b) The company can provide consultation documents but should not have provide any
other document to the reviewer as those are confidential.

(c) The reviewer can review the consultation document but should ask for further details,
if required.
(d) The company cannot provide documents of any other consultant to the reviewer.
However, the documents related to cases can be shared with the reviewer.
4. During the forensic review, the reviewer observed certain points and the report for the same
was shared with the management.
(a) The management should share these observations with the statutory auditor also if
they have any bearing on the financials.
(b) The management should keep the forensic report very confidential and should report
all these matters to the Reserve Bank of India (RBI).
(c) The management should keep the forensic report very confidential and should report
all these matters to the National Highway Authority of India (NHAI).
(d) The management needs to assess the matters on its own and cannot get forensic audit
in this manner.
5. At the time of investigation, the investigation officer asked for the information of financials for
the last 5-7 years.
The management explained that there was no need for this investigation. Further the
company has gone through the processes of due diligence and forensic audit in the past. Also
the financial statements related to the period prior to investigation are audited and hence
cannot be shared.
(a) Since the company went through audit process related to period prior to investigation,
investigation should not have been set up.
(b) Since the company went through processes of due diligence in the past, investigation
cannot be set up.
(c) Since the company went through processes of forensic audit in the past, investigation
cannot be set up.
(d) The contention of the management is not correct.
1. Refer Financial Due Diligence given in Para 4 of Unit 1.
2. Refer Para 7 of Unit 1.
3. Refer Para 6.4 of Unit 2.
4. Refer Para 6.2 of Unit 2.

6. Refer Para 5.5.1 of Unit 2.

7. In assessing the turnover which the business would be able to maintain in the future,
the following factors should be taken into account:
(i) Trend: Whether in the past, sales have been increasing consistently or they have been
fluctuating. A proper study of this phenomenon should be made.
(ii) Marketability: Is it possible to extend the sales into new markets or that these have
been fully exploited? Product wise estimation should be made.
(iii) Political and economic considerations: Are the policies pursued by the Government
likely to promote the extension of the market for goods to other countries? Whether
the sales in the home market are likely to increase or decrease as a result of various
emerging economic trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the
same field or if products which would sell in competition are placed on the market at
cheaper price? Is the demand for competing products increasing? Is the company’s
share in the total trade constant or has it been fluctuating?

1. (d) 2. (c) 3. (c)
Answers to Case Study Based MCQs

1. (b) 2. (b) 3. (a) 4. (a) 5. (d)

17
PEER REVIEW & QUALITY

REVIEW
LEARNING OUTCOMES
 Understand the meaning, objective and scope of Peer Review and
Quality Review.
 Gain the knowledge of role of Peer Review Board and Quality Review
Board.
 Analyse the applicability and selection of audit firms, etc.
 Recognise the Peer Review Process and Quality Review Process.
 Learn the Reporting and other procedures in both the case.
CHAPTER OVERVIEW
Peer Peer Quality Quality Reporting and
Objective & Scope and Selection of
Applicability Review Review Review Review Other Checklist
Scope Functions Audit Firms
Board Process Board Process Procedures
Peer Review (PR) Quality Review (QR) Others
Overview

UNIT 1: PEER REVIEW
1. INTRODUCTION
The term "peer" means a person of similar standing. The term "review" means conduct of re-
examination or retrospective evaluation of the subject matter. In general, for a professional, the
term "peer review" would mean review of work done by a professional, by another professional of
similar standing.
‘Peer Review’ is defined as, a regulatory mechanism for monitoring the performances of
professionals for maintaining quality of service expected of them for enhancing the reliance placed
by the users of financial statements for economic decision-making.
As per the Statement of Peer Review, “Peer
Review” means an examination and review
of the systems and procedures to determine
whether they have been put in place by the
practice unit for ensuring the quality of
assurance services as envisaged and
implied/mandated by the Technical
Standards, Ethical Standards and
Professional Standards and whether these
were effective or not during the period
under review".
The examination and review of a practice unit would be carried out by a "reviewer", i.e., a
member, selected from a panel of reviewers maintained by the Board. The term "practice unit"
means members in practice, whether practising individually or as a firm of Chartered Accountants.
The word Board mean Peer Review Board.
2. OBJECTIVES OF PEER REVIEW

The main objective of Peer Review is to ensure that in carrying out the assurance service
assignments, the members of the Institute-
Thus, the primary
•(a) comply with Technical, Professional and
Ethical Standards as applicable including objective of peer
other regulatory requirements thereto and review is not to find out
Objectives deficiencies but to
•(b) have in place proper systems including improve the quality of
documentation thereof, to amply demonstrate services rendered by
the quality of the assurance services. members of the
profession.

PEER REVIEW AND QUALITY REVIEW 17.3
The Statement of Peer Review also makes it clear that the peer review, "does not seek to redefine
the scope and authority of the Technical Standards specified by the Council but seeks to enforce
them within the parameters prescribed by the Technical Standards".
The peer review is directed towards maintenance as well as enhancement of quality of assurance
services and to provide guidance to members to improve their performance and adherence to
various statutory and other regulatory requirements. Such an objective of the peer review process
makes it amply clear that the reviewer is not going to sit on the judgement of the practice unit while
rendering assurance services but to evaluate the procedure followed by the practice unit in
rendering such a service.
Accordingly, where a practice unit is not following technical standards, the reviewers are expected
to recommend measures to improve the procedures. To elaborate further, the key objective of peer
review exercise is not to identify isolated cases of engagement failure, but to identify weaknesses
that are pervasive and chronic in nature.
Absence of formal planning of an audit represents a serious deficiency that needs to be
remedied by the practice unit. An instance of the auditor not carrying out physical
verification of furniture and fixture may not attract the same comment. However, certain
items of assets are best verified through the physical verification process and not adopting the
same procedure may rightly be viewed as a systemic failure.
The conclusion, therefore, is that the peer review seeks to identify and address patterns of non-
compliance with quality control standards.
3. SCOPE OF PEER REVIEW

The Statement on Peer Review lays down the scope of review to be conducted as under:
The Peer Review process shall apply to all the assurance services provided by a Practice Unit.
1. Once a Practice Unit is selected for Review, its assurance engagement records pertaining
to the Peer Review Period shall be subjected to Review.
2. The Review shall cover:
(i) Compliance with Technical, Professional and Ethical Standards.
(ii) Quality of reporting.
(iii) Systems and procedures for carrying out assurance services.
(iv) Training programmes for staff (including articled and audit assistants) concerned
with assurance functions, including availability of appropriate infrastructure.

(v) Compliance with directions and / or guidelines issued by the Council to the Members,
including Fees to be charged, Number of audits undertaken, register for Assurance
Engagements conducted during the year and such other related records.
(vi) Compliance with directions and / or guidelines issued by the Council in relating to
article assistants and / or audit assistants, including attendance register, work
diaries, stipend payments, and such other related records.
As it is clear from the above, that the Statement of Peer Review aims to confine the scope of
review to preceding three years since this would establish the consistency or deviations, if any,
in respect of procedures followed by the practice unit. A Practice Unit means members in
practice, whether practicing individually or a firm of Chartered Accountants.
The Statement defines the scope of peer review which revolves around compliance with technical,
ethical and professional standards; quality of reporting; office systems and procedures with regard
to compliance of assurance engagements; and, training programmes for staff including articled
and audit assistants involved in assurance engagements. The entire peer review process is
directed at the assurance services. Assurance Services means assurance engagements services
as specified in the “Framework for Assurance Engagements” issued by the Institute of Chartered
Accountants of India and as may be amended from time to time.
As per the Statement, Technical, Professional and Ethical Standards - means
(i) Accounting Standards issued by ICAI and/or prescribed and notified by the Central
Government of India;
(ii) Standards;
Standards issued by the Institute of Chartered Accountants of India including-

(a) Engagement (d) Standards on Internal Audit.
standards (e) Statements on Quality Control.
(b) Statements (f) Notifications/Directions/Announcements/
(c) Guidance notes Guidelines/Pronouncements/Professional
standards issued from time to time by the
Council or any of its committees.
(iii) Framework for the Preparation and presentation of financial statements, Framework of
Statements and Standard on Auditing, Standard on Assurance Engagements, Standards on
Quality Control and Guidance Notes on related services issued, from time to time, by the
Institute of Chartered Accountants of India and Framework for Assurance Engagements;
(iv) Provisions of the various relevant statutes and / or regulations which are applicable in the
context of the specific engagements being reviewed including instructions, guidelines,

notifications, directions issued by regulatory bodies as covered in the scope of assurance

engagements.
Students may note that assurance services shall not include:
(i) Management Consultancy Engagements;
(ii) Representation before various Authorities;
(iii) Engagements to prepare tax returns or advising clients in taxation matters;
(iv) Engagements for the compilation of financial statements;
(v) Engagements solely to assist the client in preparing, compiling or collating information other
than financial statements;
(vi) Testifying as an expert witness;
(vii) Providing expert opinion on points of principle, such as Accounting Standards or the
applicability of certain laws, on the basis of facts provided by the client; and
(viii) Engagement for Due diligence.
The phrase 'Assurance Services' is used interchangeably with Audit Services, Attestation
Functions, and Audit Functions.
4. APPLICABILITY
Practice Units subject to Review
1. Every Practice Unit, based on their category as determined below will be subject to Peer
Review in accordance with this statement.
Level I: A Practice Unit which has undertaken any of the under-mentioned assurance
services in the period under review:
(i) Central Statutory Audit of Public Sector Banks, Private Sector Banks, Foreign Banks,
Cooperative Banks and Public Financial Institutions;
(ii) Central Statutory Audit of Central or State Public Sector Undertakings and Central
Cooperative Societies based on criteria such as turnover or paid up capital etc. as
may be decided by the Board;
(iii) Central Statutory Audit of Insurance Companies;
(iv) Statutory Audit of asset management companies or mutual funds;
(v) Statutory Audit of enterprises whose equity or debt securities are listed in India or
abroad;
(vi) Statutory Audit of Entities which have raised funds from public or banks or financial

institutions of over Rupees Fifty Crores during the period under Review;
(vii) Statutory Audit of Entities which have raised donations and / or contributions over
Rupees Fifty Crores during the period under Review;
(viii) Statutory Audit of entities having Net Worth of more than Rupees Five Hundred
Crores at any time during the period under Review;
(ix) Statutory Audit of entities which have been funded by Central and / or State
Government(s) schemes of over Rupees Fifty Cores during the period under Review.
Level II: A Practice Unit which has undertaken any of the under-mentioned assurance
services in the period under review:
(i) Statutory/Internal/Concurrent/Systems/Tax audit and/or Departmental Review of
Branches/Offices of
(a) Public Sector or Private Sector and / or Foreign Banks;
(b) Insurance Companies;
(c) Co-operative Banks;
(d) Statutory Audit of Regional Rural Banks;
(e) Statutory Audit of Non – Banking Financial Companies (NBFCs).
(ii) Statutory Audit of entities having Net Worth of over rupees Five Crores or an annual
turnover of more than rupees. Fifty Crores during the period under Review.
Level III: Any other Practice Unit providing assurance services not covered in Level I and
Level II hereinabove.
2. Any Practice Unit not selected for Peer Review, may suo moto apply to the Board for the
conduct of its Peer Review. The Board shall act upon the same within 30 days from the date
of receipt of such request.
3. An Auditee (Client) may request the Board for the conduct of Peer Review of its auditor
(Practice Unit). The Board shall act upon the same within 30 days from the date of receipt of
such request.
Periodicity of Peer Review
The Periodicity of Peer Review will be:
(a) Level - I Practice Units – Once in 3 years.
(b) Level - II Practice Units – Once in 4 years
(c) Level - III Practice Units – Once in 5 Years

However, if the Board so decides or otherwise at the request of the Practice Unit, the Peer Review
for a Practice Unit can be conducted at shorter intervals. Further, CA firm should hold a valid peer
review certificate to be an auditor of listed companies.
5. PEER REVIEW BOARD

The Board shall be constituted by the Council. The Board shall consist of a maximum of twelve
members to be appointed by the Council, of whom not less than 50% shall be from amongst the
members of the Council as defined in Section 9 of the Chartered Accountants Act, 1949, as
amended from time to time.
The Council may nominate members to the Board from outside bodies and from amongst
prominent individuals of high integrity and reputation, including but not limited to, regulatory
authorities, bankers, academicians, economists, legal Professionals and business executives. The
Council shall appoint the Chairman and the Vice-Chairman from amongst its elected Council
members appointed on the Board.
The term of a member shall be for one year, or such other period as may be prescribed by the
Council from time to time. Casual vacancies on the Board shall be filled by the Council. A
Member of the Disciplinary Committee or the Disciplinary Board or the Committee on Ethical
Standards or the Committee on Financial Reporting and Review Board of the Institute of Chartered
Accountants of India shall not be a member of the Board.
5.1 Eligibility to be a Reviewer
1. A Peer Reviewer shall: -
(a) Be a member with at least 10 years of experience in practice.
(b) Is in Practice as per the Chartered Accountants Act, 1949.
(c) Should have undergone the requisite training as prescribed by the Board.
(d) Should furnish a declaration as prescribed by the Board, at the time of
acceptance of Peer Review appointment.
(e) Should have signed the Declaration of Confidentiality as prescribed by the
Board.
(f) Should have conducted audit of Level I Entities for at least 7 years to be eligible
for conducting Peer Review of Level I Entities as referred to in Para II of this
Statement.
2. For being a Reviewer a member should not have: -
(i) Disciplinary action / proceedings pending against him.
(ii) been found guilty by the Council or the Disciplinary Board or Committee at any

time.
(iii) been convicted by a Competent Court whether within or outside India, of an
offence involving moral turpitude and punishable with transportation or
imprisonment.
(iv) any Obligation or conflict of interest in the Practice Unit or its Partners /
Personnel.
3. A Reviewer shall not accept any professional assignment from the Practice Unit
for a period two years from the date of appointment.
5.2 Qualified Assistant

 The reviewer may take the help of a qualified assistant while carrying out peer review. In
this context, the Board decided to clarify that a reviewer is permitted to take the assistance
of only one assistant who shall be a chartered accountant and a person who does not
attract any of the dis-qualifications prescribed under Section 8 or Section 21 of the
Chartered Accountants Act, 1949.
 The name of the qualified assistant which the reviewer would like to assist him shall be
identified and intimated to the Board as well as the practice unit before the commencement
of the peer review.
 Such a qualified assistant shall also have to sign the declaration of confidentiality as
annexed to the Statement.
 He shall have no direct interface either with the practice unit or the Board. Further the
person chosen for assisting the reviewer shall be from the firm of the reviewer and should
have been working with him for at least one year as a member in practice.
5.3 Confidentiality
Strict confidentiality shall be maintained by all those involved in the Peer Review process, namely,
Reviewers, members of the Board, any Qualified Assistants or Practice Unit.
All persons governed by the secrecy provisions:
(a) shall at all times preserve and aid in preserving secrecy with regard to any matter arising in
the performance or in assisting in the performance of any function, directly or indirectly
related to the process and conduct of Peer Reviews;
(b) Reviewer shall not make use of or disclose the contents of Review report or any confidential
information about the process of Review unless as required by the Board or the Council.
Non-compliance with the secrecy provisions in the above clause shall amount to
professional misconduct as defined under Section 22 of the Chartered Accountants Act,
1949.

A Declaration of Confidentiality shall be signed by the persons who are responsible for the conduct
of Peer Review i.e., Reviewers and his Qualified Assistants and be filed with the Board. All
members of the Board shall also sign a declaration of Confidentiality in a manner as may be
prescribed by the Board.
6. APPROACH OF THE REVIEWER

Briefly, the stepwise approach which may be adopted by the reviewer is discussed in the
following paragraphs:
(a) The reviewer should gain an understanding of the engagement letter since an assurance
engagement or for that matter any other kind of engagement should begin with an
engagement letter.
Engagement letter is an important document as it defines the nature and scope of the
assurance engagement, practice unit's responsibilities with regard to the engagement. This
understanding would help him in planning the review of documentation. The reviewer
should focus the review primarily on the key engagement matters. The reviewer should also
consider the materiality of the matter while planning the review.
(b) The number of assurance engagements to be selected requires the exercise of judgement
by the reviewer based on the evaluation of replies given in the questionnaire and the size of
the practice unit. The objective is to obtain a reasonable cross-section of the practice unit's
clients although greater weight may be given to large clients.
(c) The practice unit may have policies and procedures for accepting a particular engagement.
These policies and procedures may not exist in the form of records in each practice unit. In
such a case the reviewer should consider enquiring from the concerned persons about such
policies and procedures. The reviewer should, wherever possible, examine that the policies
and procedures for acceptance of audit have been complied with and necessary
documentation with regard to the same exists.
(d) The reviewer may follow a combination of compliance procedures and substantive
procedures throughout the peer review process. The mix of compliance and substantive
procedures depends upon the professional judgement of the reviewer. The reviewer may
consider the following:
In carrying out the compliance tests, the In performing substantive tests, the
reviewer may evaluate whether the policies reviewer should evaluate whether the
and procedures of the practice unit are practice unit's working papers relating to
sufficient to ensure compliance of technical the client adequately document the
standards and whether these policies and findings and conclusions and whether
procedures are adequately communicated to the report of practice unit is in
all staff who are involved in carrying out the consonance with the findings and
assurance work. conclusions drawn.

(e) Finally, the reviewer while evaluating records may consider the following:
determine that any significant issues, matters, problems that arose during the course of the
engagement have been appropriately considered, resolved and documented;
determine that adequate audit evidence or other relevant evidence in relation to the engagement is
obtained to support the reasonableness of the conclusions drawn; and
determine that significant decisions relating to the engagement, use of professional judgement,
resolution of significant matters have been properly documented.
7. THE PEER REVIEW PROCESS

The Peer Review process will include-.
Selection of
Practice Unit and
Planning, Execution, Reporting.
Appointment of
Reviewer,
Image showing Peer Review Process

7.1. Selection of Practice Unit & Appointment of Reviewer
(i) Notification to the Practice Unit: A Practice Unit which has been selected for a Peer
Review shall be notified by the Board.
(ii) Name of three Reviewers shall be recommended by the Board to the Practice Unit so
selected.
(iii) The Practice Unit shall select one out of the three Reviewers & intimate to the Board within
seven days of receipt of the names.
(iv) The Board shall intimate the Reviewer so selected and seek his consent within seven days.
7.2. Planning
(i) Information to be furnished by Practice Unit: On intimation by the Board, of the
Reviewer’s consent, the Practice Unit shall within 15 days furnish the following information
to the Reviewer:

(a) Duly filled-in Questionnaire sent by the

Board.
(b) Complete list of assurance service clients
indicating the nature of service provided and
the fees charged for the period under Review.
(c) A note on the policies and procedures
adopted by the Practice Unit in relation to
Independence, Staff Supervision and
Development, ‘Second Person’ Review and the
process generally followed in carrying out
assurance services.
(d) Details of any proceedings against the
Practice Unit or any of its partners or qualified
assistants taken by any regulatory, monitoring
or enforcement bodies relating to investigation
or allegation of deficiency in the conduct of
Attest function by them during the period of three years preceding the period of Review or at
any time thereafter i.e. till the date of submission of the duly filled-in Questionnaire.
(ii) Selection of Sample by the Reviewer:
(a) The Reviewer shall within 15 days of receiving the information from the Practice Unit
select a sample of the assurance services that he would like to Review and intimate
the same to the Practice Unit.
(b) The Reviewer may also seek further / additional clarification from the Practice Unit
on the information furnished / not furnished.
(c) The Reviewer shall plan for an on–site Review visit or initial meeting in consultation
with the Practice Unit. The Reviewer shall give the Practice Unit at least fifteen days’
time to keep ready the necessary records of the selected assurance services.
(d) The Reviewer and Practice Unit shall mutually cooperate and ensure that the entire
Review process is completed within 90 days from the date of notifying the Practice
Unit about its selection for Review.
Note: Flowchart of Peer Review Process Planning Step is given at the end of the chapter in
Appendix.
7.3. Execution
(i) On-sight Review: Peer Review visits will be conducted at the Practice Unit's head office or
/and branch(es) or any other locations. This on-site Review should not extend beyond
seven working days.

(ii) Compliance Review-General Controls: The Reviewer is required to carry out a

compliance Review of the following General Controls for evaluating the degree of reliance
to be placed upon them for effective Review:
♦ Independence
♦ Maintenance of Professional Skills and Standards
♦ Outside Consultation
♦ Staff recruitment, Supervision and Development
♦ Office Administration
(iii) Selection of Assurance Service Engagements for Review:
(a) The number of assurance service engagements to be reviewed shall depend upon:
♦ Standard of quality controls generally prevailing;
♦ The size and nature of assurance service engagements undertaken by the
Practice Unit.
♦ The methodology generally adopted by the Practice Unit in providing
assurance services.
♦ The number of partners / members involved in assurance service
engagements in the Practice Unit;
♦ The number of locations / branch offices of the practice Unit;
♦ The Fees charged / received / service tax paid by the Practice unit.
(b) From the initial sample selected at the planning stage, the Reviewer, in consultation
with the Practice Unit, may reduce or enlarge the initial sample size of assurance
service engagements for Review.
(iv) Review of Records: The Reviewer is required to adopt a combination of compliance
approach and substantive approach in the Review process.
(A) Compliance Approach – Assurance Service Engagements: The compliance
approach is to assess whether proper control procedures have been established /
followed by the Practice Unit to ensure that assurance services are being performed
in accordance with Technical, Professional and Ethical Standards.
The following areas shall be considered:
♦ Assurance services records for Administration
♦ Review and Evaluation of System of Internal controls
♦ Substantive Tests

♦ Financial Statements Presentation and

♦ Assurance Services Conclusions
♦ Assurance Services Reporting
(B) Substantive Approach - Assurance Service Engagements: This approach
requires a Review of the assurance working papers in order to establish the extent of
compliance, whether the assurance work has been carried out as per the Technical,
Ethical, and Professional Standards.
(Note: Flowchart of Peer Review Process Execution Step is given at the end of the
chapter in Appendix.)
7.4. Reporting
The Peer Review Report should state that the system of quality control for the assurance services
of the Practice Unit for the period under Review has been designed so as to carry out the
assurance services in a manner that ensures compliance with Technical, Professional and Ethical
standards.
The Peer Review Report shall address his report of compliance or otherwise on
the following areas of controls:
Maintenance of Staff recruitment,

Outside Office
Independence Professional skills Supervision and
Consultation Administration
and standards Development
(i) Discussion/Communication of Findings

(a) After completing the on-site Review, the Reviewer, before making his Report to the
Board, shall communicate his findings in the Preliminary Report to the Practice Unit if
in his opinion, the systems and procedures are deficient or non-compliant with
reference to any matter that has been noticed by him or if there are other matters
where he wants to seek clarification.

(b) The Practice Unit shall within 15 days after the date of receipt of the findings, make
any submissions or representations, in writing to the Reviewer. (i.e. Response to the
Preliminary Report).
(ii) Peer Review Report of Reviewer
(a) At the end of an on-site Review if the Reviewer is satisfied with the reply received
from the Practice Unit, he shall submit a Peer Review Report to the Board along with
his initial findings, response by the Practice Unit and the manner in which the
responses have been dealt with. A copy of the report shall also be forwarded to the
Practice Unit.
(b) In case the Reviewer is of the opinion that the response by the Practice Unit is not
satisfactory, the Reviewer shall accordingly submit a modified Report to the Board
incorporating his reasons for the same. The Reviewer shall also submit initial
findings (i.e. Preliminary Report), response by the Practice Unit (Response to
Preliminary Report) and the manner in which the responses have been dealt with. A
copy of the report shall also be forwarded to the Practice Unit.
(c) In case of a modified report, The Board shall order for a “Follow On” Review after a
period of one year from the date of issue of report as mentioned in (b) above. If the
Board so decides, the period of one year may be reduced but shall not be less than
six months from the date of issue of the report.
Illustrative Qualifications:
The PU does not have any documented policies for its system of quality control in accordance with
SQC 1, Standard on Quality Control. In view of this it was not possible for us to evaluate
compliance with the PU’s quality controls. We did, however make specific inquiries of the
managing partner of the PU with regard to policies implemented with regard to the various
elements given in the Standard. On an overall basis, it was found that policies implemented were
rudimentary and not commensurate with the size of the PU and the nature of its practice. There
were particular deficiencies in establishing and implementing quality control policies and
procedures in the areas of (i) Ethical requirements, and (ii) Acceptance and continuance of client
relationships and specific engagements.
The PU has no practice of documenting the samples selected for tests of details, what audit
procedures were applied to test the samples, or the outcome of such testing, if performed. The
only document that evidences performance of tests of details are query sheets. In several
instances, it was observed that queries were raised but there is nothing to evidence how they were
solved or disposed of.

During review of one of the audit files it was found that the entity’s current liabilities were in excess
of its current assets by several multiples, the entity had made cash losses during the last three
years and its accumulated losses were five times its share capital. In spite of this, there was no
evidence in the audit file of the engagement team’s evaluation of the management’s assessment of
going concern in accordance with SA 570, Going Concern, while the financial statements were
prepared on a going concern basis.
8. INHERENT LIMITATIONS OF REVIEW

The reviewer conducts the review in accordance with the Statement on Peer Review. The review
would not necessarily disclose all weaknesses in compliance of technical standards and
maintenance of quality of assurance services since it would be based on selective tests. As there
are inherent limitations in the effectiveness of any system of quality control which happens to be
subject-matter of review, departure from the system may occur and may not be detected.
9. ILLUSTRATIVE CHECKLIST OF AUDIT PROGRAMME

OF A PRACTICE UNIT
A checklist which illustrates the contents of the audit programme of a reviewee practice
unit for the guidance of the reviewer is given hereunder:
 Appointment letter and the relevant resolution for the appointment.
 Terms of the engagement including reports required and manner of determining audit fees.
 System of book-keeping and the list of the books of accounts maintained by the entity.
 Particulars of the promoters, directors and their powers.
 Names of persons who write the books of accounts and other authorised officers.
 Memorandum and Articles of Association, Partnership Deed as applicable.
 Details of business of client and its accounting systems by reviewing and assessing
information on:
• nature of business of the entity;
• internal control system including owner/manager controls.

 Statement of Profit and Loss account, Balance sheet, Auditors’ and Directors' reports of the
previous year and the reports of internal auditor.
 Analytical review procedures in order to:
• identify areas of accounts which are important because of their size;
• highlight unusual or unexpected figures or relationships in the accounts;

• design audit test which concentrates on important and unusual items;

• obtain sufficient audit assurance to allow the reduction or even elimination of
detailed testing in some areas.
 Assessment of audit risk by using the professional judgement and audit procedures to
ensure that it is reduced to an acceptable low level.
 Preliminary estimates of materiality for the audit as a whole.
 Class of accounting transactions which are relevant and to decide the type of testing and
samples.
 Selection of representative samples.
 Compliance tests to evaluate the reliability of key controls.
 Material weaknesses in the operation of key controls of management.
 Performance of analytical review procedures, substantive tests of detail to obtain sufficient,
relevant and reliable audit evidence for each audit objective.
 Fundamental accounting assumptions, i.e,. consistency, going concern and accrual basis of
accounting are followed by the client in the preparation and presentation of financial statements.
 Disclosure of change in an accounting policy which has a material effect.
 Audit report is received from all the Branch Auditors and any reservation made by the
branch auditor is appropriately dealt with in the finalisation of accounts.
 Working papers contain all audit evidence, and are cross-referenced.
 Summary of work done, problems, important judgements and audit conclusions.
 Review by Senior incharge of work of all assistants, audit programme followed and work
performed as per time schedule.
 Updation of audit working papers including permanent records.
 Review of unadjusted errors to determine whether individual and aggregate effect is
material.
 Compliance with legal and regulatory requirements.
 Compliance with all mandatory Accounting Standards issued by the Institute.
 Post balance sheet events.
 Formulation of draft audit opinion.
 Comparison of budgeted time to actual and reasons for major variations.
 Complete staff evaluation forms.
 Planning of next year's audit.

Appendix: Flow Charts – Peer Review Process

Stage–I: Planning
START
PEER REVIEW BOARD (BOARD) SELECTS THE PRACTICE UNIT (PU) FOR PEER REVIEW OR PU VOLUNTARY
APLLIES FOR UNDERGOING PEER REVIEW
PU WILL BE NOTIFIED BY THE BOARD AND WILL BE SENT A QUESTIONNAIRE FOR COMPLETION ALONGWITH
THE PANEL OF ATLEAST THREE REVIEWERS
PU MAKES SPECIAL
REQUEST TO BOARD
DOES PU REQUIRE A FRESH SPECIFYING REASON FOR
PANEL OR REVIEWER FROM YES THE SAME. BOARD MAY
ANOTHER CITY / REGION PROVIDE FRESH PANEL IF
SATISFIED
NO
PU SELECTS & INFORMS THE NAME OF REVIEWER TO BOARD WITHIN 7 DAYS
A COMPLETED QUESTIONNAIRE ENCLOSING A COMPLETE LIST OF ASSURANCE SERVICES CLIENTS SENT TO

SELECTED REVIEWER WITHIN 15 DAYS
PU TO PROVIDE ANY OTHER INFORMATION WHICH THE REVIEWER MAY SEEK
AN INITIAL SAMPLE IS SELECTED BY THE REVIEWER, REPRESENTATIVE OF PU’s CLIENT PORTFOLIO
PU WILL BE NOTIFIED OF THE SELECTION OF INITIAL SAMPLE TWO WEEKS IN ADVANCE OF

COMMENCEMENT OF REVIEW
STAGE – II EXECUTION BEGINS

Stage– II: Execution
START
INITIAL MEETING BETWEEN PU AND REVIEWER
FIXATION OF DATE OF INITIAL MEETING
COMPLIANCE REVIEW OF GENERAL CONTROLS (FIVE KEY CONTROLS INDEPENDENCE MAINTENANCE

OF PROFESSIONAL SKILLS & STANDARDS OUTSIDE CONSULTATION STAFF SUPERVISION &
DEVELOPMENT AND OFFICE ADMINISTRATION
FINAL SELECTION OF ASSURANCE SERVICES ENGAGEMENTS & CLIENT FILES TO BE REVIEWED ON

RANDOM SELECTION BASIS
REVIEW OF RECORDS
COMPLIANCE WHICH
APPROACH APROACH TO SUBSTANTIVE APPROACH
ADOPT
PROPER CONTROL NO
PROCEDURES DETERMINE NATURE TIMING AND EXTENT OF
EXIST? SUBSTANTIVE PROCEDURES - MORE
EXTENSIVE
YES
CONSIDER EFFECTIVENESS AND EFFICACY OF

CONTROL PROCEDURES
INTEND TO RELY NO
ON CONTROL
PROCEDURES
PERFORM SUBSTANTIVE PROCEDURES MORE
YES EXTENSIVE
PERFORM SUBSTANTIVE PROCEDURES

LESS EXTENSIVE
STAGE III-
REPORTING

Stage– III: Reporting
START
IS REVIEWER YES SUBMIT FINAL

SATISFIED WITH REPORT TO
SYSTEMS AND BOARD
PROCEDURES OF PU
NO
REVIEWER SENDS A PRELIMINARY REPORT TO PU. THE PU SUBMIT ITS REPRESENTATION ON

DEFICIENCIES/ NON – COMPLIANCE, IF ANY, TO REVIEWER WITHIN 15 DAYS OF RECEIPT OF PRELIMINARY
REPORT
SUBMIT FINAL REPORT TO

IS REVIEWER
YES BOARD ALONGWITH
SATISFIED WITH
PRELIMINARY REPORT
REPRESENTATION
AND PU’S SUBMISSIONS
NO
SUBMIT FINAL REPORT TO BOARD INCORPORATING REASONS FOR DIS -

SATISFICATION ALONGWITH PRELIMINARY REPORT AND PU’S
SUBMISSIONS

UNIT 2: QUALITY REVIEW
1. INTRODUCTION
Quality means doing it right when no one is looking. Every audit firm is required to establish a
system of quality control designed to provide it with reasonable assurance that the firm and its
personnel comply with professional standards and regulatory and legal requirements and that
reports issued by the firm or engagement partner(s) are appropriate in the circumstances.
Standard on Quality Control (SQC) 1 requires that every firm’s system of quality control should
include policies and procedures addressing each of the following elements:
(a) Leadership responsibilities for quality within the firm
(b) Ethical requirements
(c) Acceptance and continuance of client relationships and specific engagements
(d) Human resources
(e) Engagement performance
2. OBJECTIVES OF QUALITY REVIEW

Quality review is directed towards evaluation of audit quality and adherence to various statutory
and other regulatory requirements. They are designed to identify and address weaknesses and
deficiencies related to how the audits were performed by the audit firms. To achieve that goal,
quality reviews included reviews of certain aspects of selected statutory audits performed by the
firm and reviews of other matters related to the firm’s quality control system.
In the course of reviewing aspects of selected audits, a review may identify ways in which a
particular audit is deficient, including failures by the firm to identify, or to address appropriately,
aspects in which an entity’s financial statements do not present fairly the financial position or the
results of operations in conformity with the applicable Generally Accepted Accounting Principles
(GAAP) and other technical standards. It is not the purpose of a review, however, to review all
of a firm’s audits or to identify every aspect in which a reviewed audit is deficient.
Accordingly, a review should not be understood to provide any assurance that the firm’s audits, or
its clients’ financial statements or reporting thereon, are free of any deficiencies.

3. SCOPE OF QUALITY REVIEW

The scope of the quality review includes:
(a) Examining whether the Engagement Partner has ensured compliance with the applicable
technical standards in India and other applicable professional and ethical standards and
requirements.
(b) Examining whether the Engagement Partner has ensured compliance with the relevant laws
and regulations.
(c) Examining whether the Audit firm has implemented a system of quality control as envisaged
in line with the Standard on Quality Control (SQC) 1, Quality Control for Firms that Perform
Audits and Reviews of Historical Financial Information, and Other Assurance and Related
Services Engagements.
As per the QRB, the term “Technical Standards” in the context of the Chartered
Accountants (Procedures of Meetings of Quality Review Board, and Terms and Conditions
of Service and Allowances of the Chairperson and Members of the Board) Rules, 2006
includes:
The Accounting Standards notified under section 133 of the Companies Act, 2013;
The Accounting Standards issued by the Institute of Chartered Accountants of India;
The Framework for the Preparation and Presentation of Financial Statements issued by the
Institute of Chartered Accountants of India;
The applicable Quality Control and Engagement Standards issued by the Institute of
Chartered Accountants of India;
The Statements on Auditing issued by the Institute of Chartered Accountants of India;
The Guidance Notes on accounting and auditing matters issued by the Institute of
Chartered Accountants of India;
The Notifications/Directions/Guidelines issued by the Institute of Chartered Accountants of
India including those of a self-regulatory nature.
The Code of Ethics issued by the Institute of Chartered Accountants of India.
Presently, the review undertaken by QRB covers statutory audit services only and does not extend
to internal audit services provided by the members of the Institute. These are proposed to be
covered by the Board at a later stage. Further, this review also does not extend to services
provided by the members of the Institute, in employment.

4. THE QUALITY REVIEW BOARD (QRB)

4.1 Constitution and Composition of Quality Review Board
The Quality Review Board (hereinafter “QRB”/ “the Board”) has been set up by the Central
Government under section 28A of the Chartered Accountants Act, 1949 (hereinafter “the Act”).
The first Quality Review Board was constituted by the Central Government, in exercise of the
powers conferred by section 28A of the Chartered Accountants Act, 1949, vide Notification GSR.
448 (E) dated 28th June, 2007.
In terms of section 28A of the Chartered Accountants Act, 1949, the Board comprises of a
Chairperson and ten other members. Sub-section (2) of section 28A of the aforesaid Act
requires that the Chairperson and members of the Board shall be appointed from amongst the
persons of eminence having experience in the field of law, economics, business, finance or
accountancy.
With a view to provide a fair balance between the interests of the external stakeholders vis a vis
audit Profession in the Board’s functioning, sub-section (3) of section 28A of the Act provides that
five members of the Board shall be nominated by the Central Government and other five members
shall be nominated by the Council of the Institute of Chartered Accountants of India (hereinafter
“ICAI”/“the Institute”).
4.2 Functions of Quality Review Board
A quality review carried by the QRB is directed towards inspection/evaluation of audit quality and
adherence to various statutory and
other regulatory requirements. It
involves inspection and assessment of Review
quality of
the work of the practitioner 1 while services
carrying out their audit function so as provided by
to enable QRB to assess: the members
• the quality of compliance with Make recommendations to
the accounting standards and the Council for quality of
disclosure requirements services provided by the
followed by the entity on which members
the audit report is issued; Guide the members to improve the
• the quality of audit and quality of services and adherence to
the various statutory and other
reporting by the practitioner; regulatory requirements
and the quality control
framework adopted by the practitioner/audit firms in conducting audit.
1
The term “practitioner” used in the Technical Guide has the same meaning as in the ICAI Code of Ethics.

4.3 Powers of Quality Review Board

The Government of India has, in exercise of the powers conferred by clauses (f) and (g) of Sub-
section (2) of Section 29A read with Section 28C and Sub-section (1) of Section 28D of the
Chartered Accountants Act, 1949 (38 of 1949), made ‘Chartered Accountants Procedures of
Meetings of Quality Review Board, and Terms and Conditions of Service and Allowances of the
Chairperson and Members of the Board Rules, 2006’.
To facilitate the discharge of its functions, Rule 6 of aforesaid rules provides:
The Rules also provide that where the Board does not receive the information called for by it from
any member of the Institute, the Board may request the Institute to obtain the information from the
member and furnish the same to the Board. Similarly, if the Board does not receive the
information called for by it from any company registered under the Companies Act,
1956/Companies Act, 2013, the Board may request the Central Government through the Ministry
of Corporate Affairs for assistance in obtaining the information.
5. SELECTION OF AUDIT FIRMS

The quality review has been introduced in stages, with firms selected from different classes or
types of audit firms being subjected to review at each stage. The selection of an audit firm for
review can be either based on the financial statements of the enterprise/s audited by it or certain
other factors identified by the QRB.

(a) Selection of Audit Firm based on the Financial Statements of the Enterprise/s Audited
by the latter: Under this category, in the initial stage, the audited accounts of companies
having wider public interest, such as listed companies, insurance companies, NBFCs,
unlisted public sector undertakings, asset management companies may be selected by
QRB on the basis of one or more of the following:
• suo moto or random selection from particular class of enterprises/audit firms;
• on account of being a part of a sector otherwise identified as being susceptible to
risk on the basis of market intelligence reports;
• regulatory concerns pointing towards stakeholder risks;
• reported fraud or likelihood of fraud;
• serious accounting irregularities reported in media or other reports;
• major non-compliances with provisions relating to disclosures under relevant statutes;
• reference made to it by any regulatory body such as Reserve Bank of India,
Securities and Exchange Board of India, Insurance Regulatory and Development
Authority, Ministry of Corporate Affairs, etc.
The criteria for selection of general purpose financial statements of the Public Sector
Undertakings may be separately determined by the Board.
The Secretariat of QRB places the details of the enterprises selected for review before the
Board for its consideration. The Board may consider whether the case warrants a review by
a Quality Review Group constituted for this purpose and may refer the cases selected for
review to the relevant Quality Review Group. The Board may obtain the Annual Report of
the company concerned.
(b) Criteria based on Audit Firms Auditing the Accounts: Selection of audit firms may also
be made for review of their work on random basis, the volume of work handled by them
represented by the number and nature of clients, their involvement in sectors that may be
identified as facing high risk, as well as on account of their reported involvement in fraud or
likelihood of fraud. Audit firms auditing large as well as mid-cap/small cap companies may
be selected for the purpose.
6. THE QUALITY REVIEW PROCESS

A quality review is an engagement that needs to be carried out in a manner
that ensures that the work performed by the Technical Reviewer appointed for
the review and the review team meet the professional standards established by
ICAI. Any shortcomings in the quality of the quality review would defeat the
very purpose of the process of a quality review established by the Quality

Review Board. It is, therefore, of utmost importance that ensuring quality in a quality review remains a
priority for a technical reviewer.
In so far as the technical reviewer is concerned, the quality of a quality review is directly
affected by factors such as:
• Knowledge and experience of the technical reviewer;
• Time devoted by the technical reviewer;
• Composition of the quality review team;
• Understanding of the objective and scope of work;
• Monitoring, direction and supervision of the quality review team by the technical reviewer.
In fact, maintaining the quality in a quality review as also the final report of the quality review is and
remains the responsibility of the technical reviewer.
6.1 Various Stages involved in the Conduct of the Quality Review
Assignments
The following table describes the various stages involved in the conduct of the quality review
assignments:
Selection of Audit Firm and Technical Reviewer to conduct Quality Review and sending Offer
Letter of Engagement to the Technical Reviewer.
Technical Reviewer to convey his acceptance of Letter of Engagement by sending necessary
declarations for meeting eligibility conditions and furnishing statement of confidentiality by the
Technical Reviewer and his assistant/s, if any.
Intimation to the Audit Firm about the proposed Quality Review and acceptance of the
assignment by the Technical Reviewer. Also marking a copy of the intimation to the Technical
Reviewer.
Technical Reviewer to send the specified Quality Review Program General Questionnaire to
the Audit firm for filling-up and call for additional information from the Audit Firm, if required.
Technical Reviewer to carry out the Quality Review by visiting the office of the Audit Firm by
fixing the date as per mutual consent.
Technical Reviewer to send the preliminary report to Audit firm.
Audit firm to submit representation on the preliminary report to the Technical Reviewer.
Technical Reviewer to submit final report alongwith a copy of Annual report of the
company/entity for the year, to the Board in the specified format, on their (individual)
letterhead, duly signed and dated within 45 days from the date of acceptance of the
assignment.
Technical Reviewer should also send a copy of their final report to the Statutory Auditor/Audit
firm, requesting the firm to send their submissions thereon to the Board within 7 days of receipt

of the final report with a copy to Technical Reviewer. Upon receipt of their final submission,
Technical Reviewer shall submit within next 7 days a summary of their findings, reply of the
audit firm thereon alongwith their final comments in the specified format.
Quality Review Group to consider the report of the Technical Reviewer and responses of the
Audit firm and make recommendations to Quality Review Board.
Quality Review Board to consider the report of the Quality Review Group and decide the final
course of action.
6.2 Objective of Technical Review

The objective of the technical review in conducting the quality review is to obtain sufficient
appropriate evidence to support the conclusion in the quality review report to be issued pursuant to
the Review. As per the Reporting Guidelines issued by the Board, the technical reviewer is
required to examine the procedures and implementation thereof in the Audit firm under
review (AFUR) for ensuring:
(a) compliance with the applicable technical standards in India, other applicable professional
and ethical standards and relevant laws and regulations;
(b) implementation of a system of quality control with reference to the applicable quality control
standards;
(c) consideration of SA 240, “The Auditors’ Responsibilities relating to Fraud in an Audit of
Financial Statements” issued by The Institute of Chartered Accountants of India (ICAI); and
(d) whether there is no material misstatement of assets and liabilities as at the reporting date in
respect of the Company/entity audited by the AFUR.
A quality review of the audit services of the firm in terms of the Procedure for Quality Review of
Audit Services of Audit Firms issued by the QRB (“the Procedures”) involves interviewing, making
enquiries and performing such other procedures to examine whether the Firm has complied with
the applicable technical standards relating to the audit of the financial statements, the professional
and ethical standards as issued by the Institute of Chartered Accountants of India (ICAI) including
whether the Firm has considered SA 240 “The Auditors’ Responsibilities relating to Fraud in an
Audit of Financial Statements” issued by ICAI and considered relevant laws and regulations. It also
includes review of the system of quality control which the Firm has implemented as required by
such technical standards.
In order to effectively discharge the responsibilities, the Technical reviewers are expected to have
the knowledge of inter alia, SQC 1, Standards on Auditing issued by the Institute of Chartered
Accountants of India, the applicable financial reporting framework and the applicable laws and
regulations. The reviewer is also expected to have knowledge about the independence and ethical
requirements.

6.3 Independence and Qualifications of Technical Reviewers

While assigning the quality review work to the respective Technical Reviewers, in order to ensure
independence and avoid conflict of interest, the following eligibility conditions were specified for
carrying out the specified quality review assignment to the Technical Reviewers who were required
to submit a declaration of eligibility before starting the assignment. For being a technical
reviewer:
A member should not have disciplinary A member or his/her firm or any of the network
proceeding under the Chartered Accountants firms or any of the partners of the firm or that
Act, 1949 pending against him/her or any of the network firms should not have been the
disciplinary action under the Chartered statutory auditor of the company, as specified,
Accountants Act, 1949 / penal action under or have rendered any other services to the
any other law taken/pending against you said company/entity during last three financial
during last three financial years and/or years and /or thereafter.
thereafter.
A member to comply with all the eligibility

A member or his/her firm or any of the network
conditions laid down for appointment as an
firms or any of the partners of the firm or that
auditor of a company u/s 141(3) of the
of the network firms should not have had any
Companies Act, 2013 which apply mutatis
association with the specified statutory audit
mutandis in respect of the review of the quality
firm, during the last three financial years and
of statutory audit of the company/entity, as
/or thereafter.
specified, so far as applicable.
6.4 Empanelment of Technical Reviewers

Further to the above, with a view to further augment the number of Technical Reviewers
empanelled with the Board, the Board decided the following criteria for empanelment of Technical
Reviewers with the Board during the financial year 2015-16:
• Reviewer should have minimum fifteen years of post qualification experience as a
chartered accountant and be currently active in the practice of accounting and
auditing.
• Reviewer should have handled as a signing partner/proprietor at least three
statutory audit assignments as a Central Statutory Auditor of Banks/Public Limited
Companies/Government Companies/Private Limited Companies having annual
turnover of rupees fifty crores and above during the last ten financial years;
Provided that out of the aforesaid three statutory audit assignments, at least one
must be in respect of entities other than Private Limited Companies.

• Reviewer should not have any disciplinary proceeding under the Chartered
Accountants Act, 1949 pending against you or any disciplinary action under the
Chartered Accountants Act, 1949 / penal action under any other law taken/pending
against you during last three financial years and/or thereafter.
• Reviewer should not currently be a Member of the QRB or ICAI’s Central
Council/Regional Council/Branch level Management Committee.
6.5 On-site Visit and Qualified Assistant

The technical reviewers for carrying out the quality review assignment, could undertake a
maximum of one on-site visit to the Statutory Audit firm which shall not extend beyond seven days
or, in exceptional circumstances, such other extended period, for specific reasons to be recorded
in writing, with the prior approval of the Chairperson, Quality Review Board, which shall not, in any
case, extend beyond fourteen days. For this purpose, they could also take the assistance of
not more than three assistants who:
(a) shall be chartered accountant;
(b) do not attract any of the disqualifications prescribed under the Chartered Accountants Act,
1949;
(c) shall also have to sign the statement of confidentiality in a prescribed format;
(d) shall have no direct interface either with the audit firm under review or the Board;
(e) should have been working with them for atleast one year as a member/a partner in the CA
firm with them;
(f) should not have been associated with the Statutory auditor/audit firm under review and the
company/ entity selected during last three financial years and/or thereafter.
6.6 Confidentiality
Confidentiality of information pertaining to the quality review assignments is of paramount
importance. Technical Reviewers should ensure that all information, papers, materials, documents
etc. relating to the company/audit firm, as selected and assigned to them, that they will gain during
the course of assignment are kept in strict confidence. They are required to send duly signed
statement of confidentiality including by each one of their assistants in a prescribed format. There
should be no conflict of interest of all those connected with the entire review process. All persons
involved with the entire review process including members of Board/Group, Technical Reviewers,
his/her assistants and QRB secretariat shall maintain confidentiality of information obtained during
reviews and also appropriately disclose to the Board, from time to time, their interests or that of the
partners of their firm or their relatives, if any, in relation to statutory audit firm being reviewed by
Board or entity concerned whose audit was selected for review.

6.7 Stage-wise Approach of Quality Review Process

(i) The Board may constitute one or more Quality Review Groups (hereinafter referred to as
Review Groups) to conduct preliminary reviews of the general purpose financial statements,
with a view to assessing the quality of audit and reporting by the auditors, in consultation
with the Board. There could be two categories of the Review Groups:
(a) Industry Specific (for reviewing general purpose financial statements of enterprises
associated with a particular industry, for example, banking, insurance, electricity,
mutual funds, merchant bankers, etc.
(b) Generic.
(ii) Each of the Review Group would be assisted by Technical Reviewer(s), who may be an
outsourced service provider. The job of the Technical Reviewer(s) would be to prepare a
report on the review of general purpose financial statements, with a view to assessing the
quality of audit and reporting by the auditors, and the review of quality control framework
adopted by the auditors/audit firms in conducting audit.
(iii) The report, so prepared by the Technical Reviewer, may be considered at the meetings of
the Review Group. The Review Group may also consult the Board on any issue, on which
the Group feels that the guidance of the Board is necessary.
The Review Group may complete the review of cases referred to it and submit its report on
the same to the Board within the specified period of time. The Board may, however, extend
this time limit for submission of reports by the Review Group.
(iv) The report of the Review Group shall expressly state the following:
Particulars of the Enterprise;
A detailed description of the non-compliance with the matters stated in

the Terms of Reference, if any;
A detailed description of the evidences that support the non-compliance;

and
Review Group’s recommendations about the actions that are required to be

taken in a particular case.

(v) The Technical Reviewer, after completion of his review, is required to submit a preliminary
report to the audit firm on the review of the quality of audit and reporting by the auditors in
the general purpose financial statements within the specified period of time before
submitting the final report to the Board. The Board may, however, extend the time limit for
submission of preliminary review report.
6.8 Evaluation of Findings
The Technical reviewer or Quality review team may note a non-compliance with one or more
standards on auditing or accounting standards or disclosure requirements as may be applicable to
the engagement. Whenever such a finding is noted, the Technical reviewer/ Quality reviewer’s
team are required to evaluate the finding in the light of the following considerations:
(a) The responses given by the engagement team;
(b) Materiality of the items of the financial statements involved;
(c) Accounting and auditing practices under the legal and regulatory framework applicable to
the industry to which the audit client belongs; and
(d) If the findings are related to non-compliance with the procedures required to be performed
in accordance with the Standards on Auditing, whether the engagement team carried out
alternative procedures to obtain sufficient appropriate audit evidence in relation to the
financial statement assertion under question.
The responses given by the engagement team are also important to determine the extent of non-
compliance. The Technical reviewer must consider the responses provided by the engagement
team. These responses may help the Technical reviewer in understanding the perspective and the
circumstances in which the audit procedures were carried out. As mentioned earlier, the Technical
reviewer should evaluate the findings of quality review and the responses given by the
engagement team based on the facts and circumstances that existed at the time when the AFUR
issued the audit opinion.
7. REPORTING AND OTHER PROCEDURES

The reviewer, after completion of his review, is required to submit a preliminary report to the audit
firm on the review of the quality of audit and reporting by the auditors in the general purpose
financial statements within the specified period of time before submitting the final report to the
Board. The Board may, however, extend the time limit for submission of preliminary review report.
The reviewer, based upon his satisfaction from the representation by the audit firm, may decide to
issue either an interim report or a final report to the Board. The purpose is to establish the
guidelines on the form and contents of the reviewer's report issued pursuant to review of the
quality of audit services of an audit firm.

The reviewer should adhere to the principle requirements mentioned while preparing his report. It
may be noted that the requirements mentioned apply to the interim as well as the final reports of
the reviewer.
Reviewers, based on the conclusions drawn from the review, shall issue a preliminary report and
subsequently the final report. A clean report indicates that the reviewer is of the opinion that the
affairs are being conducted in a manner that ensures the quality of services rendered. However, a
reviewer may qualify the report due to one or more of the following:
♦ non-compliance with technical standards;
♦ non-compliance with relevant laws and regulations;
♦ quality control system design deficiency;
♦ non-compliance with quality control policies and procedures; or
♦ non-existence of adequate training programmes for staff.
Basic Elements of the Reviewer's Report:
The report should contain:
(a) Elements relating to audit quality of companies:
i. A reference to the description of the scope of the review and the period of review of audit
firm conducted alongwith existence of limitation(s), if any, on the review conducted with
reference to the scope as envisaged.
ii. A statement indicating the instances of lack of compliance with technical standards and
other professional and ethical standards.
iii. A statement indicating the instances of lack of compliance with relevant laws and
regulations.
(b) Elements relating to quality control framework adopted by the audit firm in conducting
audit:
i. An indication of whether the firm has implemented a system of quality control with
reference to the quality control standards.
ii. A statement indicating that the system of quality control is the responsibility of the
reviewed firm.
iii. An opinion on whether the reviewed firm's system of quality control has been designed to
meet the requirements of the quality control standards for attestation services and
whether it was complied with during the period reviewed to provide the reviewer with
reasonable assurance of complying with technical standards in all material respects.
iv. Where the reviewer concludes that a modification in the report is necessary, a description

of the reasons for modification. The report of the reviewer should also contain the
suggestions.
v. A reference to the preliminary report.
vi. An attachment which describes the quality review conducted including an overview and
information on planning and performing the review.
The Quality Review Report should be issued on the reviewer's (individual) letterhead and signed
by the reviewer. The report should be addressed to the Board and should be dated as of the date
of the conclusion of the review.
Type of Report to be issued: In deciding on the type of report to be issued, a reviewer should
consider the evidence obtained and should document the overall conclusions with respect to the year
being reviewed in respect of following matters:
(a) whether the policies and procedures that constitute the reviewed firm's system of quality
control for its attestation services have been designed to ensure quality control to provide
the firm with reasonable assurance of complying with technical standards.
(b) whether personnel of the reviewed firm complied with such policies and procedures in order
to provide the firm with reasonable assurance of complying with technical standards.
(c) whether independence of audit firm/ auditors is maintained in conducting audit.
(d) whether the firm has instituted adequate mechanism for training of staff.
(e) whether the audit firm ensures the availability of expertise and/or experienced individuals
for consultation with the consent of the auditee.
(f) whether the skill and competence of assistants are considered before assignment of
attestation engagement.
(g) whether the progress of attestation service is monitored and work performed by each
assistant is reviewed by the service incharge and necessary guidance is provided to
assistants.
(h) whether the audit firm has established procedure to record the audit plan, the nature, timing
and extent of auditing procedures performed and the conclusions drawn from the evidences
obtained.
(i) whether the audit firm maintains the permanent file and the current file as per the standards
laid down by the ICAI.
(j) whether the audit firm verifies compliance with laws and regulations to the extent it has
material effect on financial statement.
(k) whether the internal controls within the audit firm contribute towards maintenance of quality
of reporting.

Illustrative Qualifications – Non –compliance with Standards on Auditing

Independence declaration from audit members received on sign off date of auditors report.
Independence confirmation not received from all members.
No process of maintaining standard checklists, manuals, working papers to ensure
consistency in the quality of each engagement.
No audit evidences for evaluation of estimates made by the management.
No presentations were made to the Audit Committee about the audit plan, audit strategy and
the audit findings.
It was difficult to conclude whether fraud risk factors were considered during the audit of the
Company’s financial statements. Audit process in relation to fraud inquiry procedures were
not performed and hence not documented.
As envisaged by Para 13 of SA 250 that the firm shall obtain sufficient appropriate audit
evidence, however no copy of legal advice was available in auditor’s file with regard to the
legal advice obtained against crystallization of liability on account of demand raised by fiscal
authorities which had been disputed.
There was no documentation to substantiate communication by the auditor with management
in writing, about significant deficiencies in internal control that the auditor has communicated
or intends to communicate to those charged with governance, unless it would be
inappropriate to communicate directly to management in the circumstances.
No hard copies were kept for identification to obtain sufficient and appropriate audit evidence
for all subsequent events up to the date of the auditor’s report that requires adjustments/
disclosures in the financial statements.
No confirmations of balances have been obtained pertaining to parties to Debtors, Creditors,
Advances and related party balances.
Management representation letter had been obtained for the general points covering the
financial statements not on other specific items of the financial statements.
Provisions of AS-10 and AS-16 had not been complied with, however, the auditor in their
audit report under the head Basis for Qualified opinion and in addition to this para 2(d) of
report on other legal and regulatory requirements had stated that qualification constitutes
departure from accounting standards but in the report there was no clear mention of which AS
were not complied with.
Illustrative Qualifications – Non –compliance with Accounting Standards

Significant Accounting Policies did not include disclosures of policies in respect of:
- Recognition of Insurance claims.

- Accounting of Leases.
- Treatment of IPO Expenses.
Inventory of traded goods was not shown separately from that of finished goods.
Method of preparation of cash flow statement had not been disclosed in standalone financial
statements and consolidated financial statements. Company had not disclosed the
components of Cash and Cash Equivalent in the Cash Flow Statement in consonance of the
AS 3.
Accounting policy on revenue recognition did not capture the point of recognition where
significant risks and rewards were transferred.
In respect of derivative contracts, premium paid, gain/losses on settlement and provision for
losses on restatement were recognized along with the underlying transactions and charged to
statement of profit and loss which was not in accordance with AS 11.
Amount provided for diminution in value of investments was not disclosed.
AS 15 detailed disclosures like assumptions, movements in P&L, movements in Balance
sheet had not been provided.
Disclosures relating to previous year figures in regard to related parties were not given.
Basic & Diluted Earnings per share had not been separately disclosed on the face of the
Statement of Profit and Loss as per AS-20, even though both were same.
Measurement of Deferred tax assets and liabilities was on the basis of effective tax rate
instead of the tax rates and tax laws that have been enacted or substantively enacted by the
balance sheet date.
There was no distinction between internally generated intangible assets and other intangible
assets. Non-disclosure & policy was not in line as per AS-26.
AS-29 Disclosure for claim against the Bank had not been disclosed in Schedule of
Contingent Liabilities.
Quality Control Framework (SQC-1): Failure to implement various elements of the system of
quality control was the most common finding. Other findings included failure to set out criteria for
determining the need for safeguards to reduce the familiarity threat to an acceptable level when
using the same senior personnel on an assurance engagement over a long period of time; failure
to establish policies and procedures designed to provide reasonable assurance that the firm and
its personnel comply with relevant ethical requirements; failure to establish policies and
procedures designed to provide with reasonable assurance that firm has sufficient personnel with
the capabilities, competence and commitment to ethical principles necessary to perform its
engagements in accordance with professional standards and regulatory and legal requirements.

Consideration of the Reports of the Review Groups: The Review Group’s Report on the quality
of audit by the auditor of a Public Sector Undertaking (PSU) should be furnished to the Office of
Comptroller and Auditor General of India (C&AG), on case to case basis, and the C&AG’s views, if
any, shall be put-up before the Board along with the Report (on the particular PSU) of the Review
Group. In all other cases, the Review Group’s Report alongwith the decision of the Board on the
quality of audit by the auditor of a PSU should be furnished to the Office of the C&AG for
information.
The reports of the Review Groups on the quality of audits by the auditors of enterprises (other than
those covered above) shall be placed before the Board for its consideration directly.
The Board may, after due consideration of the report and comments of Office of C&AG, wherever
applicable, decide whether the recommendation made by the Review Group should be accepted or
otherwise. The Board may, suo moto, take such further action, as it may deem appropriate. If the
Board decides against the recommendations made by the Review Group in its report, the Board
shall record the reasons for doing so. Actions to be recommended by the Board.
The Board had specified the format for the Final Report, and the Quality Review Program General
Questionnaire containing questions concerning various aspects of an audit firm such as Quality
control, ethical requirements & audit independence; leadership and responsibilities; assurance
practices; client relationships & engagements; human resources, consultation; differences of
opinion; engagement quality control review; engagement documentation; audit planning & risk
assessment; materiality; audit sampling & other selective testing procedures; audit documentation;
audit evidence; written representations; and Auditor’s report.

8. ACTIONS THAT MAY BE RECOMMENDED BY THE

QUALITY REVIEW BOARD
The actions that may be recommended by the Board include one or more of the following:
Referring the case to the Director (Discipline) of the Institute for necessary action under the
Chartered Accountants Act, 1949;
Informing the details of the non-compliance to the regulatory bod(y)/ies relevant to the
enterprise;
Intimating the concerned auditor as to the findings of the Report as well as action initiated under
(a) and/or (b) above;
Consider the matter complete and inform the audit firm/auditor accordingly.
9. QUALITY REVIEW CHECKLIST

In addition to compliance with the statutory provisions and technical standards, the
following checklist should be used for quality reviews:
Question Response
Whether the company has prepared and presented the financial statements in
the format relevant to it?
Are all the accounting policies in accordance with the requirements of the
applicable accounting standards and Guidance Notes, issued by the ICAI?
Whether all significant accounting policies that should have been disclosed are
disclosed?
Whether the auditor has appropriately dealt with in his report the deviations
from accounting standards?
Verify whether the disclosures required by the law/regulations, requirements
prescribed by the regulations and those required by the accounting standards

have been made.

Where the audit report is qualified:
• Whether the qualifications have been made in a clear and unambiguous
manner;
• Whether the qualifications made have been quantified? If not, whether
adequate justification is provided for the same;
• Whether the auditor has considered the overall effect of the qualifications
on the true and fair view presented by the financial statements.
Whether the auditor has complied with the requirements of the Auditing
Standard SA-700, The Auditor’s Report on Financial Statements, and the
Statement on Qualifications in Auditor’s Report, in the preparation of audit
report.
Examine the financial statements with a view to ascertain whether there is any
unusual accounting treatment/accounting entry? If yes, comment on how it has
been dealt with in the financial statements.
Does the auditor/audit firm has a policy to ensure independence, objectivity and
integrity, on the part of partners and staff? Who is responsible for this policy?
Does auditor monitor compliance with policies and procedures relating to
independence?
Does the auditor/audit firm has an established recruitment policy? Does the
auditor conduct programmes for developing expertise in specialised areas and
industries?
Does auditor/audit firm has established procedures for record retention,
including security aspects?
Does the auditor/audit firm evaluate the accounting and internal control systems
of the auditee?
Whether the procedures followed ensure that audit report is in accordance with
the relevant authoritative requirements or technical standards including
accounting standards?

TEST YOUR KNOWLEDGE

1. A, a practicing Chartered Accountant is appointed to conduct the peer review of another
practicing unit. What areas A should review in the assessment of independence of the
practicing unit?
2. What are the areas excluded from the scope of peer reviewer?
3. Write short notes on the following:
(a) Scope of Peer Review.
(b) Technical, ethical and professional standards as per Statement on Peer Review.
4. What are the objectives of the Quality review?
5. What are the reporting responsibilities of the technical reviewer while carrying out a Quality
review assignment?
6. Give examples of areas on which the reviewer may qualify the report?
7. What are the consequences if the Quality review board notices major non-compliances with
the requirements of the Standards on quality control or standards on auditing or accounting
standards?
1. ICAI is responsible for monitoring the quality of the work of it’s members for performing
audits of financial statements?
(a) Yes - for all audits of financial statements
(b) Yes - for all audits except those of listed entities
(c) No, responsibility for quality assurance for all audits rests with another body
(d) Yes - for all audits except those of unlisted entities
2. What types of engagements are not included in the scope of the quality assurance review
program?
(a) Financial statement audit - listed entities (minimum requirement)
(b) Financial statement audit - audit of other than listed entities
(c) Other services (e.g., review, compilation)
(d) Insolvency

Case Study based MCQ

Shivam & Co LLP is a large firm of Chartered Accountants based out of Delhi-NCR. The firm has 6
offices in India – Delhi, Noida, Bangalore, Kolkata, Chennai and Chandigarh. The firm has 35
partners across various offices. The staff size of firm is 250 approximately.
The firm is offering various services to its clients and has accordingly set up separate departments
for those services which are headed by the Partners. The firm has clients as both listed and
unlisted companies to whom services include statutory audit, internal audit, risk advisory, due
diligence, tax support etc. The firm also has a Managing Partner who sits in Chandigarh office. All
in all one can say it’s an all solutions firm as far as services of a CA are concerned.
The firm focuses significantly on its quality and accordingly has set up various controls in place.
The firm ensures that the engagements of each partners are reviewed in terms of quality of work
by other partner of the firm independently every year. For this purpose, firm has set up a process
and one or two engagement file of a partner is selected. Quality assessment also carries weight in
terms of assessment of profit sharing of the partners.
The firm has been subject to peer review which was last conducted 3 years back.
During the financial year ended 31 March 2019, the firm got an intimation for the peer review on 1
July 2018, with which it was not fine considering that it was done only 3 years back and was not
due. The firm discussed this matter with the relevant authorities but that did not work. The process
of peer review got started and completed on 15 September 2018 which included the on-site review
from 1 August 2018 to 16 August 2018.
Since the firm was not fine with its selection and also faced some problems during the peer review
process, it also consulted another firm of his friend, Shubham, Shubham & Associates. One of the
engagements of Shubham & Associates was picked up for quality review by the Quality Review
Board and this firm also faced various challenges during that process in terms of the selection
criteria and also the observations of the reviewer.
Considering the above mentioned facts, you are required to advise on the following matters:
(i) Shivam & Co LLP submitted a list of its assurance and due diligence services in respect of
selection of the engagement for the peer review.
(a) Peer reviewer may select any sample out of assurance and due diligence
engagement.
(b) Peer reviewer may select any sample out of assurance engagement.
(c) Peer reviewer may select any sample out of due diligence engagement.
(d) Peer reviewer may select an engagement on a piecemeal basis covering any service
- assurance or due diligence.

(ii) The concern of Shivam & Co LLP regarding its selection of peer review arose because
it assessed itself as Level III entity which was different from assessment by the Peer
Review Board.
(a) The firm should be Level I based on criteria of Level 1, 2 and 3 given by ICAI
regarding applicability of Accounting Standards.
(b) The firm should be Level II based on criteria of Level 1, 2 and 3 given by ICAI
regarding applicability of Accounting Standards.
(c) The firm should be Level I based on its engagements/services.
(d) The firm should be Level II based on criteria of Level 1, 2 and 3 given by ICAI
regarding applicability of Accounting Standards and its engagements/services.
(iii) Shivam & Co LLP also objected to the time taken by the Peer reviewer on site, however, as
per Peer Reviewer, the entire review process got completed within 90 days from the date
of notifying the firm about its selection for review.
(a) The time for onsite review should not have extended beyond 7 working days.
(b) The time for onsite review should not have extended beyond 10 working days.
(c) The time for complete review should be completed within 120 days.
(d) The time for complete review should be completed within 60 days.
(iv) The peer reviewer did not share any of his observations with Shivam & Co LLP as draft and
final report was submitted to the firm.
(a) Peer reviewer need not share any draft report with the firm if there are no
observations.
(b) Even the final report is not required to be submitted to the firm.
(c) Peer reviewer needs to share draft report with the firm before finalisation.
(d) There are no reports in case of peer review. On completion, a certificate to
that effect is issued.
(v) In case of Shubham & Associates, to improve upon the quality and strengthen the base, the
Board took the current member of the Regional Council of the ICAI as a technical reviewer.
(a) The Reviewer should not currently be a member of the Regional Council.
(b) If the reviewer is a member of the Regional Council then the time allotted for review
should be 60 days.
(c) If the reviewer is a member of the Regional Council then the time allotted for
review would be 30 days.

(d) If the reviewer is a member of the Regional Council then he can not accompany any
staff with him for the purpose of the review.
(vi) In case of Shubham & Associates, the reviewer raised on observation that one of the audit
team member (when the team on the audit engagement was large) signed the
independence confirmation dated 1 August 2016 when the audit report was signed on 1
August 2016. This was objected by Shubham & Associates because the audit team
completed the documentation as required by the auditing standard.
(a) Observation of reviewer was correct.
(b) Observation of reviewer was not correct.
(c) Observation of reviewer was correct but when only one audit member has not
complied then it should have been dropped.
(d) Observation of reviewer was not correct and also the fact that out of a large team, it
involved only one audit member.
1. Review in the Assessment of Independence of the Practicing Unit – The reviewer
should carry out the compliance review of the five general controls, i.e., independence,
maintenance of professional skills and standards, outside consultation, staff supervision
and development and office administration and evaluate the degree of reliance to be placed
upon them. The degree of reliance will, ultimately, affect the attestation service
engagements to be reviewed.
A, a practicing Chartered Accountant should review following controls in respect of
assessment of independence of the practicing unit:
(i) Does the practice unit have a policy to ensure independence, objectivity and
integrity, on the part of partners and staff? Who is responsible for this policy?
(ii) Does the practice unit communicate these policies and the expected standards of
professional behaviour to all staff?
(iii) Does the practice unit monitor compliance with policies and procedures relating to
independence?
(iv) Does the practice unit periodically review the practice unit's association with clients
to ensure objectivity and independence?
2. Refer Para 3 of Peer Review.
3. (a) Refer Para 3 of Peer Review.
(b) Refer Para 3 of Peer Review.
4. Refer Para 2 of Quality Review.

5. The Technical Reviewers expresses an opinion on whether the system of quality control for
the attestation services of the firm under review has been designed so as to carry out
professional attestation services assignments in a manner that ensures compliance with the
applicable Technical standards and maintenance of the quality of attestation service work
they perform. The Technical Reviewer’s review would not necessarily disclose all
weaknesses in the quality of attestation work or all instances of lack of compliance with
applicable Technical Standards. As there are inherent limitations in the effectiveness of any
system of quality control, departure from the system may occur and not be detected. Also,
projection of any evaluation of system of quality control to future periods is subject to the
risk that the system of quality controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies and procedures may
deteriorate. In the process, the Technical Reviewers also identified what they considered to
be deficiencies and any defects in, or criticisms of the firm’s quality control system.
1. (a) 2. (d)
Answer to Case Study based MCQ
(i) (b) (ii) (c) (iii) (a) (iv) (c) (v) (a) (vi) (a)

18
PROFESSIONAL ETHICS
LEARNING OUTCOMES

 Understand the Application of the Code of Ethics theoretically/practically.
 Gain the knowledge of Conceptual Framework applicable on Professional
Accountants in Public Practice and Business.
 Learn the Application of Fundamental Principles of Professional Ethics by
Professional Accountants while conducting Audit, Assurance and other
services.
 Identifying threats and Safeguards measures while Compliance of
Fundamental Principles of Professional Ethics.
 Determine and apply knowledge of Code of Ethics to your professional
practice.

CHAPTER OVERVIEW
CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS
PART A PART B PART C
General Professional
Professional
Application of the Accountants in Public
Accountants in
Code Practice
Business
SECTION SECTION 200-290 SECTION

100-150 300-350
- INTRODUCTION
- APPOINTMENT
- CONFLICT OF INTERESTS - INTRODUCTION
INRODUCTION - POTENTIAL
- SECOND OPINION
AND CONFLICTS
- FEES/ REMUNERATION
FUNDAMENTAL - PREPRATION
- MARKETING
PRINCIPLES AND REPORTING
- GIFTS/HOSPITALITY
- CUSTODY OF CLIENTS - EXPERTISE
ASSETS - FINANCIAL
- OBJECTIVITY INTEREST
- INDEPENDENCE –AE - INDUCEMENTS
- APPLICATION OF
FRAMEWORK TO
SPECIFIC SITUATION
- LONG ASSOCIATION OF
SENIOR PERSONNEL
WITH ASSURANCE
CLIENTS
S C G
DEFINITIONS AND
EFFECTIVE DATES

PROFESSIONAL ETHICS 18.3
1. INRODUCTION
The term “Ethics” means moral principles which govern a person’s behaviour or the conducting of
an activity. It is the branch of knowledge that deals with moral principles, whereas “Professional
Ethics” consist of personal, organizational and corporate standards of behaviour expected for
professionals.
A doctor lies to a patient about the serious condition of his health, thinking that
disclosing the seriousness of health may cause more distress to the patient. This would
be morally wrong as the doctor is hiding imperative information from the patient.
However, here, improvement in health is given moral priority and hence it is justifiable to contravene
other morals.
A lawyer is responsible to his immediate client only. It doesn’t matter whether the client has
committed an offence or not, the lawyer has to defend him before the court of law, whereas a
Chartered Accountant, as an auditor, has the responsibility to highlight and bring to the knowledge
of stakeholders about where the client has flawed. This implies that there can be different moral
codes to different sections of society or professionals.
Chartered Accountants as professionals are engaged in building trust to vast variety of users,
whether shareholders, government, banks, investors, employees or others, which imposes a public
interest responsibility on their profession. Like other professionals, Chartered Accountants also have
some set of code of ethics. This Code of Ethics establishes ethical requirements for
Professional Accountants.
A Chartered Accountant, either in practice or in service, has to
abide by these ethical behaviours. They are expected to follow
the fundamental principles of professional ethics while
performing their jobs. Service users of professionals should be
able to feel secure that there exists a framework of
professional ethics which governs the provision of those
services. Any deviation from the ethical responsibilities brings
the disciplinary mechanism into action against the Chartered Fig: Professional Ethics∗
Accountants.
Code of Ethics– Its Necessity: Ethics are as old as human civilization. It is nothing but the laws or
rules of acceptable behaviour. The whole foundation of any profession, particularly CA profession,
is its credibility. The sole purpose of Code of Ethics is to ensure and uphold this credibility. The main
ingredient of our profession is independence. An auditor needs to be independent while carrying out
his audit. The provisions discussed in the same ensure that the independence of members of the
Institute is not affected.
Our Institute’s Motto – ‘Ya Esha Supteshu Jagrati’ is adopted from Kathopanishad and it denotes
‘eternal vigilance’ – awakening when the world is asleep.

Many of our members perceive Code of Ethics as a burden. They are totally mistaken. On the
contrary Code of Ethics seeks to protect the interests of the profession as a whole. It is a shield that
enables us to command respect.
2. PART A: GENERAL APPLICATION OF THE CODE

2.1 Introduction and Fundamental Principles - Section 100
1. A Professional Accountant’s responsibility is not exclusively to satisfy the needs of an
individual client or employer but also acting in the public interest. A professional accountant
should observe and comply with the ethical requirements of this Code.
2. This Code is in three parts. Part A establishes the fundamental principles of professional
ethics for Professional Accountants and provides a conceptual framework for applying those
principles.
• The conceptual framework provides guidance on fundamental ethical principles.
• Professional accountants are required to apply this conceptual framework to identify
threats to compliance with the fundamental principles, to evaluate their significance
and, if such threats are other than clearly insignificant to apply safeguards to eliminate
them or reduce them to an acceptable level such that compliance with the fundamental
principles is not compromised.
3. Parts B and C illustrates how the conceptual framework is to be applied in specific situations.
It provides examples of safeguards that may be appropriate to address threats to compliance
with the fundamental principles and also provides examples of situations where safeguards
are not available to address the threats and consequently the activity or relationship creating
the threats should be avoided.
• Part B applies to professional accountants in public practice.
• Part C applies to professional accountants in business.
Professional accountants in public practice may also find the guidance in Part C relevant to
their particular circumstances
2.1.1 Fundamental Principles
In order to achieve the objectives of the Accountancy profession, professional accountants have to
observe a number of prerequisites or fundamental principles. The fundamental principles as
discussed in Code of Ethics of ICAI, to be complied, are given below:

Integrity
Objectivity
Professional
Competence and
Due Care
Confidentiality
Professional
Behaviour
(a) Integrity – Section 110

1. The principle of integrity imposes an obligation on all professional accountants to be
straightforward and honest in both Professional and Business relationships.
2. Professional Accountant should not be associated with reports, returns, communications or
other information where they believe that the information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information furnished recklessly; or
(c) Omits or obscures information required to be included where such omission or
obscurity would be misleading.
However, a professional accountant will not be considered to be in breach of matters mentioned
above in paragraph 2 if the professional accountant provides a modified report in respect of such
above mentioned matter.
(b) Objectivity- Section 120
1. The principle of objectivity imposes an obligation on all Professional Accountants not to
compromise their professional or business judgment because of bias, conflict of interest
or the undue influence of others.
2. Relationships that bias or unduly influence the professional judgment of the professional
accountant should be avoided.

(c) Professional Competence and Due Care – Section 130

1. The principle of professional competence and due care imposes the following obligations on
professional accountants:
(a) To maintain professional knowledge and skill at the level required to ensure that clients
or employers receive competent professional service; and
(b) To act diligently in accordance with applicable technical and professional standards.
2. Competent professional service requires the exercise of sound judgment in applying
professional knowledge and skill in the performance of such service. Professional
competence may be divided into two separate phases:
(a) Attainment of professional competence; and
(b) Maintenance of professional competence.
3. The maintenance of professional competence requires a continuing awareness and an
understanding of relevant technical professional and business developments. Which to
perform competently within the professional environments.
4. Diligence encompasses the responsibility to act in accordance with the requirements of an
assignment, carefully, thoroughly and on a timely basis.
5. Professional accountant should take steps to ensure that those working under the
professional accountant’s authority in a professional capacity have appropriate training and
supervision.
Where appropriate should make clients, employers or other users of the professional services
aware of limitations inherent in the services to avoid the misinterpretation of an Expression of
Opinion
(d) Confidentiality- Section 140
1. The principle of confidentiality imposes an obligation on professional accountants to refrain
from:
(a) Disclosing outside the firm or employing organization confidential information
without proper and specific authority or unless there is a legal or professional right or
duty to disclose; and
(b) Using confidential information acquired as a result of professional and business
relationships to their personal advantage or the advantage of third parties.
2. Maintain confidentiality even in a social environment. The Professional Accountant should be
alert to the possibility of inadvertent disclosure, particularly in circumstances involving long
association with a business associate or a close or immediate family member.
3. Maintain confidentiality of information disclosed by a prospective client or employer.

4. Consider the need to maintain confidentiality of information within the firm or employing
organization.
5. Take all reasonable steps to ensure that staff under the professional accountant’s control
and persons from whom advice and assistance is obtained.
6. Comply with the principle of confidentiality continues even after the end of relationships
between a professional accountant and a client or employer.
7. The following are circumstances where professional accountants are or may be required to
disclose confidential information or when such disclosure may be appropriate:
(a) Disclosure is permitted by law and is authorized by the client or the employer;
(b) Disclosure is required by law,
Production of documents or other provision of evidence in the course of legal
proceedings.
Disclosure to the appropriate public authorities of infringements of the law
that come to light.
(c) There is a professional duty or right to disclose, when not prohibited by law:
(i) To comply with the quality review;
(ii) To respond to an inquiry or investigation;
(iii) To protect the professional interests of a professional accountant in legal
proceedings; or
(iv) To comply with technical standards and ethics requirements.
8. In deciding whether to disclose confidential information, professional accountants
should consider the following points:
(a) Whether the interests of all parties, including third parties whose interests may be
affected, could be harmed if the client or employer consents to the disclosure of
information by the professional accountant;
(b) Whether all the relevant information is known and substantiated, to the extent it is
practicable; and
(c) The type of communication that is expected and to whom it is addressed; in particular
that the parties to whom the communication is addressed are appropriate
recipients.

(e) Professional Behaviour- Section 150

1. Imposes an obligation on professional accountants to comply with relevant laws and
regulations and avoid any action that may bring discredit to the profession.
2. In marketing and promoting themselves and their work, professional accountants should not
bring the profession into disrepute. Professional accountants should be honest and truthful
and should not:
(a) Make exaggerated claims for the services they are able to offer, the qualifications they
possess, or experience they have gained; or
(b) Make disparaging references or unsubstantiated comparisons to the work of others.
2.2 Part B: Professional Accountants In Public Practice
2.2.1 Introduction – Section 200
This Part of the Code illustrates how the conceptual framework contained in Part A is to be
applied by professional accountants in public practice. The examples in the following sections are
not intended nor interpreted as an exhaustive list of all circumstances experienced by a professional
accountant in public practice that may create threats to compliance with the fundamental principles.
A professional Accountant in public practice should not engage in any business, occupation or
activity that impairs integrity, objectivity or the good reputation of the profession and as a result
would be incompatible with the rendering of professional services.
2.2.2 Threats and Safeguards
A. Threats: Compliance with the fundamental principles may potentially be threatened by range of
circumstances. Many threats fall into the following categories:
Self-Interest Self-Review Advocacy
Familiarity Intimidation
The nature and significance of the threats may differ depending on whether they arise in relation to
the provision of services to a financial statement audit client, a non-financial statement audit
assurance client or a non-assurance client.

Circumstances that may create self-interest threats

A financial interest in a client or jointly holding a financial interest with a client.
Undue dependence on total fees from a client.
Having a close business relationship with a client.
Concern about the possibility of losing a client.
Potential employment with a client.
Contingent fees relating to an assurance engagement.
A loan to or from an assurance client or any of its directors or officers
Examples of circumstances that may create self-review threats
1. The discovery of a significant error during a re-evaluation of the work of the professional
accountant in public practice.
2. Reporting on the operation of financial systems after being involved in their design or
implementation.
3. Having prepared the original data used to generate records that are the subject matter of
the engagement.
4. A member of the assurance team being, or having recently been, a director or officer of
that client.
5. A member of the assurance team being, or having recently been, employed by the client in a
position to exert direct and significant influence over the subject matter of the engagement.
6. Performing a service for a client that directly affects the subject matter of the assurance
engagement.
Examples of circumstances that may create advocacy threats:
Acting as an advocate on behalf of an

Promoting shares in a listed entity when that
assurance client in litigation or
entity is a financial statement audit client.
disputes with third parties.
Examples of circumstances that may create familiarity threats

1. A member of the engagement team having a close or immediate family relationship with
a director or officer of the client.

2. A member of the engagement team having a close or immediate family relationship with an
employee of the client who is in a position to exert direct and significant influence over the
subject matter of the engagement.
3. A former partner of the firm being a director or officer of the client or an employee in a position
to exert direct and significant influence over the subject matter of the engagement.
4. Accepting gifts or preferential treatment from a client, unless the value is clearly
insignificant.
5. Long association of senior personnel with the assurance client.
Examples of circumstances that may create intimidation threats
1. Being threatened with dismissal or replacement in relation to a client

engagement.
2. Being threatened with litigation.
3. Being pressured to reduce inappropriately the extent of work performed in order to

reduce fees.
Specific circumstances give rise to unique threats to compliance with one or more of the fundamental
principles. Such unique threats obviously cannot be categorized. In either professional or business
relationships, a professional accountant in public practice should always be on the alert for such
circumstances and threats.
B. Safeguards that may eliminate or reduce threats to an acceptable level fall into two broad
categories:
(a) Safeguards created by the profession, legislation or regulation; and
(b) Safeguards in the work environment
• Work environment safeguards comprise firm-wide safeguards and engagement
specific safeguards. A professional accountant in public practice should exercise
judgment to determine how to best deal with an identified threat.
• Firm-wide safeguards in the work environment may include:
1. Leadership of the firm that stresses the importance of compliance with the
fundamental principles.
2. Leadership of the firm that establishes the expectation that members of an
assurance team will act in the public interest.
3. Policies and procedures to implement and monitor quality control of
engagements.

4. Documented policies regarding the identification of threats to compliance with

the fundamental principles, the evaluation of the significance of these threats
and the identification and the application of safeguards to eliminate or reduce
the threats, other than those that are clearly insignificant, to an acceptable level
5. For firms that perform assurance engagements, documented independence
policies regarding the identification of threats to independence, the evaluation
of the significance of these threats and the evaluation and application of
safeguards to eliminate or reduce the threats, other than those that are clearly
insignificant, to an acceptable level.
6. Documented internal policies and procedures requiring compliance with the
fundamental principles.
7. Policies and procedures that will enable the identification of interests or
relationships between the firm or members of engagement teams and clients.
8. Policies and procedures to monitor and, if necessary, manage the reliance on
revenue received from a single client.
9. Using different partners and engagement teams with separate reporting lines
for the provision of non-assurance services to an assurance client.
10. Policies and procedures to prohibit individuals who are not members of an
engagement team from inappropriately influencing the outcome of the
engagement.
11. Timely communication of a firm’s policies and procedures, including any
changes to them, to all partners and professional staff, and appropriate training
and education on such policies and procedures.
12. Designating a member of senior management to be responsible for overseeing
the adequate functioning of the firm’s quality control system.
13. Advising partners and professional staff of those assurance clients and related
entities from which they must be independent.
14. A disciplinary mechanism to promote compliance with policies and procedures.
15. Published policies and procedures to encourage and empower staff to
communicate to senior levels within the firm any issue relating to compliance
with the fundamental principles that concerns them.
• Engagement-specific safeguards in the work environment may include:
1. Involving an additional professional accountant to review the work done or
otherwise advise as necessary

2. Consulting an independent third party, such as a committee of independent

directors, a professional regulatory body or another professional accountant.
3. Discussing ethical issues with those charged with governance of the client.
4. Disclosing to those charged with governance of the client the nature of services
provided and extent of fees charged.
5. Involving another firm to perform or re-perform part of the engagement.
6. Rotating senior assurance team personnel.
2.3 PART C: PROFESSIONAL ACCOUNTANTS IN BUSINESS
Introduction – Section 300
1. This Part of the Code illustrates the application of conceptual framework contained in Part A
to Professional Accountants in Business.
2. The examples presented in the following sections are intended to illustrate how the
conceptual framework is to be applied and are not intended to be, nor should they be
interpreted as, an exhaustive list of all circumstances experienced by a professional
accountant in business that may create threats to compliance with the principles.
Consequently, it is not sufficient for a professional accountant in business merely to comply
with the examples; rather, the framework should be applied to the particular circumstances
faced
3. MEMBERSHIP OF THE INSTITUTE

On acceptance of application by the Council, the applicant's name shall be entered in the Register
and a certificate of membership in the appropriate Form shall be issued to the applicant.
Particulars of the Register: Section 19 of the Act provides the particulars to be included in the
Register about every member of the Institute, namely-
his full name, date of birth, domicile, residential and professional address;
date of entry of name in the Register; his qualifications;
whether he holds a COP; and any other prescribed particulars.
3.1 Disabilities for the Purpose of Membership

Section 8 of the Chartered Accountants Act, 1949 enumerates the circumstances under which a
person is debarred from having his name entered in or borne on the Register of Members, as follows:
(i) If he has not attained the age of 21 years at the time of his application for the entry of his
name in the Register; or

(ii) If he is of unsound mind and stands so adjudged by a competent court; or

(iii) If he is an undischarged insolvent; or
(iv) If he, being a discharged insolvent, has not obtained from the court a certificate stating that
his insolvency was caused by misfortune without any misconduct on his part; or
(v) If he has been convicted by a competent Court whether within or without India, of an offence
involving moral turpitude and punishable with transportation or imprisonment or of an offence,
not of a technical nature, committed by him in his professional capacity unless in respect of
the offence committed he has either been granted a pardon or, on an application made by
him in this behalf, the Central Government has, by an order in writing, removed the disability;
or
(vi) If he has been removed from membership of the Institute on being found on inquiry to have
been guilty of professional or other misconduct;
It may be noted that a person who has been removed from membership for a specified period, shall
not be entitled to have his name entered in the Register until the expiry of such period.
In addition, failure on the part of a person to disclose the fact that he suffers from any one of the
disabilities aforementioned would constitute professional misconduct. The name of the person, who
is found to have been subject at any time to any of the disabilities aforementioned, can be removed
from the Register of Members by the Council.
3.2 Types of Members of the Institute
Section 5 of the Chartered Accountants Act, 1949 provides the division of members of the Institute.
The members shall be divided into two classes designated as Associates and Fellows.
Associate Member: Any person, whose
Classes of Members name has been entered in the Register, shall
of the Institute be deemed to have become an Associate of
the Institute and shall also be entitled to use
the letters A.C.A. after his name to indicate
that he is an Associate Member of the
Associates Fellows Institute.
Fellow Member: The name of following
types of members shall be entered into the
Register as a Fellow of the Institute, on payment of such fees along with the application made and
granted in the prescribed manner-
(i) An associate member who has been in continuous practice in India for at least 5 years,
(ii) A member who has been an associate for a continuous period of not less than 5 years and
who possess such qualifications as may be prescribed by the Council with a view to ensuring

that he has experience equivalent to the experience normally acquired as a result of

continuous practice for a period of 5 years as a Chartered Accountant.
The abovementioned members shall be entitled to use the letters F.C.A. after his name to indicate
that he is a Fellow Member of the Institute.
3.3 Removal of Name from the Register
As per section 20 of the Act, the Council may remove, from the Register, the name of any member
of the Institute in the following cases-
(i) who is dead; or
(ii) from whom a request has been received to that effect; or
(iii) who has not paid any prescribed fee required to be paid by him; or
(iv) who is found to have been subject at the time when his name was entered in the Register, or
who at any time thereafter has become subject, to any of the disabilities mentioned in Section
8, or who for any other reason has ceased to be entitled to have his name borne on the
Register.
The Council shall remove the name of any member from the Register in respect of whom an order
has been passed under this Act removing him from membership of the Institute.
If the name of any member has been removed from the Register for non-payment of prescribed fee
as required to be paid by him, then, on receipt of an application, his name may be entered again in
the Register on payment of the arrears of annual fee and entrance fee along with such additional
fee, as may be determined by the Council.
3.4 Restoration of Membership

In addition to the provisions of the section 20 of the Chartered Accountants Act, 1949 (as discussed
in above Para), Regulation 19 of the Chartered Accountants Regulations, 1988, as well states that
the name of the member may be restored by the Council in the Register on an application, in the
appropriate Form, received in this behalf whose name has been removed from the Register for non-
payment of prescribed fee as required to be paid by him, if he is otherwise eligible to such
membership, on his paying the arrears of annual membership fee, entrance fee and additional fee
determined by the Council under the Act.
However, the effective date in case of restoration of cancelled membership, in different situations,
shall be in the following manner:

Application for restoration and requisite • Restoration shall be with effect from
fees are made within the same year of the date on which it was removed from
removal the Register.
Removal of name under the orders of the

Board of Discipline or the Disciplinary • Restoration shall be in accordance with
Committee or the Appellate Authority or such orders.
the High Court
• Restoration shall be with effect from the

In other cases date on which the application and fee
are received.
3.5 Penalty for Falsely Claiming to be a Member etc.

Section 24 of the Chartered Accountants Act, 1949 provides that any person who-
(i) not being a member of the Institute;
(a) represents that he is a member of the Institute; or
(b) uses the designation Chartered Accountant;
(ii) being a member of the Institute, but not having a certificate of practice, represents that he is
in practice or practices as a Chartered Accountant,
shall be punishable on first conviction with fine which may extend to ` 1000, and on any subsequent
conviction with imprisonment which may extend to 6 months or with fine which may extend to
` 5,000, or with both.
The provision may be understood with a case, where, the Court of Additional Chief Judicial
Magistrate had by its judgement found the accused guilty under Section 24(i)(a) & (b) of the
Chartered Accountants Act, 1949 and Section 465 of the Indian Penal Code. The Court imposed a
fine on the accused and in the event of his failure to pay the fine, sentenced to rigorous imprisonment
for three months. (Case of Prem Batra decided on 18.7.1989)
4. CHARTERED ACCOUNTANTS IN PRACTICE

A practicing Chartered Accountant is a person who is a member of the Institute and is holding
Certificate of Practice; and includes such members of the Institute who are deemed to be in Practice
in accordance with the provisions of the Chartered Accountants Act, 1949.

4.1 Significance of the Certificate of Practice

A member who is not in practice is precluded from accepting engagement to render services of any
of the types normally prescribed for a Chartered Accountant, even though for doing so, he does not
require special qualifications. The Council of the institute is of view that-
(i) Once the person concerned becomes a member of the Institute, he is bound by the provisions
of the Chartered Accountants Act and its Regulations. If and when he appears before the
Income-tax Tribunal as an Income-tax representative after having become a member of the
Institute, he could so appear only in his capacity as a Chartered Accountant and a member
of the Institute. Having, as it were, brought himself within the jurisdiction of the Chartered
Accountants Act and its Regulations, he could not set them at naught by contending that even
though he continues to be a member of the Institute and has been punished by suspension
from practice as a member, he would be entitled, in substance, to practice in some other
capacity.
(ii) A member of the Institute can have no other capacity in which he can take up such practice,
separable from his capacity to practice as a member of the Institute.”
Therefore, in nutshell, a Chartered Accountant whose name has been removed from the membership
for professional and/or other misconduct, during such period of removal, will not appear before the
various tax authorities or other bodies before whom he could have appeared in his capacity as a
member of this Institute.
Case Study
A Chartered Accountant in practice has been suspended from practice for a period of
6 months and he had surrendered his Certificate of Practice for the said period. During the said
period of suspension, though the member did not undertake any audit assignments, he undertook
representation assignments for income tax whereby he would appear before the tax authorities in
his capacity as a Chartered Accountant.
Solution
Undertaking Tax Representation Work: A chartered accountant not holding certificate of
practice cannot take up any other work because it would amount to violation of the relevant
provisions of the Chartered Accountants Act, 1949.
In case a member is suspended and is not holding Certificate of Practice, he cannot in any other
capacity take up any practice separable from his capacity to practices as a member of the Institute.
This is because once a person becomes a member of the Institute; he is bound by the provisions
of the Chartered Accountants Act, 1949 and its Regulations.
If he appears before the income tax authorities, he is only doing so in his capacity as a chartered
accountant and a member of the Institute. Having bound himself by the said Act and its
Regulations made there under, he cannot then set the Regulations at naught by contending that
even though he continues to be a member and has been punished by suspension, he would be

entitled to practice in some other capacity.

Conclusion: Thus, in the instant case, a chartered accountant would not be allowed to represent
before the income tax authorities for the period he remains suspended. Accordingly, in the present
case he is guilty of professional misconduct.
4.2 Cancellation and Restoration of Certificate of Practice

Regulation 10 provides that a Certificate of Practice (COP) shall be liable for cancellation, if:
(i) the name of the holder of the certificate is removed from the Register; or
(ii) the Council is satisfied, after giving an opportunity of being heard to the person
concerned, that such certificate was issued on the basis of incorrect, misleading or false
information, or by mistake or inadvertence; or
(iii) a member has ceased to practise; or
(iv) a member has not paid annual fee for certificate of practice till 30th day of September of
the relevant year.
Where a COP is cancelled, the holder shall surrender the same to the Secretary.
Further, Regulation 11 on restoration of COP states that, on an application made in the approved
Form and on payment of such fee, the Council may restore the COP with effect from the date on
which it was cancelled, to a member whose certificate has been cancelled due to non-payment of
the annual fee for the COP and whose application, complete in all respects, together with the fee, is
received by the Secretary before the expiry of the relevant year.
4.3 Members - Deemed to be in Practice
Every member of the Institute is entitled to designate himself as a Chartered Accountant. There are
two classes of members, those who are in practice and those who are otherwise occupied. In Section
2(2) of the Act, the term deemed “to be in practice” has been defined as follows:
“A member of the Institute shall be deemed “to be in practice” when individually or in partnership
with Chartered Accountants in practice, or in partnership with members of such other recognised
professions as may be prescribed, he, in consideration of remuneration received or to be received-
(i) engages himself in the practice of accountancy; or

(ii) offers to perform or performs service involving the auditing or verification of financial
transactions, books, accounts or records, or the preparation, verification or certification
of financial accounting and related statements or holds himself out to the public as an
accountant; or
(iii) renders professional services or assistance in or about matters of principle or detail
relating to accounting procedure or the recording, presentation or certification of financial

facts or data; or
(iv) renders such other services as, in the opinion of the Council, are or may be rendered by
a Chartered Accountant in practice;
and the words “to be in practice” with their grammatical variations and cognate expressions shall be
construed accordingly.
Explanation - An associate or a fellow of the Institute who is a salaried employee of a Chartered
Accountant in practice or a firm of such Chartered Accountants or firm consisting of one or more
chartered accountants and members of any other professional body having prescribed qualifications
shall, notwithstanding such employment, be deemed to be in practice for the limited purpose of the
training of Articled Assistants”.
Pursuant to Section 2(2)(iv) above, the Council has passed a resolution permitting a Chartered
Accountant in practice to render entire range of “Management Consultancy and other Services”.
The expression “Management Consultancy and other Services” shall not include the function of
statutory or periodical audit, tax (both direct taxes and indirect taxes) representation or advice
concerning tax matters or acting as liquidator, trustee, executor, administrator, arbitrator or receiver,
but shall include the following-
(i) Financial management planning and financial policy determination.*

(ii) Capital structure planning and advice regarding raising finance.*
(iii) Working capital management.*
(iv) Preparing project reports and feasibility studies.*
(v) Preparing cash budget, cash flow statements, profitability statements, statements of
sources and application of funds etc.
(vi) Budgeting including capital budgets and revenue budgets.
(vii) Inventory management, material handling and storage.
(viii) Market research and demand studies.
(ix) Price-fixation and other management decision making.
(x) Management accounting systems, cost control and value analysis.
(xi) Control methods and management information and reporting.
(xii) Personnel recruitment and selection.
* Consideration of “tax implications” while rendering the services at (i), (ii), (iii) and (iv) above will be considered as part of
“Management Consultancy and other services”.

(xiii) Setting up executive incentive plans, wage incentive plans etc.

(xiv) Management and operational audits.
(xv) Valuation of shares and business and advice regarding amalgamation, merger and
acquisition.
(xvi) Business Policy, corporate planning, organisation development, growth and diversification.
(xvii) Organisation structure and behaviour, development of human resources including design
and conduct of training programmes, work study, job-description, job evaluation and
evaluation of workloads.
(xviii) Systems analysis and design, and computer related services including selection of
hardware and development of software in all areas of services which can otherwise be
rendered by a Chartered Accountant in practice and also to carry out any other professional
services relating to EDP.
(xix) Acting as advisor or consultant to an issue, including such matters as:
(a) Drafting of prospectus and memorandum containing salient futures of prospectus.
Drafting and filing of listing agreement and completing formalities with Stock
Exchanges, Registrar of Companies and SEBI.
(b) Preparation of publicity budget, advice regarding arrangements for selection of (i) ad-
media, (ii) centres for holding conferences of brokers, investors, etc., (iii) bankers to
issue, (iv) collection centres, (v) brokers to issue, (vi) underwriters and the
underwriting arrangement, distribution of publicity and issue material including
application form, prospectus and brochure and deciding on the quantum of issue
material (In doing so, the relevant provisions of the Code of Ethics must be kept in
mind).
(c) Advice regarding selection of various agencies connected with issue, namely
Registrars to Issue, printers and advertising agencies.
(d) Advice on the post issue activities, e.g., follow up steps which include listing of
instruments and dispatch of certificates and refunds, with the various agencies
connected with the work.
Explanation - For removal of doubts, it is hereby clarified that the activities of broking,
underwriting and portfolio management are not permitted.
(xx) Investment counselling in respect of securities [as defined in the Securities Contracts
(Regulation) Act, 1956 and other financial instruments.] (In doing so, the relevant provisions
of the Code of Ethics must be kept in mind).
(xxi) Acting as registrar to an issue and for transfer of shares/other securities. (In doing so, the
relevant provisions of the Code of Ethics must be kept in mind).

(xxii) Quality Audit.

(xxiii) Environment Audit.
(xxiv) Energy Audit.
(xxv) Acting as Recovery Consultant in the Banking Sector.
(xxvi) Insurance Financial Advisory Services under the Insurance Regulatory & Development
Authority Act, 1999, including Insurance Brokerage.
Pursuant to Section 2(2)(iv) of the Chartered Accountants Act, 1949, read with Regulation 191 of
Chartered Accountants Regulations, 1988 a member shall be deemed to be in practice if he, in his
professional capacity and neither in his personal capacity nor in his capacity as an employee, acts
as a liquidator, trustee, executor, administrator, arbitrator, receiver, adviser or representative for
costing, financial or taxation matters or takes up an appointment made by the Central Government
or a State Government or a court of law or any other legal authority or acts as a Secretary unless
his employment is on a salary-cum-full-time basis.
It is necessary to note that a person is deemed to be in practice not only when he is actually engaged
in the practice of accountancy but also when he offers to render accounting services whether or not
he in fact does so. In other words, the act of setting up of an establishment offering to perform
accounting services would tantamount to being in practice even though no client has been served.
It may also be noted that a member of the Institute is deemed to be in practice during the period he
renders ‘service with armed forces’.
The above provisions need to be correlated with the provisions of section 144 of the Companies Act,
2013 which prohibits an auditor of the company from rendering certain services directly or indirectly
to the company or its holding company or its subsidiary company.
(Students may refer Chapter 6 ‘The Company Audit’ of the Study Material for detailed understanding
of provisions on section 144 of the Companies Act, 2013)
Case Study
Mr. A, a practicing Chartered Accountant agreed to select and recruit personnel, conduct training
programmes for and on behalf of a client.
Solution
Providing Management Consultancy and Other Services: Under Section 2(2)(iv) of the
Chartered Accountants Act, 1949, a member of the Institute shall be deemed “to be in practice”
when individually or in partnership with Chartered Accountants in practice, he, in consideration
of remuneration received or to be received renders such other services as, in the opinion of the
Council, are or may be rendered by a Chartered Accountant in practice. Pursuant to Section
2(2)(iv) above, the Council has passed a resolution permitting a Chartered Accountant in practice

to render entire range of “Management Consultancy and other Services”.

The definition of the expression “Management Consultancy and other Services” includes
Personnel recruitment and selection. Personnel Recruitment and selection includes,
development of human resources including designing and conduct of training programmes, work
study, job description, job evaluation and evaluations of work loads.
Conclusion: Therefore, Mr. A is not guilty of professional misconduct.
4.4 Companies not to Engage in Accountancy

Section 25 of the Chartered Accountants Act, 1949 provides that:
(1) No company, whether incorporated in India or elsewhere, shall practise as chartered
accountants.
Here, the term “company” shall include any limited liability partnership which has company
as its partner for the purpose of this section.
(2) If any company contravenes this provision then, without prejudice to any other proceedings
which may be taken against the company, every director, manager, secretary and any other
officer thereof who is knowingly a party to such contravention shall be punishable with fine
which may extend on first conviction to ` 1,000 and on any subsequent conviction to ` 5,000.
In addition, as per section 141(2) of the Companies Act, 2013, where a firm (including a limited
liability partnership) is appointed as an auditor of a company, then, only the partners who are
chartered accountants shall be authorised to act and sign on behalf of the firm.
On thoroughly studying the provisions of both the Acts, the LLPs, though allowed to be appointed
as an auditor in accordance with the Companies Act, 2013, however, it can’t be engaged into
practice, if it has company as its partner, as per the Chartered Accountants Act, 1949.
Therefore, in short, the LLP not having any company as its partner, can be engaged into practicing
and thus take audit assignments.
4.5 Member in Practice Prohibited from using a Designation Other Than
Chartered Accountant
(i) The member of the Institute are now permitted to use the word 'CA' as prefix before their
name irrespective of the fact that they are in practice or not.
(ii) Under Section 7 of the Chartered Accountants Act, 1949 a member in practice cannot use
any designation other than that of a Chartered Accountant, nor can he use any other
description, whether in addition thereto or in substitution therefor, but a member who is not
in practice and does not use the designation of a Chartered Accountant may use any other
description. Nevertheless a member in practice may use any other letters or description
indicating membership of Accountancy Bodies which have been approved by the Council or

of bodies other than Accountancy Institutes so long as such use does not imply adoption of
a designation and/or does not amount to advertisement or publicity.
For example, though a member cannot designate himself as a Cost Accountant, he can use
the letters A.I.C.W.A. after his name, when he is a member of that Institute.
“It
is improper for a Chartered Accountant to state on his professional documents that he is
an Income-tax Consultant, Cost Accountant, Company Secretary, Cost Consultant or a
Management Consultant”.
“Member are allowed to appear before the various authorities including Company Law Board,
Income Tax Appellate Tribunal, Sales Tax Tribunal where the law has permitted the same,
so far as the designation “Corporate Lawyer” is concerned, the Council was of the view that
as per the existing provisions of law, a Chartered Accountant in practice is not entitled to use
the designation “Corporate Lawyer”.
Further, the members are not permitted to use the initials ‘CPA’ (standing for Certified Public
Accountant) on their visiting cards”.
“Members of the Institute in practice who are otherwise eligible may also practice as Company
Secretaries and/or Cost Accountants. Such members shall, however, not use designation/s
of the aforesaid Institute/s simultaneously with the designation “Chartered Accountant”.
4.6 Maintenance of Branch Offices
In terms of Section 27 of the Act, if a Chartered Accountant in practice or a Firm of Chartered
Accountants has more than one office in India, each one of such offices should be in the separate
charge of a member of the Institute. Failure on the part of a member or a firm to have a member in
charge of its branch and a separate member in case of each of the branches, where there is more
than one, would constitute professional misconduct.
However, exemption has been given to members practicing in hill areas subject to certain
conditions. The conditions are:
(1) Such members/firm be allowed to open temporary offices in a city in the plains for a limited
period not exceeding 3 months in a year.
(2) The regular office need not be closed during this period and all correspondence can
continue to be made at the regular office.
(3) The name board of the firm in the temporary office should not be displayed at times other
than the period such office is permitted to function as above.
(4) The temporary office should not be mentioned in the letterheads, visiting cards or any other
documents as a place of business of the member/firm.
(5) Before commencement of every winter it shall be obligatory on the member/firm to inform
the Institute that he/it is opening the temporary office from a particular date and after the

office is closed at the expiry of the period of permission, an intimation to that effect should
also be sent to the office of the Institute by registered post.
It is necessary to mention that the Chartered Accountant in-charge of the branch of another firm
should be associated with him or with the firm either as a partner or as a paid assistant. If he is a
paid assistant, he must be in whole time employment with him.
However, a member can be in-charge of two offices if they are located in one and the same
Accommodation. In this context some of the Council’s decisions are as follows:
(1) With regard to the use of the name-board, there will be no bar to the putting up of a name-
board in the place of residence of a member with the designation of Chartered Accountant,
provided it is a name-plate or a name-board of an individual member and not of the firm.
Case Study
Mr. X & Mr. Y, partners of a Chartered Accountant Firm, one in-charge of Head Office
and another in-charge of Branch at a distance of 80 kms from the municipal limits, puts
up a name-board of the firm in both premises and also in their respective residences.
Putting Name Board of the Firm at Residence: The council of the Institute has decided
that with regard to the use of the name-board, there will be no bar to the putting up of a
name-board in the place of residence of a member with the designation of chartered
accountant, provided, it is a name-plate or board of an individual member and not of the
firm.
In the given case, partners of XY & Co., put up a name board of the firm in both offices
and also in their respective residences.
Conclusion: Thus, the chartered accountants are guilty of misconduct. Distance given in
the question is not relevant for deciding.
(2) The exemption may be granted to a member or a firm of Chartered Accountants in practice
to have a second office without such second office being under the separate charge of a
member of the Institute, provided-
(a) the second office is located in the same premises, in which the first office is located
or,
(b) the second office is located in the same city, in which the first office is located or,
City X
1st Office
2nd Office

(c) the second office is located within a distance of 50 km. from the municipal limits of a
city, in which the first office is located.
City X Municipal Limit City Y
1stOffice 2nd Office
(Head Office) (Branch Office)
15 km 10 km
35 km
Effective distance from 1st Office = 35 km + 10 km = 45 km

A member having two offices of the type referred to above shall have to declare, which of the
two offices is his main office, which would constitute his professional address.
Case Study
Mr. K, Chartered Accountant in practice as a sole proprietor at Chennai has an office in the
suburbs of Chennai. Due to increase in the income tax assessment work, he opens another
office near the income tax office, which is within the city and at a distance of 30 kms. from his
office in the suburb. For running the new office, he has employed a retired Income Tax
Commissioner who is not a Chartered Accountant.
Solution:
Maintenance of Branch Office in the Same City: As per section 27 of the Chartered
Accountants Act, 1949 if a chartered accountant in practice has more than one office in India,
each one of these offices should be in the separate charge of a member of the Institute.
However, a member can be in charge of two offices if the second office is located in the same
premises or in the same city, in which the first office is located; or the second office is located
within a distance of 50 kms from the municipal limits of a city, in which the first office is located.
In the given case, Mr. K, Chartered Accountant in practice as a sole proprietor at Chennai has
an office in suburbs of Chennai, and due to increase in the work he opened another branch
within the city near the income tax office. He also employed a retired income tax commissioner
to run the new office and the second office is situated within a distance of 30 kilometers from
his office in the suburb.
Conclusion: In view of above provisions, there will be no misconduct if Mr. K will be in-charge
of both the offices. However, he is bound to declare which of the two offices is the main office.

4.7 KYC Norms for CA in Practice

The financial services industry globally is required to obtain information of their clients and comply
with Know Your Client Norms (KYC norms). Keeping in mind the highest standards of Chartered
Accountancy profession in India, the Council of ICAI thought it necessary to issue such norms to be
observed by the members of the profession who are in practice.
In light of this background, the Council of ICAI approved the following KYC Norms which are
mandatory in nature and shall apply in all assignments pertaining to attest functions.
The KYC Norms approved by the Council of ICAI are given below:
1. Where Client is an Individual/ Proprietor

A. General Information
Name of the Individual
PAN No. or Aadhar Card No. of the Individual
Business Description
Copy of last Audited Financial Statement
B. Engagement Information
Type of Engagement
2. Where Client is a Corporate Entity

Name and Address of the Entity
Name of the Parent Company in case of Subsidiary
Type of Engagement
C. Regulatory Information
Company PAN No.
Company Identification No.
Directors’ Names & Addresses
Directors’ Identification No.

3. Where Client is a Non-Corporate Entity

Name and Address of the Entity
Copy of PAN No.
Partner’s Names & Addresses (with their PAN/Aadhar Card/DIN No.)
Type of Engagement
5. CHARTERED ACCOUNTANTS IN SERVICE

In accordance with the definitions provided under the Code of Ethics, a Professional Accountant in
Service or Chartered Accountant in Service means a professional accountant employed or engaged
in an executive or non-executive capacity in such areas as commerce, industry, service, the public
sector, education, the not for profit sector, regulatory bodies or professional bodies, or a professional
accountant contracted by such entities.
6 DISCIPLINARY PROCEDURE
Provisions of the Chartered Accountant, Act, 1949 regarding:
(i) Disciplinary Directorate,
(ii) Board of Discipline,
(iii) Disciplinary Committee,
(iv) Appellate Authority and procedure in enquiries for disciplinary matters relating to misconduct
of the members of the Institute are as hereunder:

Flow Chart of Discipline Procedure Mechanism

Receipt of (i) Complaint along with prescribed fee, or (ii) Information,
against member of ICAI of alleged misconduct
Disciplinary Directorate
Prima Facie Opinion
Guilty Not Guilty
Submit all information &

Falling in Falling in complaints to
First Schedule Second Schedule or Both Board of Discipline
Place the matter Place the matter
before Board of Discipline before Accepted Rejected
Disciplinary Committee
Accepted Rejected
Accepted Rejected Advice the Director
Conduct Close the (Discipline) to further
enquiry matter investigate
Conduct Close the
enquiry matter
Found guilty May proceed with the
Found guilty matter, if it’s allied to
the First Schedule
Yes No
Yes No
It can,
(i) reprimand the member It can, Refer the matter to the
(ii) remove name of the (i) reprimand the member Disciplinary
member upto period of 3 (ii) remove name of the Committee, if it’s allied
months member permanently or for to the Second
(iii) impose fine upto any duration, it thinks fit Schedule or Both
` 1,00,000 (iii) impose fine upto
` 5,00,000
Any member or Director (Discipline) aggrieved by order of Board or

Disciplinary Committee can prefer an appeal within 90 days
Appellate Authority
It can,
(i) Confirm, modify or set aside the order.
(ii) Impose, Set aside, Reduce or enhance penalty.
(iii) remit the case to the Board of Discipline or Disciplinary Committee
for reconsideration.
(iv) Pass such order as the Authority thinks fit.
[For detailed knowledge with respect to Disciplinary Procedure, students are advised to refer
Chartered Accountants Act, 1949 produced under Annexure 2 at the end of this Chapter.]

7 TYPES OF MISCONDUCT-PROFESSIONAL OR OTHER

According to section 22 of the Act, for the purposes of this Act, the expression “professional or other
misconduct” shall be deemed to include any act or omission provided in any of the Schedules, but
nothing in this section shall be construed to limit or abridge in any way the power conferred or duty
cast on the Director (Discipline) under sub-section (1) of section 21 to inquire into the conduct of
any member of the Institute under any other circumstances.
A member is liable to disciplinary action under Section 21 of the Chartered Accountants Act, if he is
found guilty of any Professional or Other Misconduct.
7.1 Professional Misconduct
Professional misconduct has been defined in part I, II and III of the First Schedule; and part I and II
of the Second Schedule. A member who is engaged in the profession of accountancy whether in
practice or in service should conduct/restrict his action in accordance with the provisions contained
in the respective parts of the schedules. If the member is found guilty of any of the acts or omissions
stated in any of the respective parts of the Schedule, he/she shall be deemed to be guilty of
professional misconduct.
7.2 Other Misconduct
Other misconduct has been defined in part IV of the First Schedule and part III of the Second Schedule.
These provisions empower the Council to inquire into any misconduct of a member even it does not arise
out of his professional work. This is considered necessary because a chartered accountant is expected
to maintain the highest standards of integrity even in his personal affairs and any deviation from these
standards, even in his non-professional work, would expose him to disciplinary action. For example, a
member who is found to have forged the will of a relative, would be liable to disciplinary action even
though the forgery may not have been done in the course of his professional duty.
Other misconduct would also relate to conviction by a competent court for an offence involving moral
turpitude punishable with transportation or imprisonment to an offence not of a technical nature
committed by the member in his professional capacity. [See section 8(v) of the Act].
Some illustrative examples, where a member may be found guilty of “Other Misconduct”,
under the aforesaid provisions rendering, himself unfit to be member are:
(i) Where a chartered accountant retains the books of account and documents of the client
and fails to return these to the client on request without a reasonable cause.
(ii) Where a chartered accountant makes a material misrepresentation.
(iii) Where a chartered accountant uses the services of his articled or audit assistant for
purposes other than professional practice.
(iv) Conviction by a competent court of law for any offence under Section 8 (v) of the
Chartered Accountants Act 1949.

(v) Misappropriation by office-bearer of a Regional Council of the Institute, of a large amount

and utilisation thereof for his personal use.
(vi) Not replying within a reasonable time and without a good cause to the letter of the public
authorities.
(vii) Where certain assessment records of income tax department belonging to the client of
Chartered Accountant were found in the almirah of the bed-room of the chartered
accountant.
(viii) Where a chartered accountant had adopted coercive methods on a bank for having a loan
sanctioned to him.
8. SCHEDULES TO THE ACT

Acts or omissions which comprise professional misconduct within the meaning of Section 22 of the
Chartered Accountants Act are defined in two Schedules viz. the First Schedule and the Second
Schedule. The First Schedule is divided into four parts, Part I of the First Schedule deals with the
misconduct of a member in practice which would have the effect generally of compromising his
position as an independent person. Part II deals with misconduct of members in services. Part III
deals with the misconduct of members generally and Part IV deals with other misconduct in relation
to members of the institute generally.
The Second Schedule is divided into three parts. Part I deals with misconduct in relation to a member
in practice, Part II deals with misconduct of members generally and Part III deals with other
misconduct in relation to members of the Institute generally.
Part I: Professional misconduct in relation to Chartered
Accountants in practice
(No. of Clauses: 12)
Part II: Professional misconduct in relation to Members of the
Institute in service
(No. of Clauses: 2)
First Schedule
Part III: Professional misconduct in relation to Members of the
Institute generally
(No. of Clauses: 3)
Types of Schedules
Part IV: Other misconduct in relation to Members of the Institute

generally
(No. of Clauses: 2)
Part I: Professional misconduct in relation to Chartered
Accountants in practice
(No. of Clauses: 10)
Part II: Professional misconduct in relation to Members of the
Second Schedule Institute generally
(No. of Clauses: 4)
Part III: Other misconduct in
relation to Members of the
Institute generally (No. of Clause: 1)

The implications of the different clauses in the schedules are discussed below:
8.1 THE FIRST SCHEDULE

Where the Director (Discipline) is of the opinion that member is guilty of any professional or other
misconduct mentioned in the First Schedule; he shall place the matter before the Board of Discipline.
PART I - Professional Misconduct in relation to Chartered Accountants in Practice
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he:
Clause (1) allows any person to practice in his name as a chartered accountant unless such
person is also a chartered accountant in practice and is in partnership with or employed by
him.
Who can be allowed to

practice in a CA’s name?
Chartered Accountant in
Non- Chartered Accountant
practice
Not allowed Partner Employee Others
Allowed Allowed Not Allowed
The above clause is intended to safeguard the public against unqualified accountant practicing under
the cover of qualified accountants. It ensures that the work of the accountant will be carried out by
a Chartered Accountant who may be his partner, or his employee and would work under his control
and supervision.
Clause (2) pays or allows or agrees to pay or allow, directly or indirectly, any share,
commission or brokerage in the fees or profits of his professional business, to any person
other than a member of the Institute or a partner or a retired partner or the legal representative
of a deceased partner, or a member of any other professional body or with such other persons
having such qualification as may be prescribed, for the purpose of rendering such
professional services from time to time in or outside India.
Explanation - In this item, “partner” includes a person residing outside India with whom a chartered
accountant in practice has entered into partnership which is not in contravention of item (4) of this Part.
It is in order for a member to share his fees or profits with another member of the Institute and/or a
firm of Chartered Accountants. A practicing Member of the Institute can share fees or profits arising
out of his professional business with such members of other professional bodies or with such other
persons having such qualifications as may be prescribed from time to time by the Council.

The Council has prescribed [Regulation 53A(1) of the Chartered Accountants Regulations,
1988] the professional bodies, which are as under:-
(a) The Institute of Company Secretaries of India established under the Company
Secretaries Act, 1980.
(b) The Institute of Cost & Works Accountants of India established under the Cost & Works
Accountants Act, 1959.
(c) Bar Council of India established under the Advocates Act, 1961.
(d) The Indian Institute of Architects established under the Architects Act, 1972.
(e) The Institute of Actuaries of India established under the Actuaries Act, 2006.
Further, the Council has also prescribed [Regulation 53A(3) of the Chartered Accountants
Regulations, 1988] the persons qualified in India, which are as under:
(i) Company Secretary within the meaning of the Company Secretaries Act, 1980;
(ii) Cost Accountant within the meaning of the Cost and Works Accountants Act, 1959;
(iii) Actuary within the meaning of the Actuaries Act, 2006;
(iv) Bachelor in Engineering from a University established by law or an Institution recognised
by law;
(v) Bachelor in Technology from a University established by law or an institution recognised
by law;
(vi) Bachelor in Architecture from a University established by law or an institution recognised
by law;
(vii) Bachelor in Law from a University established by law or an institution recognised by law;
(viii) Master in Business Administration from Universities established by law or technical
institutions recognised by All India Council for Technical Education.
The Institute came across certain Circulars/Orders issued by the Registrars of various State Co-
operative Societies wherein it has been mentioned that certain amount of audit fee is payable to the
concerned State Government and the auditor has to deposit a percentage of his audit fee in the
state Treasury by a prescribed challan within a prescribed time of the receipt of Audit fee. The
Council considered the issue and while noting that the Government is asking auditors to deposit
such percentage of their audit fee for recovering the administrative and other expenses incurred in
the process, the Council decided that as such there is no bar in the Code of Ethics to accept such
assignment wherein a percentage of professional fee is deducted by the Government to meet the
administrative and other expenditure.
Considering the case where a Chartered Accountant gave 50% of the audit fees received by him to
the complainant, who was not a Chartered Accountant, under the nomenclature of office allowance

and such an arrangement continued for a number of years, it was held by the Council that in
substance the Chartered Accountant had shared his profits and, therefore, was guilty of professional
misconduct under the clause. It is not the nomenclature to a transaction that is material but it is the
substance of the transaction, which has to be looked into.
Treatment of Goodwill –
Share of Profit / Sale

of Goodwill
Partnership Proprietorship
Firm Firm
There are two or No sharing of fees between

more partners Goodwill of a proprietary
Legal Representative of firm of chartered accountant
and one of them single member firm and
dies can be sold/transferred to
purchaser of Goodwill of the another eligible member of
firm on the death of the Sole the Institute, after the death
Proprietor of the firm of the proprietor concerned.
Legal Payments may be made in * The Council permitted the
Representative instalments, provided the sale/transfer of goodwill for
(say, widow) of agreement of the sale of such cases in the following
the deceased goodwill contains such manner:
partner can provision
continue to
receive a share of
the firm,
only if partnership
agreement Death of proprietor
Death of proprietor concerned occurred Death of proprietor
contains such concerned occurred on concerned had occurred
provision on or after 30.8.1998
or after 30.8.1998 and there existed a on or before 29th August,
dispute as to the legal 1998
heir of the deceased
proprietor
Provided such sale is
completed in all aspects
within a year of the death of Provided the Provided such
such proprietor concerned. information as to the sale/transfer is
The name of the concerned existence of the dispute completed/effected and
firm would be kept in is received by the the Institute's
abeyance (i.e. not removed Institute within a year of permission to practice
on receipt of information the death of the in the deceased's
about the death of the proprietor concerned. proprietary firm name is
proprietor as is being done sought for by 28th
The name of concerned August, 1999 and the
at present) only upto a firm shall be kept in
period of 1 year from the firm name concerned is
abeyance till 1 year still available with the
death of proprietor from the date of
concerned as aforesaid Institute
settlement of dispute
* In case of a partnership firm when all the partners die at the same time, the above Council decision
would also be applicable.

Case Study
Mr. Qureshi, Chartered Accountant, in practice died in a road accident. His widow proposes to
sell the practice of her husband to Mr. Pardeshi, Chartered Accountant, for ` 5 lakhs. The price
also includes right to use the firm name - Qureshi and Associates. Can widow of Qureshi sell
the practice and can Mr. Pardeshi continue to practice in that name as a proprietor?
Solution
Sale of Goodwill: With reference to Clause (2) of Part I to the First Schedule to Chartered
Accountants’ Act, 1949, the Council of the Institute of Chartered Accountants of India had an
occasion to consider whether the goodwill of a proprietary concern of chartered accountant can
be sold to another member who is otherwise eligible, after the death of the proprietor.
It lay down that the sale is permitted subject to certain conditions discussed in above diagram.
It further resolved that the legal heir of the deceased member has to obtain the permission of
the Council within a year of the death of the proprietor concerned.
Conclusion: Thus, in a given case and on the facts, the widow of Mr. Qureshi, who has sold
the practice for ` 5 lakhs is nothing but sale of goodwill. Thus, the act of Mrs. Qureshi is
permissible and Mr. Pardeshi can continue to practice in that name as a proprietor.
Clause (3) accepts or agrees to accept any part of the profits of the professional work of a
person who is not a member of the Institute.
Provided that nothing herein contained shall be construed as prohibiting a member ‘from
entering into profit sharing or other similar arrangements, including receiving any share
commission or brokerage in the fees, with a member of such professional body or other
person having qualifications, as is referred to in item (2) of this part.
Just as a member cannot share his fees with a non-member, he is also not permitted to receive and
share the fees of others except for sharing with Member of such professional body or other person
having such qualification as may be prescribed (Regulation 53A of the Chartered Accountants
Regulations, 1988) by the Council for the purpose of Clause (2), (3) and (5) of Part I of First
Schedule. Such a restriction is necessary so that a Chartered Accountant who is often required to
engage or to recommend for engagement by his clients, the services of the members of other
professions, cannot share the fees received by other persons who are otherwise not permitted by
the Council in terms of provision of this clause.
Clause (4) enters into partnership, in or outside India, with any person other than Chartered
Accountant in practice or such other person who is a member of any other professional body
having such qualifications as may be prescribed, including a resident who but for his
residence abroad would be entitled to be registered as a member under clause (v) of sub-
section (1) of section 4 or whose qualifications are recognized by the Central Government or
the Council for the purpose of permitting such partnerships.

The Council has prescribed Regulation 53A(3) (as discussed under clause (2) of this part) and
Regulation 53B of the Chartered Accountants Regulations, 1988 for the persons qualified and
the professional bodies.
The Regulation 53B prescribes the membership of following professional bodies for entering into
partnership:
(a) Company Secretary, member, The Institute of Company Secretaries of India, established under
the Company Secretaries Act, 1980;
(b) Cost Accountant, member, The Institute of Cost and Works Accountants of India established
under the Cost and Works Accountants Act, 1959;
(c) Advocate, member, Bar Council of India established under the Advocates Act, 1961;
(d) Engineer, member, The Institution of Engineers, or Engineering from a University established by
law or an institution recognized by law.
(e) Architect, member, The Indian Institute of Architects established under the Architects Act, 1972;
(f) Actuary, member, The Institute of Actuaries of India, established under the Actuaries Act, 2006.
Some of the decisions of the Council under this clause are given below:
Where a Chartered Accountant had engaged himself as a partner in two business firms and
Managing Director in two Companies and was also holding Certificate of Practice without obtaining
permission of the Institute. Held that he was guilty of professional misconduct inter alia under
Clauses (4) and (11). (Harish kumar in re:- Pages 286 of Vol. VIII (2) of Disciplinary cases – Council’s
decision dated 1st to 3rd August, 2001)
The Respondent was a Taxation Advisor of a group of Companies. During search and seizure under
Section 132 of The Income Tax Act, 1961 of the group and also of the Chartered Accountant, the
Complainant found that the Respondent was colluding with this group in evasion of tax. The
Respondent had signed two sets of financial statements of the same auditee, for the same financial
year. The two financial statements showed different figures of contract receipts, net profits and
balance sheet. He was grossly negligent in the conduct of his professional duties. The Respondent
admitted that he was managing partner/partner in two partnership firms where there were other
partners who were not Chartered Accountants. Held, the respondent is guilty under Clause (4) of
Part I of First Schedule and under Clauses (5), (6) & (7) of Part I of Second Schedule.[Assistant
Director of Income Tax (investment), Calicut v. P Subramanian. Council Decision of 281 st Meeting
held in October, (2008)].
Case Study
Mr. P, a Chartered Accountant in practice entered into a partnership with Mr. L, an advocate for
sharing of fees for work sent by one to the other. However, due to some disputes, the
partnership was dissolved after 1 month without any fees having been received.

Partnership with an Advocate: As per Clause (4) of Part I of the First Schedule to the
Chartered Accountants Act, 1949, a chartered accountant will be guilty of professional
misconduct if he enters into partnership with any person other than a chartered accountant in
practice or a person resident without India who but for his residence abroad would be entitled
to be registered as a member under Clause (v) of Sub-section (1) of Section 4 or whose
qualification are recognized by the Central Government or the Council for the purpose of
permitting such partnership.
However, Regulation 53B of the Chartered Accountants Regulations, 1988 permits a Chartered
Accountant in practice to enter into partnership with other prescribed Professionals which
includes an Advocate, a member of Bar Council of India.
In the instant case, Mr. P, a chartered accountant, has entered into partnership with Mr. L, an
advocate.
Conclusion: Thus, he would not be guilty of professional misconduct as per Clause (4) of Part
I of First Schedule read with Regulation 53B.
Clause (5) Secures either through the services of a person who is not an employee of such
Chartered Accountant or who is not his partner or by means which are not open to a Chartered
Accountant, any professional business.
Provided that nothing herein contained shall be construed as prohibiting any agreement
permitted in terms of item (2), (3) and (4) of this part.
“A man must stand erect, and not to be kept erect by others”, is a dictum by Marcus Aurelius which
though applicable for a man in every walk of life is more so in the case of a professional life. He
must seek work not through any agency, but by the respect, that he is able to command for his
professional talent and skill and by the confidence he is able to inspire by his reputation. All forms
of canvassing on that account are regarded unethical and are prohibited. The decision of the Council
under this clause is given below:
A Chartered Accountant wrote various letters to officers of different Army Canteens giving details
about him and his experience, his partner & office and the norms for charging audit fees. He was
held guilty for violation of Clauses (5) & (6). (Jethanand Sharda vs. Deepak Mehta – Council’s
decision dated 1st to 4th July, 1998 – Page 61 of Volume VIII(2) of Disciplinary Cases).
Clause (6) Solicits clients or professional work either directly or indirectly by circular,
advertisement, personal communication or interview or by any other means.
Provided that nothing herein contained shall be construed as preventing or prohibiting -
(i) Any Chartered Accountant from applying or requesting for or inviting or securing
professional work from another chartered accountant in practice; or
(ii) A member from responding to tenders or enquiries issued by various users of
professional services or organizations from time to time and securing professional
work as a consequence.

However, as per the guideline issued by the Council of the Institute of Chartered
Accountants of India, a member of the Institute in practice shall not respond to any
tender issued by an organization or user of professional services in areas of services
which are exclusively reserved for chartered accountants, such as audit and
attestation services. However, such restriction shall not be applicable where minimum
fee of the assignment is prescribed in the tender document itself or where the areas
are open to other professionals along with the Chartered Accountants.
Further, Keeping in view the broad purview of Clause (6) of Part I of the First Schedule
to the Chartered Accountants Act, 1949, an advertisement of Coaching /teaching
activities by a member in practice may amount to indirect solicitation, as well as
solicitation by any other means, and may therefore be violative of the provisions of
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949.
In view of the above, such members are advised to abstain from advertising their association with
Coaching / teaching activities through hoardings, posters, banners and by any other means, failing
which they may be liable for disciplinary action, as per the provisions of Chartered Accountants Act,
1949 and Rules/Regulations framed thereunder. However, it may be noted that subject to the above
prohibition, such members may put, outside their Coaching/teaching premises, sign board
mentioning the name of Coaching/teaching Institute, contact details and subjects taught therein only.
As regards the size and type of sign board, the Council Guidelines as applicable to Firms of
Chartered Accountants would apply.
It is an elaboration of the principle propounded in the preceding clause enjoining that for securing
professional work the help of others should not be sought. This clause further enjoins on a member
not to solicit professional work by means of advertisement, circular, personal communication or
interview or by any other means. The members should not adopt any indirect methods to adventure
their professional practice with a view to gain publicity and thereby solicit clients or professional
work. Such a restraint must be practiced so that members may maintain their independence of
judgment and may be able to command the respect of their prospective clients.
In the early years of their professional career, members may find this restraint inconvenient and
irksome. A question may arise in their minds as to how they would be able to find professional work
if they are not permitted to advertise or solicit work.
A little reflection would show that professional work cannot be secured either by advertisement or
by circulars or by solicitation. It can only be obtained by a member gradually building confidence in
his ability and integrity. The service tendered by an accountant is of a personal and intimate nature
and its value can be appraised only by personal contact and experience. A public advertisement is
likely to lead to an impression that the professional person is over anxious to win confidence, which
however will have the opposite effect. The satisfaction of clients would be the best advertisement,
which would lead to other clients. Unabashed advertisement would affect the public esteem in which
the profession is held and would act to the disadvantage of its members. An advertisement is not a
key to success in the profession. It is the quality service, which attracts and retains the clients.

Consequent to amendment made by Chartered Accountant (Amendment) Act, 2006 in Clause (6) of
Part I of the First Schedule, Ban on Solicitation is relaxed in the following situation of client or
professional work:
(i) If work or professional work occurs within the fraternity; or

(ii) If professional work is secured from responding to tenders, or enquiries issued by various
users of professional services or organization.
Some forms of soliciting work which the Council has prohibited are discussed below:
(a) Advertisement and note in the press – Members should not advertise for soliciting work or
advertise in a manner which could be interpreted as soliciting or offering to undertake
professional work. They are also not permitted to use the less open method of circulating
letters to a small field of possible clients. Personal canvassing or canvassing for clients of
previous employer through the help of the employees are also not permitted. The exceptions
to the above rule are:
(i) A member may request another Chartered Accountant in practice for professional
work.
(ii) a member may advertise changes in partnerships or dissolution of a firm, or of any
change in address of practice and telephone numbers. Such announcements should
be limited to a bare statement of facts and consideration given to the appropriateness
of the area of distribution of the newspaper or magazine and number of insertions.
(iii) a member is also permitted to issue a classified advertisement in the journal/
newsletter of the Institute intended to give information for sharing professional work
on assignment basis or for seeking partnership or salaried employment of an
accountancy nature, provided it only contains the accountant’s name, address or
telephone number, fax number, e-mail address.
(b) Application for empanelment for allotment of audit and other professional work – The
Government departments, government companies/Corporations, courts, co-operative
societies and banks and other similar institutions prepare panels of chartered accountants for
allotment of audit and other professional work. Where the existence of such a panel is within
the knowledge of a member, he is free to write to the concerned organization with a request
to place his name on the panel. However, it would not be proper for the Chartered
Accountant to make roving enquiries by applying to any such organization for having
his name included in any such panel. It is permissible to quote fees on enquiries being
received from such bodies, which maintain such panel.
(c) Publication of Name or Firm Name by Chartered Accountants in the Telephone or other
Directories published by Telephone Authorities or Private Bodies – The Council has held
that it would not be proper for a chartered accountant to have entries made in a Telephone
Directory either by making a special request or by means of an additional payment. The

Council has also considered the question of permitting entries in respect of chartered
accountants and their firms under specified groups in telephone/trade directories brought out
by government and nongovernment agencies. It has decided to permit such entries subject
to certain restrictions.
(d) Responding to Tenders, Advertisements and Circulars – It is not prohibited to the
members to respond to tenders and requests made by users of professional work.
(e) Publication of Books or Articles – A member is not permitted to indicate in a book or an
article, published by him, the association with any firm of Chartered Accountants.
(f) Issue of greeting cards or invitations – The Council does not approve of the issue of
greeting cards or personal invitations by members indicating their professional designation,
status and qualification etc. However, the Council is of the view that the designation
“Chartered Accountant” as well as the name of the firm may be used in greeting cards,
invitations for marriages and religious ceremonies and any invitation for opening or
inauguration of office of the members, change in office premises and change in telephone
numbers, provided that such greeting cards or invitations etc. are sent only to clients, relatives
and close friends of the members concerned.
(g) Soliciting professional work by making roving inquiries – It is not permissible for a
member to address letters or circulars to persons who are likely to require services of a
Chartered Accountant since it would tantamount to advertisement.
(h) Seeking work from professional colleagues – The issue of an advertisement or a circular
by a Chartered Accountant, seeking work from professional colleagues on any basis
whatsoever except as provided above would be in violation of this Clause.
(i) Scope of Representation which an auditor is entitled to make under Section 225(3)
Companies Act, 1956 (now section 140(4)(iii) of the Companies Act, 2013) – The right to
make representation does not mean that an auditor has any prescriptive right or a lien to an
audit. The wording of his representation should be such that apart from the opportunity not
being abused to secure needless publicity, it does not tantamount directly or indirectly to
canvassing or soliciting for his continuance as an auditor. The letter should merely set out in
a dignified manner how he has been acting independently and conscientiously through the
term of office and may, in addition, indicate if he so chooses his willingness to continue as
auditor if re appointed by the shareholders.
(j) Acceptance of original professional work by a member emanating from the client
Introduced to him by another member – The Council has decided that a member should
not accept the original professional work emanating from a client introduced to him by another
member. If any professional work of such client comes to him directly, it should be his duty
to ask the client that he should come through the other member dealing generally with his
original work.

(k) Giving public Interviews – While giving any interview or otherwise furnishing details about
themselves or their firms in public interviews or to the press or at any forum, the members
should ensure that it should not result in publicity. Due care should be taken to ensure that
such interviews or details about the members or their firms are not given in a manner
highlighting their professional attainments.
(k) Members and/or firms who publish advertisements under Box numbers –
Members/Firms are prohibited from inserting advertisements for soliciting clients or
professional work under box numbers in the newspapers. This practice is in violation of this
clause.
(m) Website –
The Council at its 212th meeting held in January, 2001 approved the detailed guidelines for
posting the particulars on Website by Chartered Accountant(s) in practice and firm(s) of
Chartered Accountants in practice. Subsequently, the Council at its 235th meeting held in
July, 2003 amended sub-paras (8) & (20) of the said guidelines. Thereafter, the Council at its
242nd meeting held in April, 2004 ∗ and its 345th Meeting held in August, 2015 again revised
the said guidelines. The amended guidelines issued by the Council are as under:
(1) The Chartered Accountants and/or Chartered Accountants’ Firms would be free to
create their own Website subject to the overall guidelines laid down by the Council
hereunder. The actual format of the Website is not being prescribed nor any standard
format of the Website is being given to provide independence to the Members. There
is no restriction on the colours which may be used in the Website.
(2) Individual Members would also be permitted to have their Webpages in their trade
name or individual name.
(3) The Chartered Accountants and/or Chartered Accountants’ Firms would ensure that
their Websites are run on a “pull” model and not a “push” model of the technology to
ensure that any person who wishes to locate the Chartered Accountants or Chartered
Accountants’ firms would only have access to the information and the information
should be provided only on the basis of specific “pull” request.
(4) The Chartered Accountants and/or Chartered Accountants’ Firms should ensure that
none of the information contained in the Website be circulated on their own or through
E-mail or by any other mode or technique except on a specific “pull” request.
(5) The Chartered Accountants would also not issue any circular or any other
advertisement or any other material of any kind whatsoever by virtue of which they
solicit people to visit their Website. The Chartered Accountants would, however, be
permitted to mention their Website address on their professional stationery.
∗
The Council at its 345th Meeting amended the para 6(ix) of the Guidelines

(6) The following information may be allowed to be displayed on the Firms/Members’

Websites:
(i) Member/Trade/Firm name.
(ii) Year of establishment.
(iii) Member/Firm’s Address (both Head Office and Branches)
Tel. No(s)
Fax No(s)
E-mail ID(s)
(iv) Nature of services rendered (to be displayable only on specific “pull” request)
(v) Partners
Partners Year of Other Tel Area of Experience (to
Name Qualification Qualification(s) be displayable only on
Off. – Direct
Specific “pull” request)
Res.
Mobile
E-mail address
(vi) Details of Employees –

Professional Others Name Designation Area of Experience (to be
displayable only on Specific
“pull” request)
(vii) Job vacancies for the Chartered Accountant/firm of Chartered Accountants

(including articleship).
(viii) No. of articled clerks. (to be displayable only on specific “pull” request).
(ix) Nature of assignments handled (to be displayable only on specific “pull” request).
Names of clients and fee charged cannot be given.
Note ∗: Disclosure of names of clients and/or fees charged, on the website is
permissible only where it is required by a regulator, whether or not constituted under
a statute, in India or outside India, provided that such disclosure is only to the extent
of requirement of the regulator. Where such disclosure of names of clients and/or fees
charged is made on the website, the member/ firm shall ensure that it is mentioned on
∗The amendment shown in bold was made pursuant to the decision taken by the Council at its 345th Meeting
held on 14th -16th August, 2015

the website [in italics], below such disclosure itself, that “This disclosure is in terms of
the requirement of [name of the regulator] having jurisdiction in [name of the
country/area where such regulator has jurisdiction] vide [Rule/ Directive etc. under
which the disclosure is required by the Regulator].
(7) Since Chartered Accountants in practice/firms of Chartered Accountants are not
permitted to use logo with effect from1st July, 1998, they cannot use logo on Website
also.
(8) Display of Passport size photograph is permitted.
(9) The members may include articles, professional information, professional updation
and other matters of larger importance or of professional interest.
(10) The bulletin boards can be provided.
(11) The chat rooms can be provided which permit chatting amongst members of the ICAI
and between Firms and its clients. The confidentiality protocol would have to be
observed.
(12) The members/firms can provide on line advice to their clients who specifically request
for the advice whether free of charge or on payment.
(13) The listing on suitable search engine should be permitted. However, the field of search
should be restricted only to the field of “Chartered Accountants” or “CA” or “Indian CA”,
“Indian CPA”, “Indian Chartered Accountant” or any permutation or combination
related thereto. The Websites would be subjected to the guidelines contained herein
and normally would not be vetted by the Institute of Chartered Accountants of India
(ICAI). ICAI at its sole discretion may vet any of the Websites created by its members
or individual Chartered Accountant or firms of Chartered Accountants and would have
powers to direct deletion of certain portions and/or issue specific directions. In
addition, necessary action can be taken in accordance with the Chartered Accountants
Act, 1949 and the Regulations framed thereunder, in case there is any violation of the
above guidelines.
(14) The details in the Website should be so designed that it does not amount to soliciting
client or professional work. In case any content or technical feature of Website is
against the professional Code of Conduct and Ethics as well as the restrictions
contained in the schedules to the Chartered Accountants Act, 1949 or against the
guidelines or directions issued by ICAI from time to time, appropriate action will be
initiated by the ICAI in terms of its disciplinary mechanism either suo-motto or on
complaint as provided under the Chartered Accountants Act, 1949.
(15) The Website should ensure adequate secrecy of the matters of the clients handled
through Website,

(16) A number of Chartered Accountants Societies or other bodies are creating data-bases
of Chartered Accountants or Chartered Accountants’ Firms and are offering listing to
Chartered Accountants. Such listing would be permitted with or without payment. In
case a Chartered Accountant or Chartered Accountants’ Firm is a member of a
professional body or association or Chamber of Commerce and they offer listing to the
members or firm, the same would be permitted.
(17) The Institute of Chartered Accountants of India will regularly inform the aforesaid
guidelines to the members and the Chartered Accountants’ Firms to ensure the strict
compliance of the guidelines. The guidelines may be revised from time to time.
(18) No Advertisement in the nature of banner or any other nature will be permitted on the
Website.
(19) The Website should be befitting the profession of Chartered Accountants and should
not contain any information or material which is unbecoming of a Chartered
Accountant.
(20) The Website may provide a link to the Website of ICAI, its Regional Councils and
Branches and also the Website of Govt./Govt. Departments/Regulatory
authorities/other Professional Bodies, such as, American Institute of Certified Public
Accountants (AICPA), the Institute of Chartered Accountants of England & Wales
(ICAEW) and The Canadian Institute of Chartered Accountants (CICA).
(21) The address of the Website can be different from the name of the firm. But it should
not amount to soliciting clients or professional work or advertisement of professional
attainments or services. The Website address should be as near as possible to the
individual name/trade name, firm name of the Chartered Accountant in practice or firm
of Chartered Accountants in practice. The Ethical Standards Board (ESB) of ICAI will
decide in case there is any difficulty.
(22) The Website should mention the date upto which it is updated and the information
should not be at material variance from the information as per the ICAI’s records.
The website address of the member be obtained on annual basis in the annual form
required to be filed by the member while paying fee and the same be taken as entry
on record & the website address of the member be provided to members as part of the
membership record. If the member chose not to give his website address, it did not
prevent the Institute to take suitable action against him in case his noncompliance with
the guidelines.
A number of non-Chartered Accountants’ firms, corporate including banks, finance Companies and
newspapers have set up their own Websites providing advisory services on taxation and other areas
where Chartered Accountants are rendering professional service. Some of such Websites may
request Chartered Accountants or Chartered Accountants’ firms to provide consultation and advice

through their Websites. This would be permitted subject to the condition that on the Website, contact
address of the Chartered Accountant concerned is not provided nor such Website will contain any
material which advertises professional achievements or status of such Chartered Accountant except
making a statement that they are Chartered Accountants. The name of Chartered Accountants’ firm
with suffix “Chartered Accountants” would not be permitted.
Some of the decisions of the Council/High Courts on this clause are given below:
Solicitation – Where a chartered accountant firm issued a letter of authority in favour of two other
chartered accountants to accept and carry out audits of Co-operative Societies on its behalf and
they (the two chartered accountants) issued circulars of which the firm was not aware - Held, that
the firm was not guilty of professional misconduct. [V.B. Kirtane (1958)] But the person, in whose
favour the letter of authority was given in the above case, was held guilty. [MR Walke (1958)]
A chartered accountant sent a printed circular to a person unknown to him offering his services in
profit planning and profit improvement programmes. The circular conveyed the idea that it was meant
for strangers only. Held, the chartered accountant was guilty of professional misconduct under the
clause as he used the circulars to solicit clients and professional work. [B.S.N. Bhushan (1965)]
A chartered accountant wrote several letters to Assistant Registrars/ Registrars of Co-operative
Societies, Government of West Bengal requesting for allotment of audit work and to enroll his name-
on panel of auditors. Held he was guilty of professional misconduct under the clause. The activities
of the chartered accountant went much beyond the instructions of the Council to the effect that roving
enquiries should not be made with the Government Department for empaneling the name unless it
had been ascertained in advance that specific panel was being maintained. It was also held that an
auditor of co-operative societies under a license granted by co-operative department was not its
employee and, therefore, he could not solicit work. [Chief Auditor of Co-operative Societies, West
Bengal vs. B.B. Mukherjee (1967)]
A chartered accountant, inspite of the previous reprimand, sent letters to registrar Co-operative
societies, Calcutta, stating that no allotment of audit was made to him and requested to take action
immediately and oblige. Held he was guilty of professional misconduct under the clause. [D.N. Das
Gupta, Chief auditor of Co-operative Societies, West Bengal vs. B.B. Mukherjee (1969)]
A Chartered Accountant approached the principal of a secondary school through a third person
known to the principal for his appointment as auditor of that school. Further, the chartered
accountant misrepresented to the pervious Auditor that he had been offered appointment as auditor
of the school and enquired whether he had any objection to his accepting the same though it was a
fact that the appointment of chartered accountant was not made, the chartered accountant was guilty
of professional misconduct under the clause. It was further held that writing letter by the Chartered
Accountant to the previous auditor offering his services to audit the accounts of school was not
wrong as it was an offer to professional colleague and not to a prospective client. [M. L. Agarwal
(1973)]

A member was found guilty of professional misconduct under Clauses (6) and (7) Part I of the First
Schedule for having issued circular letter regarding change of address of his firm to persons who
were not in professional relationship with him and for having written to the shareholders thanking
them for appointing him as auditor. He was reprimanded by the Council under Section 21(4), on an
appeal made by the Council having regard to the ethical requirement about publicity by the members
of the Institute as laid down in the “Code of Conduct”. [K.K. Mehta vs. M..K. Kaul (1975)]
An advertisement was published in a newspaper containing the member’s photograph wherein he
was congratulated on the occasion of the opening ceremony of his office. He was found guilty by the
Council and later, by High Court of violating the Clause (soliciting work by advertisement). The
following observations of the High Court may be relevant.
(a) The advertisement which had been put in by the member is a noticeable one and the
profession of Chartered Accountancy should maintain high standards of integrity,
professional ethics and efficiency.
(b) If soliciting of work is allowed the independence and forthrightness of a Chartered Accountant
in the discharge of duties cannot be maintained and therefore some discipline must be
maintained by the profession. [G.P. Agrawal (1982)]
A member who got an advertisement published in a newspaper offering his “services in matters of
Accounts, Income Tax, Labour laws, Law matters and Management Services was found guilty in
terms of this clause as also under Clause (7). [Anil K. Garg (1987)]
A member had an advertisement published in a newspaper regarding inauguration of his
professional office. It was held that having regard to:
(i) the nature of the advertisement;
(ii) the function organised on that occasion;
(iii) the persons invited;
(iv) the medium used;
(v) the names of various concerns which had conveyed their good wishes;
(vi) the advertisement having been released by the Respondent himself and he had solicited
professional work by advertisement, he was found guilty in terms of this clause. [Shashindra
S. Ostwal (1988)]
A member wrote a letter to a Company in standard format highlighting his expertise in sales tax
matters and had requested for a draft of ` 200/- if his knowledge of the Sales tax matters has been
found worthwhile. The member was found guilty in terms of this Clause. [K.A. Gupta (1989)]
Where a Chartered Accountant had visited personally the clients for securing the appointment as
auditors of the Institutions. Held that he was guilty under Clause (6) of Part I of First Schedule. [J.S.
Bhati Vs. M.L Aggarwal. (1991)]

Where a Chartered Accountant had addressed an undated but signed letter to-a Bank requesting
for empanelment of his firm as auditor along with the particulars of his firm showing the past
experience and other details of the firm; and a Member of Parliament had also sent a letter to the
Bank recommending the name of the said Chartered Accountant’s firm for immediate empanelling
for Internal Audit/Inspection Audit/Management Audit, Expenditure Audit. Held that the member was
guilty under Clause (6) of Part I of the First Schedule. [Naresh C.Aggarwal (1992)]
Where a Chartered Accountant had sent a letter on the letterhead of his firm to a non-member
introducing himself as a chartered accountant giving details of services rendered by him and the
schedule of his fees for rending various kinds of services. Held that he was guilty under the clause.
[Vijay Kumar Goel (1994)]
Where a Chartered Accountant had written a letter to a Co-operative Society wherein he had
mentioned that he had been authorised by the Registrar of Societies to conduct the statutory audit
of the Societies and requested it to contact him. Held that it tantamount to solicitation of the audit
and he had violated the provisions of the clause. [M. V. Lonkar (1996)]
Illustrations:
1. Mr. S, a Chartered Accountant published a book and gave his personal details as the author.
These details also mentioned his professional experience and his present association as partner
with M/s RST, a firm.
Soliciting Professional Work: Clause (6) of Part I of the First Schedule to the Chartered
Accountants Act, 1949 refers to professional misconduct of a member in practice if he solicits client
or professional work either directly or indirectly, by circular, advertisement, personal
communication or interview or by any other means. Therefore, members should not adopt any
indirect methods to advertise their professional practice with a view to gain publicity and thereby
solicit clients or professional work. Such a restraint must be practiced so that members may
maintain their independence of judgement and may be able to command the respect of their
prospective clients. While elaborating forms of soliciting work, the Council has specified that a
member is not permitted to indicate in a book or an article, published by him, the association with
any firm of chartered accountants. In this case, Mr. S a Chartered Accountant published the book
and mentioned his professional experience and his association as a partner with M/s RST, a firm
of chartered accountants.
Conclusion: Mr. S being a chartered accountant in practice has committed the professional
misconduct by mentioning that at present he is a partner in M/s. RST, a chartered accountants
firm.
2. M/s XYZ, a firm of Chartered Accountants created a website “www.xyzindia.com”. The website
besides containing details of the firm and bio-data of the partners also contains the passport size
photographs of all the partners of the firm.
Hosting Details on Website: As per detailed guidelines of the ICAI laid down in
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949, a chartered

accountant of the firm can create its own website using any format subject to guidelines. However,
the website should be so designed that it does not solicit clients or professional work and should
not amount to direct or indirect advertisement. The guidelines of the ICAI to allow a firm to put up
the details of the firm, bio-data of partners and display of a passport size photograph.
Conclusion: In the case of M/s XYZ, all the guidelines seem to have been complied and there
appears to be no violation of the Chartered Accountants Act, 1949 and its Regulations.
3. The offer document of a listed company in which Mr. D, a practising Chartered Accountant is a
director mentions the name of Mr. D as a director along with his various professional attainments
and spheres of specialisation.
The Council of the ICAI has in a communication to members stated that if a public company, in
which a chartered accountant in practice is a director, issues a prospectus or gives any
announcement that gives descriptions about the Chartered Accountant’s expertise, specialisation
and knowledge in any particular field, it shall constitute a misconduct under Clauses (6) and (7) of
Part I of the First Schedule to the Chartered Accountants Act, 1949. The Council has further stated
that in such cases the member concerned has to take necessary steps to ensure that such
prospectus or public announcements or public communications do not advertise his professional
attainments and also that such prospectus or public announcements or public communications do
not directly or indirectly amount to solicitation of clients for professional work by the members.
Conclusion: Thus, in the instant case, Mr. D would be held to be guilty of professional mis-conduct
and liable for disciplinary action.
4. M/s LMN, a firm of Chartered Accountants responded to a tender from a State Government for
computerization of land revenue records. For this purpose, the firm also paid ` 50,000 as earnest
deposit as part of the terms of the tender.
Responding to Tenders: Clause (6) of Part I of the First Schedule to the Chartered Accountants
Act, 1949 lays down guidelines for responding to tenders, etc. As per the guidelines if a matter
relates to any services other than audit, members can respond to any tender. Further, in respect
of a non-exclusive area, members are permitted to pay reasonable amount towards earnest
money/security deposits.
Conclusion: In the instance case, since computerization of land revenue records does not fall
within exclusive areas for chartered accountants, M/s LMN can respond to tender as well as deposit
` 50,000 as earnest deposit and shall not have committed any professional misconduct.
5. Mr. Honest, a Chartered Accountant in practice, wrote two letters to M/s XY Chartered
Accountants a firm of CAs; requesting them to allot him some professional work. As he did not
have a significant practice or clients he also wrote a letter to M/s ABC, a firm of Chartered
Accountants for securing professional work. Mr. Clever, another CA, informed ICAI regarding Mr.
Honest's approach to secure the professional work. Is Mr. Honest wrong in soliciting professional
work?
Securing Professional Work: Clause (6) of Part I of the First Schedule to the Chartered

Accountants Act, 1949 states that a Chartered Accountant in practice shall be deemed to be guilty
of misconduct if he solicits clients or professional work either directly or indirectly by a circular,
advertisement, personal communication or interview or by any other means. Provided that nothing
herein contained shall be construed as preventing or prohibiting any Chartered Accountant from
applying or requesting for or inviting or securing professional work from another chartered
accountant in practice.
Such a restraint has been put so that the members maintain their independence of judgment and
may be able to command respect from their prospective clients.
Conclusion: In the given case, Mr. Honest wrote letters only to other Chartered Accountants, M/s
XY and M/s ABC requesting them to allot some professional work to him, which is not prohibited
under Clause (6) as explained above. Thus, Mr. Honest is not wrong in soliciting professional work.
Clause (7) Advertises his professional attainments or services, or uses any designation or
expressions other than the Chartered Accountant on professional documents, visiting cards,
letter heads or sign boards unless it be a degree of a University established by law in India
or recognized by the Central Government or a title indicating membership of the Institute of
Chartered Accountants or of any other institution that has been recognized by the Central
Government or may be recognized by the Council.
Provided that a member in practice may advertise through a write up, setting out the service
provided by him or his firm and particulars of his firm subject to such guidelines as may be
issued by the Council.
This clause prohibits advertising of professional attainments or services of a member. It also
restrains a member from using any designation or expression other than that of a Chartered
Accountant in documents through which the professional attainments of the member would come to
the notice of the public.
It is improper for a Chartered Accountant to state on his professional documents that he is an
Income-tax Consultant or a Cost Consultant or a Management Consultant.
The date of setting up the practice by a member or the date of establishment of the firm on the
letterheads and other professional documents, etc. should not be mentioned. However in the
Website, the year of establishment can be given on the specific “pull” request.
A member must not use the designation such as ‘Member of Parliament’, Municipal Councilor any
other functionary in addition to that of Chartered Accountant.
Members of the Institute in practice who are otherwise eligible may practice as advocates subject to
the permission of the Bar Council but in such case, they should not use designation ‘chartered
accountant in respect of the matters involving the practice as an advocate. In respect of other matters
they should use the designation ‘chartered accountant’ but they should not use the designation
‘chartered accountant’ and ‘advocate’ simultaneously.
It is not proper for Chartered Accountant to use the designation “Chartered Accountant” except on

professional documents, visiting cards, letterheads or sign boards and under the circumstances
clarified under para (f) of Clause (6).
The name, description and address of member (or firm) may appear in any directory or list of
members of a particular body in which the names are listed alphabetically. For a specialised directory
or a publication such as a “Who’s Who” (including those compiled on purely local basis), a member
should use his discretion in supplying information, bearing in mind the nature and purpose of the
publications. In addition to his name, description and address and those of his firm, a member may
give where appropriate, directorship held and reasonable personal details and may state his outside
interests. He should not, however, give the names of any of his clients or details of the service
offered by his firm.
Publication of Name or Firm Name by Chartered Accountants in the Telephone or other Directories
published by Telephone Authorities or Private Bodies. Detailed directions of the Council in this
regard are published under Clause (6).
There should be no objection to the publication of photographs and brief particulars of members in
magazines provided no payment is made for such publication and there is no advertisement of
professional attainments.
Further via a clarification on whether the Chartered Accountants in practice can print their
photograph on their visiting cards, the Ethical Standard Board (ESB) of the Institute has opinioned
that mostly the business class prints the photograph on their visiting cards for promoting their
business and soliciting clients. As such, it is not permissible for the chartered accountants in practice
to print their photograph on their visiting cards.
However, a member in practice is allowed to print Quick Response Code (QR Code) on the visiting
Card, provided that the Code does not contain information that is not otherwise permissible to be
printed on a visiting Card.
A special exemption has been made as regards publication of the name and address of a member
or that of his firm, with the description Chartered Accountant(s), in an advertisement appearing in
the press in the following circumstances, provided that the advertisement is not displayed more
prominently than is usual for such advertisements or the member or that of his firm with the
designation Chartered Accountant(s) appears in type not bolder than the substance of the
advertisement.
(a) Advertisements for recruiting staff in the members’ own office.
(b) Advertisements inserted on behalf of clients requiring staff or wishing to acquire or dispose
of business or property.
(c) Advertisement for the sale of a business or property by a member acting in a professional
capacity as trustee, liquidator or receiver.

When advertising for staff, it is desirable that members should avoid the expression such as “a well-
known firm”, since this would be form of advertisement. Similar considerations apply to
advertisements for articled clerks. The advertisements should not contain any promotional element
nor should there be any suggestion that the services offered by the Chartered Accountant or his firm
are superior to those offered by other accountants.
Notice in the press relating to the success in an examination of an individual candidate, should not
contain any element of undesirable publicity either in relation to the articled/audit clerk or an
employee or the member or the firm with whom he has served.
It is usual for local papers to publish details of the examination success of local candidates. Some
biographical information is often included. The rule aforementioned is not intended to discourage
the printing of news of local interest but is intended to indicate the need for restraint. The candidate’s
name and address, school and local background, examinations passed with details of any prize or
place gained, the name of the principal, firm and town in which the principal practices may be
published.
The reports and certificates issued by a Chartered Accountant brings him to the notice of the public
in a greater or lesser degree. It is therefore incumbent upon him to ensure that the extent and manner
of publications of certificates are limited to what is necessary to enable the report or certificate to
serve its proper purpose.
Member may appear on television and films and agree to broadcast in the Radio or give lectures at
forums and may give their names and describe themselves as Chartered Accountants. Special
qualifications or specialized knowledge directly relevant to the subject matter of the programme may
also be given but no reference should be made, in the case of practicing member to the name and
address or services of his firm. What he may say or write must not be promotional of his or his firm
but must be an objective professional view of the topic under consideration.
Publicity is permitted for appointments to positions of local or national importance or for the views
of members on matters of similar importance. Mention of the membership of the Institute is desirable
in such cases. What should be aimed at is to achieve suitable publicity for the Institute and its
member generally. Members giving talks or lectures or attending a conference may describe
themselves as Chartered Accountants only when they are acting in their capacity as Chartered
Accountant. Here again reference to the professional firm of the member should not be given.
A professional accountant in public practice holding training courses, seminars etc. for his staff may
also invite the staff of other professional accountants and clients to attend the same. However,
undue prominence should not be given to the name of the profession accountant in any booklet or
document issued in connection therewith.
Members writing articles or letters to the press on subjects connected with the profession may give
their names and use the description Chartered Accountants.

Council Guidelines for Advertisement for the Members in Practice

(Issued Pursuant to Clause (7) of Part I of the First Schedule to the Chartered Accountants Act,
1949)
The Members may advertise through a write up setting out their particulars or of their firms and
services provided by them subject to the following Guidelines and must be presented in such a
manner as to maintain the profession’s good reputation, dignity and its ability to serve the public
interest.
The Member(s)/Firm(s) should ensure that the contents of the Write up are true to the best of their
knowledge and belief and are in conformity with these Guidelines and be aware that the Institute of
Chartered Accountants of India does not own any responsibility whatsoever for such contents or
claims by the Writer Member(s)/ Firm(s).
With regard to the size of signboard for his office that member can put up, it is matter in which the
members should exercise their own discretion and good taste. Use of glow signs or lights on large-
sized boards as is used by traders or shop-keepers would not be proper. A member can have a
name board at the place of his residence with the designation of a Chartered Accountant provided
it is a name plate or name board of an individual member and not of the firm.
The Council has issued following Guidance Note for Members Holding Certificate of Practice on
acceptance of directorships in companies.
The Council’s attention has been drawn to the fact that more and more companies are appointing
Chartered Accountants as directors on their Boards. The prospectus or public announcements
issued by these companies often publish descriptions about the Chartered Accountant’s expertise,
specialization and knowledge in any particular field or add appellation or adjectives to their names.
Attention of the members in this context is invited to the provisions of Clauses (6) and (7) of Part I
of the First Schedule to the Chartered Accountants Act.
In order that the inclusion of the name of a member of the Institute in the prospectus or public
announcements or other public communications issued by the companies in which the member is a
director does not contravene the above noted provisions, it is necessary that the members should
take necessary steps to ensure that such prospectus or public announcements or public
communications do not advertise his professional attainments and also that such prospectus or
public announcements or public communications do not directly or indirectly amount to solicitation
of clients for professional work by the member. While it may be difficult to lay down a rigid rule in
this respect, the members must use their good judgement, depending upon the facts and
circumstances of each case to ensure that the above noted provisions are complied with both in
letter and spirit.
It is advisable for a member that as soon as he is appointed as a director on the Board of a Company,
he should specifically invite the attention of the management of the company to the aforesaid
provisions and should request that before any such prospectus or public announcements or public

communication mentioning the name of the member concerned, is issued, the material pertaining to
the member concerned should, as far as practicable be got approved by him The use of the
expression ‘Chartered Accountant’ is permissible. However, the member must ensure that
descriptions about his expertise, specialization and knowledge in any particular field of other
appellation or adjectives are not published with his name. Particulars about directorships held by
the member in other companies can, however, be given, but the name of the Firm of Chartered
Accountants in which the member is a partner, should not be given.
For use of logos by Members on letter heads, visiting cards etc. the Council has decided that the
logos unconnected with the first letter of the name of the firm or its partners or proprietors will not
be permitted for use by members in practice / firms of chartered accountants on their letter heads,
visiting cards etc. as the same amounts to advertisement or smacking of publicity. Accordingly, an
announcement was published in October, 1995 issue of “The Chartered Accountant”.
Subsequent to above, the Institute came across cases of registration of firm name in circumvention
of the provisions contained in the Regulation 190 of the Chartered Accountants Regulations, 1988.
The members/firms by themselves or through engineered name had been seeking to obtain firm
name approval based on the name of the partner/s selected in the manner that logo of the firm would
be identical to the firm name which would have not otherwise been permissible as firm name under
Regulation 190. In order to ensure compliance with the Regulations, the Council at its meeting held
in December, 1997, therefore, decided that the use of logo/monogram of any
kind/form/style/design/colour, etc. whatsoever on any display material or media e.g. paper
stationery, documents, visiting cards, magnetic devices, internet, sign board, by the members in
practice and/or the firm of Chartered Accountants, be prohibited. Use/printing of member/firm name
in any other manner tantamounting to logo/monogram was also prohibited.
An announcement was published in February, 1998 issue of the Journal at pages 54 & 55 informing
that the use of logo/monogram as above was prohibited with immediate effect in the case of newly
enrolled members in practice/new firms of Chartered Accountants. The members already in
practice/existing firms of Chartered Accountants using logo/monogram were advised to take
immediate steps for discontinuing use of the logo/monogram so as to stop using the logo/monogram
in any case before 1st July, 1998. The Council at its meeting held in December 1999 has reiterated
its decision to ban logo.
Some of the decisions of the Council/High Courts on this clause are given below:
A chartered accountant wrote several letters to Government Department, inter alia, pointing out
seniority of his firm, sending his life sketch and stating that he had a glorious record of service to
the country as well as to the organisation of accountancy profession with a view to get the audit
work. These letters were clearly in the nature of advertising professional attainments. Held, he
was guilty of professional misconduct under the clause. [Sirdar P.S. Sodhbans (1969)]
Where a Chartered Accountant had issued two insertions in a Journal published by a Chamber of

Commerce expressing his willingness to offer the concession in respect of all services offered by
him. Held that he was guilty under Clauses (6) & (7). [N.O. Abraham Isaac Raj (1992)]
Where a Chartered Accountant had addressed a letter to the Managing Director of a company
offering his services as a practicing chartered accountant and giving impression that the letter
had been addressed to more than one organization for the above purpose, it was held that the
member had contravened the provisions of Clauses (6) & (7). [Yogash Gupta (1996)]
A practising Chartered Accountant uses a visiting card in which he designates

himself, besides as Chartered Accountant, as a Tax Consultant
Tax Consultant: Section 7 of the Chartered Accountants Act, 1949 read with
Clause (7) of Part I of the First Schedule to the said Act prohibits advertising of professional
attainments or services of a member. It also restrains a member from using any designation or
expression other than that of a chartered accountant in documents through which the
professional attainments of the member would come to the notice of the public.
Under the clause, use of any designation or expression other than chartered accountant for a
chartered accountant in practice, on professional documents, visiting cards, etc. amounts to a
misconduct unless it be a degree of a university or a title indicating membership of any other
professional body recognised by the Central Government or the Council.
Conclusion: Thus, it is improper to use designation "Tax Consultant" since neither it is a degree
of a University established by law in India or recognised by the Central Government nor it is a
recognised professional membership by the Central Government or the Council.
B, a Chartered Accountant in practice is a partner in 3 firms. While printing his
personal letter heads, B gave the names of all the firms in which he is a partner.
Advertisement of Professional Attainments: Clause (7) of Part I of the First
Schedule to the Chartered Accountants Act, 1949 prohibits advertising of professional
attainments or services of a member. It also restrains a member from using any designation or
expression other than that of a Chartered Accountant in documents through which the
professional attainments of the member would come to the notice of the public. Even a member
is not permitted to specify the date of setting up of practice or establishment of firm on
letterheads. However, there is no prohibition for printing names of all the three firms on the
personal letterheads in which a member holding Certificate of Practice is a partner.
Conclusion: Thus, B is not guilty of any misconduct under the Chartered Accountants Act, 1949.
Clause (8) accepts a position as auditor previously held by another chartered accountant or
a certified auditor who has been issued certificate under the Restricted Certificate Rules, 1932
without first communicating with him in writing.
It must be pointed out that professional courtesy alone is not the major reason for requiring a member
to communicate with the existing accountant who is a member of the Institute or a certified auditor.

The underlying objective is that the member may have an opportunity to know the reasons for the
change in order to be able to safeguard his own interest the legitimate interest of the public and the
independence of the existing accountant. It is not intended, in any way, to prevent or obstruct the
change. When making the inquiry from the retiring auditor, the one proposed to be appointed or
already appointed should primarily find out whether there are any professional or other reasons why
he should not accept the appointment.
It is important to remember that every client has an inherent right to choose his accountant also that
he may, subject to compliance, with the statutory requirements in the case of limited companies,
make a change whenever he chooses, whether or not the reasons which had impelled him to do so
are good and valid. The change normally occurs where there has been a change of venue of
business and a local accountant is preferred or where the partner who has been dealing with the
client’s affairs retires or dies; or where temperaments clash or the client has some good reasons to
feel dissatisfied. In such cases, the retiring auditor should always accept the situation with good
grace.
The existence of a dispute as regards the fees not having been paid often may be the root cause of
an auditor being changed, but this would not constitute valid professional reasons on account of
which an audit should not be accepted by the member to whom it is offered. It is no doubt true that
the incoming auditor should in appropriate circumstances use his influence in favour of his
predecessor to have the disputes as regards the fees settled. Also a number of members would not
accept appointment in such circumstances unless and until they are satisfied that the predecessor
has been fairly treated, but there is no rule to that effect and the decision in this regard must rest
with the good sense of the member himself.
The professional reasons for not accepting an audit could be:
(i) Non-compliance of the provisions of Sections 224 and 225 of the Companies Act as
mentioned in Clause (9) [now Section 139, 140 and 142 read with Section 141 of the
Companies Act, 2013];
(ii) Non-payment of undisputed audit fees by auditees other than in case of sick units for carrying
out the statutory audit under the Companies Act or various other statutes; and
(iii) Issuance of a qualified report.
In the first two cases, an auditor who accepts the audit would be guilty of professional misconduct.
The Council has taken the view that the provision for audit fee made in accounts signed by both -
the auditee and auditor shall be considered as ‘undisputed’ audit fees. In this connection, attention
of members is invited to Council Guidelines No. 1-CA/(7)/02/2008 dated 08.08.08. In the said
guidelines, Council has explained that the provision for audit fee in accounts signed by both the
auditee and the auditor shall be considered as “undisputed” audit fee and “sick unit” shall mean
where the net worth is negative.

In the last case, however, he may accept the audit if he is satisfied that the attitude of the retiring
auditor was not proper and justified. If, on the other hand, he feels that the retiring auditor has
qualified the report for good and valid reasons, it would be a healthy practice not to accept the audit.
There is however no rule, written or unwritten, which would prevent an auditor from accepting the
appointment offered to him in these circumstances. However, before accepting the appointment he
should ascertain full facts of the case. For nothing will bring the profession to disrepute so much as
the knowledge amongst the public that if an auditor is found to be “inconvenient” by the client, he
could readily be replaced by another who would not displease the client and this point cannot be too
over-emphasized.
What should be the correct procedure to adopt when a prospective client tells you that he wants to
change his auditor and wants you to take up his work? There being two persons involved, the
company and the old auditor, the former should be asked whether the retiring auditor has been
informed of the intention to change. If the answer is in the affirmative, then a communication should
be addressed to the retiring auditor. If, however, it is learn that the old auditor has not been informed,
and the client is not willing to make the first move, it would be necessary to ask him the reason for
the proposed change. If there is no valid reason for a change, it would be healthy practice not to
accept the audit. If he decides to accept the audit he should address a communication to the retiring
auditor.
As stated earlier the object of the incoming auditor, in communicating with the retiring auditor is to
ascertain from him whether, there is any circumstances which warrants him not to accept the
appointment. For example, whether the previous auditor has been changed on account of having
qualified his report or he had expressed a wish not to continue on account of something inherently
wrong with the administration of the business. The retiring auditor may even give out information
regarding the condition of the accounts of the client or the reason that impelled him to qualify his
report. In all these cases it would be essential for the incoming auditor to carefully consider the facts
before deciding whether or not he should accept the audit, and should he do so, he must also take
into account the information while discharging his duties and responsibilities.
Sometimes, the retiring auditor fails without justifiable cause except a feeling of hurt because of the
change, to respond to the communication of the incoming auditor. So that it may not create a
deadlock, the auditor appointed can act, after waiting for a reasonable time for a reply.
The Council has taken the view that a mere posting of a letter “under certificate of posting” is not
sufficient to establish communication with the retiring auditor unless there is some evidence to show
that the letter has in fact reached the person communicated with. A Chartered Accountant who relies
solely upon a letter posted “under certificate of posting” therefore does so at his own risk.
The view taken by the Council has been confirmed in a decision by the Rajasthan High Court in J.S.
Bhati v.s. The Council of the Institute of Chartered Accountants of India and another. The following
observations of the Court are relevant in this context:

“Mere obtaining a certificate of posting in my opinion does not fulfil the requirements of Clause (8)
of Schedule I as the presumption under Section 114 of the Evidence Act that the letter in due course
reached the addressee cannot replace that positive degree of proof of the delivery of the letter to
the addressee which the letters of the law in that case required. The expression ‘in ‘ communication
with’ when read in the light of the instructions contained in the booklet ‘Code of Conduct’ (now Code
of Ethics) cannot be interpreted in any other manner but to mean that there should be positive
evidence of the fact that the communication addressed to the outgoing auditor by the incoming
auditor reached his hands. Certificate of posting of a letter cannot, in the circumstances, be taken
as a positive proof of its delivery to the addressee”.
Members should therefore communicate with a retiring auditor in such a manner as to retain in their
hands positive evidence of the delivery of the communication to the addressee. In the opinion of the
Council, communication by a letter sent “Registered Acknowledgment due” or by hand against a
written acknowledgment would in the normal course provide such evidence.
The Council is of the opinion that it would be a healthy practice if the practice of communication with
the member who had done the work previously is followed in every case where a Chartered
Accountant is required to give a certificate or in respect of a verification of the books of account for
special purpose as well as in cases where he is appointed as a Liquidator, Trustee or Receiver and
his predecessor was a Chartered Accountant.
As a matter of professional courtesy and professional obligation it is necessary for the new auditor
appointed to act jointly with the earlier auditor and to communicate with such earlier auditor.
It is desirable that a member, on receiving communication from the auditor who has been appointed
in his place, should send a reply to him as soon as possible setting out in detail the reasons which
according to him had given rise to the change and other attended circumstances but without
disclosing any information as regards the affairs of the client which he is not competent to do.
The Council has also laid down the detailed guidelines on the subject as under:
(1) The requirement for communicating with the previous auditor being a chartered accountant
in practice would apply to all types of audit viz., statutory audit, tax audit, internal audit,
concurrent audit or any other kind of audit.
(2) Various doubts have been raised by the members about the terms “audit”, “previous auditor”,
“Certificate” and “report”, normally while interpreting the aforesaid Clause (8). These terms
need to be clarified.
(3) As per para 2 of SA 200 on “Basic Principles Governing an Audit”, an “audit” is the
independent examination of financial information of any entity, whether profit oriented or not,
and irrespective of its size or legal form, when such an examination is conducted with a view
to expressing an opinion thereon.
(4) The term “previous auditor” means the immediately preceding auditor who held same or
similar assignment comprising same/similar scope of work. The mandatory communication

with the previous auditor being a Chartered Accountant is required ever in a case where the
previous auditor happens to be an auditor for a year other than the immediately preceding
year.
(5) As explained in para 2.2 of the Institute’s publication viz., ‘Guidance Note on Audit Report
and Certificates for Special Purposes’, a “certificate” is a written confirmation of the accuracy
of the facts stated therein and does not involve any estimate or opinion. A “report”, on the
other hand, a formal statement usually made after an enquiry, examination or review of
specified matters under report and includes the reporting auditor’s opinion thereon. Thus,
when a reporting auditor issue a certificate, he is responsible for the factual accuracy of what
is stated therein. On the other hand, when a reporting auditor gives a report, he is responsible
for ensuring that the report is based on factual data, that his opinion is in due accordance
with facts, and that it is arrived at by the application of due care and skill.
(6) A communication is mandatorily required for all types of audit/report if the previous auditor is
a chartered accountant. For certification, it would be healthy practice to communicate. In case
of assignments done by other professionals not being chartered accountants, it would also
be a healthy practice to communicate.
(7) Although the mandatory requirement of communication with previous auditor being chartered
accountant applies, in uniform manner, to audits of both government and non-government
entities, yet in the case of audit of government is made well in time to enable the obligation
must be complied with before accepting the audit. However, in case the time schedule given
for the assignment is such that there is no time to wait for the reply from the outgoing auditor,
the incoming auditor may give a conditional acceptance of the appointment and commence
the work which needs to be attended to immediately after he has sent the communication to
the previous auditor in accordance with this clause. In his acceptance letter, he should make
clear to the client that his acceptance of appointment is subject to professional objections, if
any, from the previous auditors and that he will decide about his final acceptance after taking
into account the information received from the previous auditor.
Some of the decisions of the BOD/Council/High Courts on this matter are briefly given in the
following paragraphs:
A Chartered Accountant commenced the work of audit on the very day he sent letter to the ‘previous
auditor - Held, he was guilty of professional misconduct under the clause. The appointment could
be accepted only when the outgoing auditor does not respond within a reasonable time. [S.N. Johri
vs. N.K. Jain (1973)]
A Chartered Accountant sent a registered letter to the previous auditor after the commencement of
the audit by him. Held he was guilty of professional misconduct under the clause. [Radhey Shyam
vs. K.S. Dubey (1974)]

A chartered accountant had sent a communication to the previous auditor under certificate of posting
without obtaining any acknowledgment thereof. The Council held the member guilty in terms of this
Clause. On an appeal made by the member, the High Court observed that the expression “in
communication with” when read in the light of the instructions contained in the booklet “Code of
Conduct” could not be interpreted in any other manner but to mean that there should be positive
evidence of the fact that the communication addressed to the outgoing auditor had reached his
hands. Certificate of Posting of a letter could not in the circumstances be taken as positive evidence
of its delivery to the addressee. [M.L. Agarwal vs. J.S. Bhati (1975)]
The provision of Clause (8) requiring a communication with the previous auditor is absolute and
applicable even in respect of an appointment by the Government agencies and even in case where
the member is aware that the previous auditor had been made aware of the appointment. [Rajeev
Kumar vs. R.K. Agrawal (1988)]
The requirements of Clause (8) of Part I of the First Schedule can be considered to have been
complied with only:
(i) if there is evidence that a communication to the previous auditor had been by R.P.A.D.
(ii) if there was positive evidence about delivery of the communication to the previous auditor.
In the absence of both, the member should be found to have contravened this Clause. [R.M. Singhai
vs. R.V. Agarwal (1988)]
Where a Chartered Accountant had conducted tax audit of a firm without first communicating in
writing with the Complainant, who was the previous tax auditor of the said firm. Held that he was
guilty under the clause. [V.A. Parikh vs. R.I. Galledar (1991)]
In this case the Respondent did not communicate with the Complainant being the previous auditor
while accepting the appointment of the aforesaid companies. The fact that the matter was impliedly
in the knowledge of the Complainant as contemplated by the Respondent in terms of the minutes of
the meeting held between the Complainant and the Respondent on 3rd October, 2001 does not
absolve the Respondent from ensuring the compliance with the requirements of Clause (8) of Part I
of the First Schedule to the Chartered Accountants Act, 1949. The onus lies on the incoming auditor
to communicate with the outgoing auditor which the Respondent has failed to do so. [CA. Manindra
Chandra Poddar vs. CA. Manas Ghosh (2013)]
Mr. X, a Chartered Accountant accepted his appointment as tax auditor of a firm

under Section 44AB, of the Income-tax Act, and commenced the tax audit within
two days of his appointment since the client was in a hurry to file Return of Income
before the due date. After commencing the audit, Mr. X realised his mistake of
accepting this tax audit without sending any communication to the previous tax auditor. In
order to rectify his mistake, before signing the tax audit report, he sent a registered post to the
previous auditor and obtained the postal acknowledgement. Will Mr. X be held guilty under the
Chartered Accountants Act?

Communication with the Previous Auditor: As per Clause (8) of Part I of First Schedule to
the Chartered Accountants Act, 1949, Mr. X will be held guilty since he has accepted the tax
audit, without first communicating with the previous auditor in writing. The object of the
incoming auditor communicating in writing with the retiring auditor is to ascertain whether there
are any circumstances which warrant him not to accept the appointment, for example, whether
the previous auditor has been changed on account of having qualified the report or he had
expressed a wish not to continue on account of something inherently wrong with the
administration of the business. The retiring auditor may even give out information regarding
the condition of the accounts of the client or the reason that impelled him to qualify his report.
Under all circumstances, it would be essential for the incoming auditor to carefully consider
the facts before deciding whether or not he should accept the audit. As a matter of professional
courtesy and professional obligation it is necessary for the new auditor appointed to
communicate with such earlier auditor.
W, a Chartered Accountant has sent letters under certificate of posting to the
previous auditor informing him his appointment as an auditor before the
commencement of audit by him.
Communication with the Previous Auditor: Clause (8) of Part I of the First
Schedule to the Chartered Accountants Act, 1949 requires communication by the incoming
auditor with the previous auditor before accepting a position by him. The Council of the Institute
has taken the view that a mere posting of a letter “under certificate of posting” is not sufficient
to establish communication with the retiring auditor unless there is some evidence to show that
the letter has in fact reached the person communicated with. A Chartered Accountant who
relies solely upon a letter posted “under certificate of posting” therefore does so at his own
risk. Since the letters were sent by “W” to the previous auditor informing him of his appointment
as an auditor before the commencement of audit by him under Certificate of Posting is not
sufficient to prove communication with the retiring auditor. In the opinion of the Council,
communication by a letter sent “Registered Acknowledgement Due” or by hand against a
written acknowledgement would in the normal course provide positive evidence.
Conclusion: Hence “W” was guilty of professional misconduct under Clause (8) of Part I of
First Schedule to the Chartered Accountants Act, 1949
Clause (9) Accepts an appointment as auditor of a company without first ascertaining from it
whether the requirements of Section 225 of the Companies Act, 1956, in respect of such
appointment have been duly complied with (now Section 139, 140 and 142 read with Section
141 of the Companies Act, 2013).
The Companies Act, 2013 provides for the requirements which an auditor appointed in respect of a
company should satisfy himself about, before he accepts the appointment. The relevant provisions
are contained in Sections 139, 140, 141 and 142 of the said Act. Section 139 contains several
provisions in the matter of appointment of auditors in different circumstances and situations; and
Section 140 lays down the procedure which must be followed when a company desires to change

its auditors, or when an auditor resigns from the company; whereas Section 141 provides the
eligibility, qualifications and disqualifications of auditors; and Section 142 contains the provisions
related to the remuneration of the auditor. In order that the validity of the appointment of an auditor
is not challenged or objected to by shareholders or the retiring auditors at a later date, it has been
made obligatory on the incoming auditor to ascertain from the company that the appropriate
procedure in the matter of appointment has been faithfully followed.
The following guidelines have been issued by the Council for this purpose:
(1) The steps to be taken by an auditor of a company who is appointed in the following
circumstances are indicated below:
(i) When the auditor appointed is the first auditor of the company.
(ii) When the auditor is appointed in place of an existing auditor who has resigned or has
been removed or has ceased to hold office for any other reason.
(iii) When the auditor or auditors appointed by the company were holding this office jointly
with others and one or more of such joint auditors are not reappointed.
(iv) When one or more of the auditors appointed by the company was/were not holding
this office earlier.
(2) Under Clause (9) of Part I of the First Schedule to the Chartered Accountants Act, 1949, the
incoming auditor has to ascertain whether the company has complied with the provisions of
the above sections. The word “ascertain” means “to find out for certain”. This would mean
that the incoming auditor should find out for certain as to whether the company has complied
with the provisions of Sections 224, 224A and 225 of the Companies Act, 1956 (now Section
139, 140 and 142 read with Section 141 of the Companies Act, 2013). In this respect, it would
not be sufficient for the incoming auditor to accept a certificate from the management of the
company that the provisions of the above sections have been complied with. It is necessary
for the incoming auditor to verify the relevant records of the company and ascertain as to
whether the company has, in fact, complied with the provisions of the above Sections. If the
company is not willing to allow the incoming auditor to verify the relevant records in order to
enable him to ascertain as to whether the provisions of the above sections have been
complied with, the incoming auditor should not accept the audit assignment.
(3) (A) As regards the mode of sending the notice of the resolution to the members of the
company as provided in Sections 224 and 225 (now Section 139, 140 and 142
read with Section 141 of the Companies Act, 2013), it should noted that there is
no provision that the notice should necessarily be sent by registered post. The
notice can be sent by the company in accordance with the provisions contained
in Section 53 (now Section 20 of the Companies Act, 2013).

For the purpose of better understanding to the students, the relevant provisions
of Section 20 of the Companies Act, 2013 are briefly summarised hereunder:
(i) A document may be served on a company or an officer thereof sending it
through registered post; or speed post; or courier service; or by leaving it
at its registered office; or by means of electronic transmission.
(ii) If the member or the person concerned has given specific direction to the
Company that the notice should be sent to him through a particular mode,
and has deposited with the Company the sum sufficient to defray the
expenses for this purpose, the notice should be sent in such specified
manner.
(iii) For above purposes, the courier means a document sent through a courier
which provides proof of delivery.
(B) If it is not practicable to send the notice of the resolution to the members by post, such
notice can be given either by advertisement in a newspaper having an appropriate
circulation or in any other mode allowed by the Articles of Association of the Company.
(C) In order to ascertain whether notice of the resolution has been sent to the members, the
incoming auditor should ascertain whether there is sufficient evidence with the Company
to indicate that the notice has been sent by any of the modes stated in (A) or (B) above.
The despatch register, postage register, postal certificate (if notice is sent under postal
certificate) or such other satisfactory evidence available with the company should be
verified.
(D) As regards the mode of sending the notice of the resolution to the retiring auditor as
provided in Sections 224 and 225 (now Section 139, 140 and 142 read with Section 141
of the Companies Act, 2013), attention is invited to the Department of Company Affairs
circular dated 17.10.1981 issued to all Chambers of Commerce, which is reproduced
below.
“I am directed to say that it has been reported by the Institute of Chartered Accountant
of India that difficulties are being experienced by retiring Auditors in the operation of the
provisions of Section 225 of the Companies Act, 1956 whenever any appointment of a
new auditor takes place. Such difficulties arise because of the fact that the copy of the
special notice required to be served under Section 225(2) of the Act on the retiring
auditors are not effectively served and proof of such service is not available. To obviate
such difficulties, therefore, it is advisable than the copy of the special notice under
Section 225(2) of the Act should be sent to the retiring auditors by Registered Post with
A/D.”
(E) Accordingly, it is necessary for the incoming auditor to satisfy himself that the notice
provided for in Sections 224 & 225 (now Section 139, 140 and 142 read with Section 141
of the Companies Act, 2013) has been effectively served on the outgoing auditor (e.g.

by seeing that the notice has been duly served through hand delivery or by Regd. Post
A.D.). Production of a certificate of posting by the company would not be adequate for
the purpose of the incoming auditor satisfying himself about compliance with Sections
224/225. Acknowledgement received from the outgoing auditor would be one of the forms
in which satisfaction can be obtained.
(4) A copy of the relevant minutes of the general meeting where the above resolution is passed
duly verified by the Chairman of the meeting should also be obtained by the incoming auditor
for his records.
(5) If any annual general meeting is adjourned without appointing an auditor, no special notice
for removal or replacement of the retiring auditor received after the adjournment can be taken
note of and acted upon by the company, since in terms of Section 190(1) of the Companies
Act, 1956 (now Section 115 of the Companies Act, 2013), special notice should be given to
the company at least fourteen clear days before the meeting in which the subject matter of
the notice is to be considered. The meeting contemplated in Section 190(1) undoubtedly is
the original meeting.
(6) If the incoming auditor is satisfied that the company has complied with the provisions of
Sections 224, 224A and 225 of the Companies Act, 1956 (now Section 139, 140 and 142
read with Section 141 of the Companies Act, 2013), he should first communicate with the
outgoing auditor in writing as provided in Clause (8) of Part I of the First Schedule to the
Chartered Accountants Act, 1949 before accepting the audit assignment.
In order to examine various ethical issues and safeguard the independence of the Auditors, the
Council has set up Ethical Standards Board. This Committee examines various issues concerning
professional ethics governing the members of the Institute which are either raised by the members
or are taken up based on their importance. The recommendations of the Committee are forwarded
to the Council for its consideration. This Committee is also charged with the responsibility of looking
into the cases of removal and resignation of auditors and making an appropriate report to the
Council. The following guidelines have been issued for this Committee for looking into the cases of
Removal of Auditors:
(A) Where an auditor resigns his appointment as an auditor of a Company or does not offer
himself for reappointment as auditor of such company, he shall send a communication, in
writing, to the Board of Directors of the Company giving reasons therefore if he considers that
there are professional reasons. Therefore, if he considers that there are professional reasons
connected with his resignation or not offering him for reappointment which, in his opinion
should be brought to the notice of the Board, and shall send a copy of such communication
to the Institute. It shall be obligatory on the incoming auditor, before accepting appointment,
to obtain a ‘copy of such communication, from the Beard and consider the same before
accepting the appointment.

(B) Where an auditor, though willing for reappointment has not been reappointed, he shall file
with the Institute a copy of the statement which he may have sent to the management of the
company for circulation among the shareholders. It shall be obligatory on the incoming auditor
before accepting the appointment, to obtain a copy of such a communication from the
company and consider it, before accepting the appointment.
(C) The Committee, on a review of the communications referred to in above paras may call for
such further information as it may require from the incoming auditor, the outgoing auditor and
the company and make a report to the Council in cases where it considers necessary.
(D) The above procedure is also followed in the case of removal of auditors by the government
and other statutory authorities.
[Students may note that, with the introduction of Companies Act, 2013, Clause 9 of
Part I of the First Schedule to the Chartered Accountants Act, 1949 also needs to be modified
in view of the new Companies Act, 2013. Till the time the Chartered Accountants Act, 1949
along with the “Code of Ethics” gets amended in accordance with Companies Act, 2013,
students may study and use section 139, 140 and 142 read with section 141 of the Companies
Act, 2013 while applying the above clause.
Further, students may refer Chapter 5 of the Study Material for detailed knowledge on the
abovementioned sections.]
CASE STUDY 1
CA Raja was appointed as the Auditor of Castle Ltd. for the year 2015-16. Since he declined to
accept the appointment, the Board of Directors appointed CA Rani as the auditor in the place of CA
Raja, which was also accepted by CA Rani.
Board can appoint the auditor in the case of casual vacancy under section 139(8) of the Companies
Act, 2013. The non-acceptance of appointment by CA. Raja does not constitute a casual vacancy to
be filled by the Board. In this case, it will be deemed that no auditor was appointed in the AGM.
Further, as per Section 139(10) of the Companies Act, 2013 when at any annual general meeting,
no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of the
company. The appointment of the auditor by the Board is defective in law.
Clause (9) of Part I of First Schedule to the Chartered Accountants Act, 1949 states that a chartered
accountant is deemed to be guilty of professional misconduct if he accepts an appointment as auditor
of a company without first ascertaining from it whether the requirements of section 225 of the
Companies Act, 1956 (now Section 139, 140 and 142 read with Section 141 of the Companies Act,
2013), in respect of such appointment have been fully complied with.
Conclusion: Hence, CA. Rani is guilty of professional misconduct since she accepted the
appointment without verification of statutory requirements.
CASE STUDY 2
Mrs. X is a Director of ABC Pvt. Ltd. During the year 2015-16, the company appointed CA Mr. Y,

Mrs. X's spouse, as its statutory auditor. Mr. Y used to deliver audit report without any comments or
disclosures, thereupon.
As per Section 141(3)(f) of the Companies Act, 2013, a person shall not be eligible for appointment
as an auditor of a company whose relative is a director or is in the employment of the company as
a director or key managerial personnel. The definition of ‘Relative’ includes husband and wife.
Clause (9) of Part I of the First Schedule to the Chartered Accountants Act, 1949, provides that a
member in practice shall be deemed to be guilty of professional misconduct if he accepts an
appointment as auditor of a company without first ascertaining from it whether the requirements of
Section 225 of the Companies Act, 1956 (now Section 139, 140 and 142 read with Section 141 of
the Companies Act, 2013), in respect of such appointment have been duly complied with.
In this case Mrs. X is a Director of ABC Pvt. Ltd. and the company has appointed Mr. Y, Chartered
Accountant, Mrs. X's spouse, as its statutory auditor. Mr. Y should not accept the appointment as
statutory auditor of the company, where his wife Mrs. X is a director. This is contravention of section
141 of the Companies Act, 2013.
Conclusion: Therefore, Mr. Y is liable for misconduct under the said clause since he accepted the
appointment without first verifying the compliance of statutory requirements.
Some decisions of the BOD/Council/High Courts on this subject are given below:
Failure to communicate with the previous auditor-
Where a chartered accountant failed to communicate in writing with the previous auditor of his
appointment as auditor of a co-operative bank and such omission was not intentional. Held that the
breach was only technical and that it was open to the High Court to award a lesser punishment than
removal of a member. [S.V. Kharwandikar vs. O.K. Borkar (1952)]
Where a chartered accountant applied in response to an advertisement in a newspaper for
appointment as auditor and was appointed by the Directors and failed to communicate with the
previous auditor and ascertain from the company whether the requirements of the Companies Act
as regards the appointment of the auditors were duly complied with. Held the respondent was guilty
on both the counts under Clauses (8) and (9). [B.N. Mohan vs. K.C.J. Satyawadi (1955)]
The contention w.r.t. deeming provision is not tenable as Section 224(2)(b) of the Companies Act,
1956 specifically requires that the retiring auditor has to give a notice in 365 writing of his
unwillingness to be reappointed and a mere silence in the matter cannot be taken as a ground to
appoint any other auditor without notice of an intended resolution to appoint some other person in
place of the retiring auditor. In view of this, the Board is of the view that the Respondent failed to
assess and verify that the compliance of Sections 224 and 225 of the Companies Act, before
accepting his appointment was complied with by the Company. Accordingly, in view of the Board,
the Respondent is held guilty of professional misconduct falling within the meaning of Clause (9) of
Part I of First Schedule of the Chartered Accountants Act, 1949. [Anil Kumar Goel vs. CA. Anurag
Nirbhaya (2014)]

Clause (10) Charges or offers to charge, accepts or offers to accept in respect of any
professional employment fees which are based on a percentage of profits or which are
contingent upon the findings, or results of such employment, except as permitted under any
regulations made under this Act.
What distinguishes a profession from a business is that professional services are not rendered with
the sole purpose of a profit motive. Personal gain is one but not the main or the only objective.
Professional opinion, therefore frowns upon methods where payment is made to depend on the basis
of results. It is obvious that a person who is to receive payment in direct proportion to the benefit
received by his client, may be tempted to exaggerate the advantage of his service or may adopt
means that are not ethical. It will have the effect of undermining his integrity and impairing his
independence. Therefore, members are prohibited from charging or accepting any remuneration
based on a percentage of the profits or on the happening of a particular contingency such as, the
successful outcome of an appeal in revenue proceedings.
Professional services should not be offered or rendered under an arrangement whereby no fee will
be charged unless a specified finding or result is obtained or where the fee is otherwise contingent
upon the findings or results of such services. However, fees should not be regarded as being,
contingent if fixed by a court or other public authority.
The Council of the Institute has however framed Regulation 192 which exempts members from the
operation of this clause in certain professional services. The said Regulation 192 is reproduced -
192. Restriction on fees - No Chartered Accountant in practice shall charge or offer to charge,
accept or offer to accept, in respect of any professional work, fees which are based on a percentage
of profits, or which are contingent upon the findings or results of such work, provided that:
(a) “In the case of a receiver or a liquidator, the fees may be based on a percentage of the
realization or disbursement of the assets;
(b) In the case of an auditor of a co-operative society, the fees may be based on a percentage
of the paid up capital or the working capital or the gross or net income or profits;
(c) In the case of a valuer for the purposes of direct taxes and duties, the fees may be based on
a percentage of the value of property valued;
(d) in the case of certain management consultancy services as may be decided by the resolution
of the Council from time to time, the fees may be based on percentage basis which may be
contingent upon the findings, or results of such work;
(e) in the case of certain fund raising services, the fees may be based on a percentage of the
fund raised;
(f) in the case of debt recovery services, the fees may be based on a percentage of the debt
recovered;

(g) in the case of services related to cost optimisation, the fees may be based on a percentage
of the benefit derived; and
(h) any other service or audit as may be decided by the Council.
Clause (11) Engages in any business or occupation other than the profession of chartered
accountant unless permitted by the Council so to engage.
Provided that nothing contained herein shall disentitle a chartered accountant from being a
director of a company (Not being managing director or a whole time director) unless he or
any of his partners is interested in such company as an auditor.
This is a provision introduced to restrain a member in practice from engaging himself in any business
or occupation other than that of chartered accountant except when permitted by the Council to be
so engaged. The objective is to restrain members from carrying on any other business in conjunction
with the profession of accountancy and combining such work with any business, which is not in
keeping with the dignity of the profession. Another reason for the introduction of such prohibition is
that a chartered accountant, if permitted to enter into all kinds of business, would be able to advertise
for his other business and thereby secure an unfair advantage in his professional practice.
The Council, on a very careful consideration of the matter, has formulated Regulation, 190A and
191 which are reproduced below, specifying the activities with which a member in practice can
associate himself with or without the permission of the Council.
190A. Chartered Accountant in practice not to engage in any other business or occupation.
“A chartered accountant in practice not to engage in any other business or occupation
other than the profession of accountancy except with the permission granted in
accordance with a resolution of the Council”.
191. Part-time employment a Chartered Accountant in practice may accept.
“Notwithstanding anything contained in Regulation 190A but subject to the control of the
Council, a chartered accountant in practice may act as a liquidator, trustee, executor,
administrator, arbitrator, receiver, adviser or representative for costing, financial or taxation
matter, or may take up an appointment that may be made by the Central Government or a
State Government or a court of law or any other legal authority or may act as a Secretary
in his professional capacity, provided his employment is not on a salary-cum-full-time
basis”.
Appendix 9 C.A. Regulations, 1988

The General and specific Resolutions passed by the Council under the power vested in it under
Regulation 190A as included in Appendix 9of C.A. Regulations, 1988 are also reproduced below for
information.

General Resolution
Permission granted generally - Members of the Institute in practice be generally permitted to
engage in the following categories of occupations, for which no specific permission from the Council
would be necessary in individual cases:
(1) Employment under Chartered Accountants in practice or firms of such chartered accountants.
(2) Private tutorship.
(3) Authorship of books and articles.
(4) Holding of Life Insurance Agency License for the limited purpose of getting renewal
commission.
(5) Attending classes and appearing for any examination.
(6) Holding of public elective offices such as M.P., M.L.A. and M.L.C.
(7) Honorary office leadership of charitable-educational or other non-commercial organisations.
(8) Acting as Notary Public, Justice of the Peace, Special Executive Magistrate and the like.
(9) Part-time tutorship under the coaching organisation of the Institute.
(10) Valuation of papers, acting as paper-setter, head-examiner or a moderator, for any
examination.
(11) Editorship of professional journals.
(12) Acting as Surveyor and Loss Assessor under the Insurance Act, 1938 provided they are
otherwise eligible.
(13) Acting as recovery consultant in the banking sector
(14) Owning agricultural land and carrying out agricultural activity (w.e.f. August 9 th, 2008).
Specific Resolution - Members of the Institute in practice may engage in the following categories
of business or occupations, after obtaining the specific and prior approval of the Council in each
case:
(1) Full-time or part-time employment in business concerns provided that the member and/or his
relatives do not hold “substantial interest” in such concerns.
(2) Full-time or part-time employment in non-business concern.
(3) Office of managing director or a whole-time director of a body corporate within the meaning
of the Companies Act, 1956 (now Companies Act, 2013).
(4) Interest in family business concerns (including such interest devolving on the members as a
result of inheritance / succession / partition of the family business) or concerns in which

interest has been acquired as a result of relationships and in the management of which no
active part is taken.
(5) Interest in an educational institution.
(6) Part-time or full-time lectureship for courses other than those relating to the Institute’s
examinations conducted under the auspices of the Institute or the Regional councils or their
branches.
(7) Part-time or full-time tutorship under any educational institution other than the coaching
organization of the Institute.
(8) Editorship of journals other than professional journals.
(9) Any other business or occupation for which the Executive Committee considers that
permission may be granted.
However, it is open to the Council to refuse permission in individual cases though covered under
any of the above categories. For the purpose of the above resolution:
(i) the expression “relative”, in relation to a member, means the husband, wife, brother or sister
or any lineal ascendant or descendant of that member;
(ii) a member shall be deemed to have a “substantial interest’ in a concern:
(a) In a case where the concern is a company, if its shares (not being shares entitled to a
fixed rate of dividend whether with or without a further right to participate in profit)
carrying not less than 20% of voting power at any time, during the relevant years are
owned beneficially by such member or by any one or more of the following persons or
partly by such member and partly by one or more of the following persons:
(i) one or more relatives of the member;
(ii) one or more partners and/or their relative;
(iii) any concern in which any of the persons referred to above has a substantial
interest.
(b) In the case of any other concern, if such member is entitled or the other persons
referred to above or such member and one or more of the other persons referred to
above or persons of such number and / or are more sections of such persons are
entitled in the aggregate, at any time during the relevant years not less than 20% of
the profits of such concern.
Attention of the members is also invited to para 3 of the above Resolution relating to the holding of
office of a managing director or a whole-time director in a company. In such cases, a member can
accept the office of a managing director or a whole- time director only after obtaining, the specific
and prior approval of the Council. Attention of the members is also invited to the provisions of Section
2(26) of the Companies Act, 1956 (now Section 2(54) of the Companies Act, 2013) under which

even where a person is not designated as a managing director or a whole-time director, he can be
deemed to be a managing director or a whole-time director if he is entrusted with the whole or
substantially the whole of the management of the affairs of the company. It may be pointed out that
a member cannot accept and hold the office of a managing director or a whole-time director in a
company if the member and/or his partners and relatives hold substantial interest in such a company.
The Council has considered the question of permitting members in practice to become a Director,
Managing Director, full time/Executive Director etc. and related issues and the following decisions
have been taken.
As regards the question of permitting member in practice to be a Director, Promoter/Promoter-
Director, Subscriber to the Memorandum and Articles of Association of any company including a
board managed company, it was decided that -
(a) Director of a Company
(i) The expression “Director Simplicitor” means an ordinary / simple Director.
(ii) A member in practice is permitted generally to be a Director Simplicitor in any company
including a board-managed company and as such he is not required to obtain any specific
permission of the council in this behalf irrespective of whether he and / or his relatives hold
substantial interest in that company.
A question arises, whether the auditor of a Subsidiary Company can be a Director of its Holding
Company-
The Ethical Standard Board (ESB) noted that, in terms of Clause (11) of Part I of the First Schedule
to the Chartered Accountants Act, 1949 a Chartered Accountant in practice can not engage (unless
permitted by the Council so to engage) in any business or occupation other that the profession of
Chartered Accountant but he can be a director of a Company (not being a managing director or
whole time director) wherein he or any of his partners is not interested in such company as an
auditor. The Board further noted that Public conscience is expected to be ahead of the law.
Members, therefore, are expected to interpret the requirement as regards independence much more
strictly than what the law requires and should not place themselves in positions which would either
compromise or jeopardise their independence. In view of the above, the Board, via a clarification,
decided that the auditor of a Subsidiary Company can’t be a Director of its Holding Company, as it
will affect the independence of an auditor.
(b) Promoter/Promoter Director - There is no bar for a member to be a promoter / signatory to the
Memorandum and Articles of Association of any company. There is also no bar for such a promoter
/ signatory to be a Director Simplicitor of that company irrespective of whether the object of the
company include areas which fall within the scope of the profession of chartered accounts. Therefore
members are not required to obtain specific permission of the Council in such cases.

Item Nos. 4 & 5 of the Specific Resolution would be equally applicable to member carrying out the
activities referred to therein in his capacity as Karta / representative of HUF provided he is not
actively engaged in carrying on such activities.
Students may also note that as per decision taken by appropriate authority in Council, Regulation
190A of the Chartered Accountants Regulations, 1988 provides that a chartered accountant in
practice shall not engage in any business or occupation other than the profession of accountancy,
except with the permission granted in accordance with a resolution of the Council. The Council has
passed a Resolution under Regulation 190A granting general permission (for private tutorship, and
part-time tutorship under Coaching organization of the Institute) and specific permission (for part-
time or full time tutorship under any educational institution other than Coaching organization of the
Institute). Such general and specific permission granted is subject to the condition that the direct
teaching hours devoted to such activities taken together should not exceed 25 hours a week in order
to be able to undertake attest functions.
Some of the decisions of the BOD/Council/High Courts on this clause are given below:
A chartered accountant in practice entered into partnership with persons who were not the members
of the Institute, for the purpose of carrying on business. The share of the chartered accountant in
the profit and losses was 25%. He was to take part in the business and was entitled to represent the
firm before Govt. authorities etc. He was operating the Bank account of the firm was receiving
moneys from the customers and was also looking after the affairs of the partnership. Held he was
guilty of professional misconduct under the clause, as he was engaged in the business, without the
permission of the Council. [K.S. Dugar (1980)]
A member in practice was authorised by a resolution of the Board of Directors of a company held on
4.9.81 to look after the day to do affairs of the company and other more than 51% the said company.
Later on 8.5.82, he applied to the Council for permission to hold the office of the Executive Chairman
of the said company. It was held on the basis of facts and circumstances of the case that during the
period 4.9.81 to 8.5.82 the member had engaged himself in ‘other occupation’ without the permission
of the Council and was found guilty in terms of this Clause. [M.K. Abrol and S.S. Bawa vs. V.P. Vijh
(1988)]
Where a Chartered Accountant who had held a salaried employment as an Assistant Manager
(Finance & Accounts) in addition to the practice of chartered accountancy without obtaining
permission of the Institute as required was held guilty under Clause (11) of Part I of First Schedule.
[Anil Kumar (1994)]
Where a Chartered Accountant while practicing as a chartered accountant had engaged himself in
other occupation as an LIC agent in another name. Held that he was guilty Clause (11) of First
Schedule. [C.I.T. (Admn.) vs. H.M. Giriya (1996)]
Where a charted Accountant had offered to help the Complainant in disposing of odd lot share
holding, sold them at much lower rate than he had sent of the Complainant notes etc. and the said

chartered accountant was personally involved in the share transfer and broker's business besides
his professional activities. Held that he was guilty under Clause (11) of Part I.
Where a charted Accountant was in full time employment besides holding full time Certificate of
Practice. Though, the Respondent submitted that he did not carry out any attestation function during
this period, yet the same cannot absolve him for the non-compliance. Thus, the Board held the
Respondent guilty of professional misconduct falling within the meaning of Clause (11) of Part I of
First Schedule to the Chartered Accountants (Amendment) Act, 2006. [CA. Shivaputra Mohan Jotwar
(2013)]
CASE STUDY
A chartered accountant holding certificate of practice and having four articled clerks registered
under him accepts appointment as a full-time lecturer in a college. Also he becomes a partner
with his brother in a business. Examine his conduct in the light of Chartered Accountants Act,
1949 and the regulations thereunder.
Clause (11) of Part I of the First Schedule to the Chartered Accountants Act, 1949 debars a
chartered accountant in practice from engaging in any business or occupation other than the
profession of chartered accountancy unless permitted by the Council of the Institute so to engage.
This clause, in effect, has empowered the Council of the Institute to permit chartered accountants
in practice to engage in any other business or occupation considered fit and proper. Accordingly,
the Council had formulated Regulations 190A and 191 to the Chartered Accountants Regulations,
1988 to provide a basis for considering applications of chartered accountants seeking permission
to engage in other business or occupation. A member can accept full- time lecturer-ship in a
college only after obtaining the specific and prior approval of the Council as also becoming a
partner in a business with his brother would require specific permission.
Conclusion: Thus, the chartered accountant is liable for professional misconduct since he failed
to obtain specific and prior approval of the Council in each case.
Mr. A, a practicing Chartered Accountant, took over as the executive chairman of Software
Company on 1.4.2019. On 10.4.2019 he applied to the Council for permission.
Specific Permission to be Obtained: As per Clause (11) of Part I of First Schedule to the
Chartered Accountants Act, 1949, a Chartered Accountant in practice will be deemed to be guilty
of professional misconduct if he engages in any business or occupation other than the profession
of Chartered Accountant unless permitted by the Council so to engage.
In the instant case, Mr. A took over as the executive chairman on 01.04.2019 and applied for
permission on 10.04.2019. On the basis of these facts, he was engaged in other occupation
between the period 01.04.2019 and 10.04.2019, without the permission of the Council.
Conclusion: Therefore, Mr. A is guilty of professional misconduct in terms of Clause (11) of Part
I of First Schedule to the Chartered Accountants Act, 1949.
C.A. Prabhu is a leading income tax practitioner and consultant for derivative products. He resides

in Mumbai near to the ABC commodity stock exchange and does trading in commodity derivatives.
Every day, he invests nearly 50% of his time to settle the commodity transactions. Is C.A. Prabhu
liable for professional misconduct?
Engaging into a Business: As per Clause (11) of Part I of First Schedule of Chartered
Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional
misconduct if he engages in any business or occupation other than the profession of Chartered
Accountant unless permitted by the Council so to engage.
However, the Council has granted general permission to the members to engage in certain
specific occupation. In respect of all other occupations specific permission of the Institute is
necessary.
In this case, CA. Prabhu is engaged in the occupation of trading in commodity derivatives which
is not covered under the general permission.
Conclusion: Hence, specific permission of the Institute has to be obtained otherwise he will be
deemed to be guilty of professional misconduct under Clause (11) of Part I of First Schedule of
Clause (12) Allows a person not being a member of the institute in practice or a member not
being his partner to sign on his behalf or on behalf of his firm, any balance sheet, profit and
loss account, report or financial statements.
The above clause prohibits a member from allowing another member who is not his partner to sign
any balance sheet, profit and loss account or financial statements on his behalf or on behalf of his
firm.
This clause is to be read in conjunction with Section 26 of the Chartered Accountants Act, 1949
which stipulates that ‘No person other than a member of the Institute shall sign any document on
behalf of a Chartered Accountant in practice or a firm of Chartered Accountants in his or its
professional capacity’.
The term ‘financial statement’ for the purposes of this clause would cover an examination of the
accounts or of financial statements given under a statutory enactment or otherwise. A report,
however, may cover a wider range of documents but in the context in which it is used in this clause,
it would mean only a report arising out of a professional assignment undertaken by him or his firm
and submitted by him or his firm to the client(s) or where so required, to an outsider on behalf of
himself or on behalf of the firm. The subject matter of report should be the expression of a
professional opinion whether, financial or non-financial. The financial statements and the reports
referred to in this clause obviously means the financial statements and reports as ultimately finalized
and submitted to the outside authorities.
The Council has clarified that the power to sign routine documents on which a professional opinion
or authentication is not required to be expressed may be delegated in the following instances and
such delegation will not attract provisions of this clause:

(i) Issue of audit queries during the course of audit.

(ii) Asking for information or issue of questionnaire.
(iii) Letter forwarding draft observations/financial statements.
(iv) Initiating and stamping of vouchers and of schedules prepared for the purpose of audit.
(v) Acknowledging and carrying on routine correspondence with clients.
(vi) Issue of memorandum of cash verification and other physical verification or recording the
results thereof in the books of the clients.
(vii) Issuing acknowledgements for records produced. Raising of bills and issuing
acknowledgements for money receipts.
(ix) Attending to routine matters in tax practice, subject to provisions of Section 288 of Income
Tax Act.
(x) Any other matter incidental to the office administration and routine work involved in practice
of accountancy.
It is also clarified that where the authority to sign documents given above is delegated by a chartered
accountant or by a firm of chartered accountants the fact that the documents have not been signed
by a chartered accountant is not a defence to him or to the firm in an enquiry relating to professional
misconduct.
However, the Council has decided that where a Chartered Accountant while signing a report or, a
financial statement or any other document is statutorily required to disclose his name, the member
should disclose his name while appending his signature on the report or document. Where there is
no such statutory requirement, the member may sign in the name of the firm.
Case Study 1
S, a practicing chartered accountant gives power of attorney to an employee chartered
accountant to sign reports and financial statements, on his behalf.
Power of Signing Reports and Financial Statements: Under Clause (12) of Part I of First
Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice is
deemed to be guilty of professional misconduct if he allows a person not being a member of the
Institute in practice or a member not being his partner to sign on his behalf or on behalf of his
firm, any balance sheet, profit and loss account, report or financial statements.
This clause read in conjunction with Section 26 of the Chartered Accountants Act, 1949
stipulates that no person other than the member of the institute shall sign any document on
behalf of a Chartered Accountant in practice or a firm of Chartered Accountants in his or its
professional capacity.
The term ‘Financial Statement’ for this purpose would cover an examination of the accounts or

financial statements given under a statutory enactment or otherwise.

Further, Clause (1) of Part II of the Second Schedule to the Chartered Accountants Act, 1949
states that a member of the Institute, whether in practice or not, shall be deemed to be guilty of
professional misconduct, if he contravenes any of the provisions of this Act or the regulations
made there under or any guidelines issued by the Council.
Conclusion: Accordingly, S is guilty of professional misconduct under Clause (12) of Part I of
First Schedule and also under Clause (1) of Part II of Second Schedule for contravening Section
26.
Case Study 2
CA. Smart, a practicing Chartered Accountant was on Europe tour between 15-9-16 and 25-9-
16. On 18-9-16 a message was received from one of his clients requesting for a stock certificate
to be produced to the bank on or before 20-9-16. Due to urgency,
CA. Smart directed his assistant, who is also a Chartered Accountant, to sign and issue the
stock certificate after due verification, on his behalf.
Allowing a Member Not Being a Partner to Sign Certificate: As per Clause (12) of Part I of
the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in practice
is deemed to be guilty of professional misconduct “if he allows a person not being a member of
the Institute in practice or a member not being his partner to sign on his behalf or on behalf of
his firm, any balance sheet, profit and loss account, report or financial statements”.
In this case, CA. Smart allowed his assistant who is not a partner but a member of the Institute
of Chartered Accountants of India to sign stock certificate on his behalf and thereby commits
misconduct.
Conclusion: Thus, CA. Smart is guilty of professional misconduct under Clause (12) of Part I
of First Schedule to the Chartered Accountants Act, 1949.
PART II - Professional misconduct in relation to members of the Institute in service

A member of the Institute (other than a member in practice) shall be deemed to be guilty of
professional misconduct, if he being an employee of any company, firm or person-
Clause (1) pays or allows or agrees to pay directly or indirectly to any person any share in
the emoluments of the employment undertaken by him.
A member of the Institute in service is deemed to be guilty of professional misconduct, if he is an
employee of any company, firm or person and during that course whatever emoluments he receives,
if he either pays or allows to pay or agree to pay any part or share thereof whether directly or
indirectly. However, this clause dose not restricts such sharing or commitments among relatives,
dependents, friends etc., if there is no relationship in procuring or retaining the job and payment is
not a consideration for job procurement or retainership.

The clear verdict of this clause is that job must be procured and retained with own professional
capabilities and not by any financial deal impairing professional dignity.
Clause (2) accepts or agrees to accept any part of fees, profits or gains from a lawyer, a
chartered accountant or broker engaged by such company, firm or person or agent or
customer of such company, firm or person by way of commission or gratification.
This clause restricts to accept or agrees to accept any part of fee, profits or gains from a lawyer, a
chartered accountant or broker engaged by such company, firm or person or agent or customer of
such company, firm or person by way of commission or gratification. The objective is that when a
member is in employment, he must maintain high level of ethics and should not accept any other
amount from anyone for which he is not entitled from employer under contractual agreement of
service.
[Note: A member in the foregoing circumstances would be guilty of misconduct regardless
of the fact that he was in whole-time or part-time employment or that he was holding
Certificate of Practice along with his employment.]
Case Study
Mr. 'C', a Chartered Accountant holds a certificate of practice while in employment also,
recommends a particular lawyer to his employer in respect of a case. The lawyer, out of the
professional fee received from employer paid a particular sum as referral fee to Mr. 'C'.
Referral Fee from Lawyer: According to Clause (2) of Part II of First Schedule of the Chartered
Accountant Act, 1949, a member of the Institute(other than a member in practice) shall be guilty
of professional misconduct, if he being an employee of any company, firm or person accepts or
agrees to accept any part of fee, profits or gains from a lawyer, a chartered accountant or broker
engaged by such company, firm or person or agent or customer of such company, firm or person
by way of commission or gratification.
In the present case, Mr. C who beside holding a certificate of practice, is also an employee and
by referring a lawyer to the company in respect of a case, he receives a particular sum as referral
fee from the lawyer out of his professional fee.
Conclusion: Therefore, Mr. C is guilty of professional misconduct by virtue of Clause (2) of Part
II of First schedule.
PART III - Professional misconduct in relation to members of the Institute generally

A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional
misconduct, if he -
Clause (1) not being a fellow of the Institute, acts as a fellow of the Institute.
Clause (2) does not supply the information called for, or does not comply with the
requirements asked for, by the Institute, Council or any of its Committees, Director
(Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the

Appellate Authority.
Clause (11) of Part I and Clauses (1) and (3) of Part III where a Chartered Accountant had not
disclosed to the Institute at any time about his engagement as a proprietor of a non-chartered
accountant’s firm while holding certificate of practice and had not furnished particulars of his
engagement as Director of a company despite various letters of the institute which remained
unreplied. Held that he was guilty under Clause (11) of Part I and Clauses (1) and (3) of Part III of
the First Schedule. [P.S. Rao (1992)]
Where a Chartered Accountant had continued to train an articled clerk though his name was removed
from the membership of the Institute and he had failed to send any reply to the Institute asking him to
send his explanation as to how he was training as his articled clerk when he was not a member of the
Institute. Held that he was guilty under Clause (2) of Part III of the First Schedule. [S.M. Vohra (1992)]
Case Study
1. Mr. 'G', while applying for a certificate of practice, did not fill in the columns which solicit
information about his engagement in other occupation or business, while he was indeed engaged
in a business.
Disclosure of Information: As per Clause (2) of Part III of First Schedule to the Chartered
Accountants Act, 1949 a member shall be held guilty if a Chartered Accountant, in practice or not,
does not supply the information called for, or does not comply with the requirements asked for, by
the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline, Disciplinary
Committee, Quality Review Board or the Appellate Authority;
In the given case, Mr. “G”, a Chartered Accountant while applying for a certificate of practice, did
not fill in the columns which solicit information about his engagement in other occupation or
business, while he was indeed engaged in a business. Details of engagement in business need to
be disclosed while applying for the certificate of practice as it was the information called for in the
application, by the Institute.
Conclusion: Thus, Mr. G will be held guilty for professional misconduct under the Clause (2) of Part
III of First Schedule of the Chartered Accountants Act, 1949.
2. Mr. X, a Chartered Accountant, employed as a paid Assistant with a Chartered Accountant firm.
On 31st December, 2016 he leaves the services of the firm. Despite many reminders from ICAI he
fails to reply regarding the date of leaving the services of the firm.
Failed to Supply Information Called For: As per Clause (2) of Part III of the First Schedule to the
Chartered Accountants Act, 1949, a member, whether in practice or not, will be deemed to be guilty
of professional misconduct if he does not supply the information called for, or does not comply with
the requirements asked for, by the Institute, Council or any of its Committees, Director (Discipline),
Board of Discipline, Disciplinary Committee, Quality Review Board or the Appellate authority.
Conclusion: Thus, in the given case, Mr. X has failed to reply to the letters of the Institute asking
him to confirm the date of leaving the service as a paid assistant. Therefore, he is held guilty of
professional misconduct as per Clause (2) of Part III of the First Schedule to the Chartered

Clause (3) while inviting professional work from another chartered accountant or while
responding to tenders or enquiries or while advertising through a write up, or anything as
provided for in items (6) and (7) of Part I of this Schedule, gives information knowing it to be false.
Any member of the Institute, in the course of procurement of professional work from another
Chartered Accountant or from any other source provides or renders any information which he knows
to be false through any documents, or acts (like tenders, enquiries, response to advertisement, CV
type write ups etc.), he would deemed to be guilty of professional misconduct under Clause (3), Part
III of First Schedule.
PART IV- Other misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other
misconduct, if he -
Clause (1) is held guilty by any civil or criminal court for an offence which is punishable with
imprisonment for a term not exceeding six months.
Clause (2) in the opinion of the Council, brings disrepute to the profession or the Institute as
a result of his action whether or not related to his professional work.
Case Study
YKS & Co., a proprietary firm of Chartered Accountants was appointed as concurrent auditor of a
bank. YKS used his influence for getting some cheques purchased and thereafter failed to repay
the loan/overdraft.
This is a case which is covered under the expression in other misconduct of the Chartered
Accountants Act, 1949. As per Clause (2) of Part IV of First Schedule to the Chartered
Accountants Act, 1949, a member of the Institute, whether in practice or not, shall be deemed to
be guilty of other misconduct, if he, in the opinion of the Council, brings disrepute to the profession
or the Institute as a result of his action whether or not related to his professional work. Here the
Chartered Accountant is expected to maintain the highest standards of integrity even in his
personal affairs and any deviation from these standards calls for disciplinary action.
In the present case, YKS & Co, being a concurrent auditor used his position to obtain the funds
and failed to repay the same to the bank. This brings disrepute to the profession of a Chartered
Accountant. This act of YKS & Co is not pardonable.
Conclusion: Therefore, YKS & Co will be held guilty of other misconduct under Clause (2) of Part
IV of First Schedule to the Chartered Accountants Act, 1949.
These Clauses (1) & (2) are self explanatory and any of the member of the Institute is found
guilty by any civil or criminal court and prosecuted for an imprisonment in an offence
involving moral turpitude or his acts bring disrepute to the profession or the Institute,
irrespective of the fact whether such acts are related to profession or not, such member will
be deemed to be guilty of other misconduct in Part IV of First Schedule.

The important point to note is that if imprisonment tenure exceeds six months, this case will be
covered in the Clause of Part III of Second Schedule.
8.2 THE SECOND SCHEDULE
Where the Director (Discipline) is of the opinion that a member is guilty of any professional or other
misconduct mentioned in the second schedule or in both the Schedule, he shall place the matter
before the Disciplinary Committee.
Part I - Professional Misconduct in relation to Chartered Accountant in practice
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he-
Clause (1) Discloses Information acquired in the course of his professional engagement to
any person other than his client so engaging him without the consent of his client or
otherwise than as required by any law for the time being in force.
An accountant in public practice has access to a great deal of information of his client, which is of a
highly confidential character. It is important for the work of an accountant and for maintaining the
dignity and status of the profession that he should treat such information as having been provided
to him, only to facilitate the performance of his professional duties for which his services have been
engaged. To divulge such information would be a breach of professional confidence, which may give
rise to the most serious consequences, even to an action by the client for the loss suffered by him
through such a breach. But for this confidence that the public has developed in the integrity of
accountants, it would not be possible for a person in a similar trade or industry to appoint the same
accountant. The accountant’s duty not to disclose continues even after the completion of his
assignment.
If disclosure is required as a part of performance of professional duty by a practicing member in
relation to a client, the fact that such performance is required by the client would itself amount to the
client consenting to such disclosure. Thus, a member in practice submitting information to, say,
exchange control authorities, while performing his professional duties cannot be considered to have
made disclosure without the aforesaid consent. But, in all cases, the request or the initiative that the
members do prefer the service, which would entail such disclosure, must come from the client in
relation to whose affairs the disclosure would be entailed.
If disclosure is required in other cases, it would be necessary to ensure that the consent of the client
is given by a person who is competent to accord such consent. Thus, in the case of a sole proprietary
concern, the consent may be given by the proprietor or his constituted attorney who is legally
empowered to give such consent. In the case of partnership firm, since in turn, every partner has
the authority to bind the firm by his acts, the consent may be given by any partner. In the case of a
company, by virtue of section 179 of the Companies Act, 2013, the Board of Directors is empowered
to do all that the company in a general meeting may do unless a resolution by the company in general
meeting is required by the Act or by the Memorandum or Articles of the company. Hence, the consent
may be given by the Managing Director if the powers of the Board of Directors are delegated to him

comprehensively enough to include the power to give such consent, but if the powers of the Board
of Directors are not so delegated, the consent should be obtained by means of resolution of the
Board of Directors of the Company.
An auditor is not required to provide the client or other auditors of the same enterprise or its related
enterprise such as a parent or a subsidiary, access to his audit working papers. The main auditors
of an enterprise do not have right of access to the audit working papers of the branch auditors. In
the case of a company, the statutory auditor has to consider the report of the branch auditor and
has a right to seek clarifications and/or to visit the branch if he deems it necessary to do so for the
performance of the duties as auditor. An auditor can rely on the work of another auditor, without
having any right of access to the audit working papers of the other auditor. For this purpose, the
term ‘auditor’ includes ‘internal auditor’.
However, the auditor may, at his discretion, in cases considered appropriate by him, make portions
of or extracts from his working papers available to the client. The above clarification has been
published in April, 2000 issue of the Journal, ‘The Chartered Accountant’.
It is not possible to set out all the circumstances under which disclosure of information may be
required by law. If under any legal compulsion and if it is not legally permissible to claim privilege
under the Evidence Act, 1872 (Section 126), the disclosure made by a member of such information
may not be considered as misconduct. However, such matters involve niceties of law and expert
legal advice may be sought prior to, such disclosure.
The only circumstance in which this duty of confidence may give rise to a difficulty is where the
accountant has reason to believe that the client has been guilty of some unlawful act or default. This
matter is of special significance in the case where the client is guilty of tax evasion.
Further, students may note that as per section 143(12) of the Companies Act, 2013, if an auditor of
a company, in the course of the performance of his duties as auditor, has reason to believe that an
offence involving fraud is being or has been committed against the company by officers or employees
of the company, he shall immediately report the matter to the Central Government within 60 days of
his knowledge and after following the prescribed procedure.
Role of chartered accountants in relation to unlawful acts by their clients -
(1) The question of the member’s liability when he is not directly involved in tax frauds committed
by his client but he discovers such fraud in the course of his professional work, the action
recommended to be taken by him is indicated below. These recommendations are generally
in line with similar recommendations made by the Institute of chartered accountants in
England and Wales for the guidance of its members.
(2) The recommendations below are based on the following premises:
(a) No duty is cast on a member, whether by Section 44 of Criminal Procedure Code, or
by any other enactment, to inform the Income tax Authorities about taxation frauds by
his client of which he comes to know during the course of his professional work.

(b) Under Section 126 of the Evidence Act, a barrister, attorney, pleader or Vakil is barred
from disclosing except with the express consent of his client, any communication made
to him in the course of and for the purpose of his employment or to state the contents
or conditions of any document with which he has become acquainted in such course.
The proceedings before the Income tax authorities are judicial proceedings and the
assessee is authorized to be represented by a chartered accountant. The privilege
given and the restrictions imposed by Section 126 apply as between the client and the
member as the member is the client’s attorney. Nothing in Section 126 shall protect
from disclosure of any fact observed by a barrister, pleader, attorney or Vakil in the
course of his employment of such showing that any crime or fraud has been committed
since the commencement of his employment.
(c) Subject to the above, it is not the duty of a member to shield a client from the
consequences of his tax frauds; on the contrary it is guiding principle of professional
conduct to discourage tax evasion.
(3) The paragraphs that follow apply to intentional suppressions or misstatement by the client in
his tax returns. If there is a genuine mistake or inadvertent omission, it is presumed that the
client would not have any objection to make a complete disclosure to the tax authorities.
(4) If the fraud discovered by the member relates to the accounts or tax matters of the client for
past year(s) for which the client was not represented by the member, the client should be
advised to make a disclosure. The member may, however, continue to act for the client in
respect of current matters, but is under no obligation so to continue. It is assumed that the
past fraud does not affect in any way the current tax matters, and the member should be extra
careful to ensure that past behaviour is not reflected in current matters.
(5) If the fraud relates to accounts etc., examined by the member and reported upon, on the basis
of which the tax assessment in the past has been made, or is currently to be made, the client
should be advised to make a complete disclosure. If the client should refuse, he should be
informed that the member would be entitled to dissociate himself from the case, and that,
further, he would inform the authorities that the accounts prepared by him and/or reported
upon by him are unreliable, on account of certain information since obtained. He should then
make such a report to the authorities. But the information subsequently obtained should not
as such be communicated to the authorities, unless the client consents in writing.
(6) Normally, if disclosure is consented to by the client it should be made immediately. But if the
suppression is trivial, the disclosure may be made when the current return is submitted. But
if there is any possibility that the collection of tax would be prejudiced, on account of the client
disposing of his property or removing his person from the jurisdiction of the Income-tax
authorities the postponement of disclosure would be improper.
(7) If the suppression etc. relates to accounts or returns currently being prepared, the member
should advise the client to make full disclosure in the accounts and/or return, and should the

client refuse, he should make full reservation in his report, and should not associate himself
with the return.
(8) If the employment of the member is dispensed with before the accounts are completed or are
reported on, or the return is submitted, no further duty regarding disclosure etc. rests on the
member.
(9) The suppression may relate to accounts, which are not prepared and/or reported upon by the
member, e.g. personal income, from investments other than business investments etc. The
client may refuse full disclosure in the tax return but still wish that the member should continue
to prepare and/ or report on his business accounts, though this is quite unlikely in practice. If
so requested, the member may continue to do so, but is under no obligation so to do.
(10) It should be impressed on the client that:
(a) While disclosure may entail only monetary penalties, nondisclosure and subsequent
discovery thereof may entail imprisonment and fine, in addition to penalties.
(b) Any intimation by the member to the Income tax authorities that the member
dissociates himself from the case is certain to start investigation by them in the whole
matter.
(11) The Income-tax authorities may summon the member for the purpose of examining him on
oath, under Section 131(1) of the Income tax Act. The immunity from disclosure afforded by
Section 126 of the Evidence Act, and the extent of such immunity are questions, which involve
niceties of law, and expert legal advice should be sought in the matter. The refusal of the
member to disclose may be taken down, and he may be required to certify it on oath.
(12) Production of books of account and other documents may be called for under Section 131(1).
Here also the protection offered by Section 126 of the Evidence Act, is a matter for expert
legal advice.
Case Study
Mr. Parekh, a Chartered Accountant was invited by the Chamber of Commerce to present a
paper in a symposium on the issues facing Indian Leather Industry. During the course of his
presentation he shared some of the vital information of his client’s business under the
impression that it will help the Nation to compete with other countries at international level.
Disclosure of Client’s Information: Clause (1) of Part I of the Second Schedule to the
Chartered Accountants Act, 1949 deals with the professional misconduct relating to the
disclosure of information by a chartered accountant in practice relating to the business of his
clients to any person other than his client without the consent of his client or otherwise than as
required by any law for the time being in force would amount to breach of conduct. The Code of
Ethics further clarifies that such a duty continues even after completion of the assignment. The
Chartered Accountant may however, disclose the information in case it is required as a part of

performance of his professional duties. In the given case, Mr. Parekh has disclosed vital
information of his client’s business without the consent of the client under the impression that it
will help the nation to compete with other countries at International level.
Conclusion: Thus it is a professional misconduct covered by Clause (1) of Part I of Second
Schedule to the Chartered Accountants Act, 1949.
Clause (2) If he certifies or submits in his name or in the name of his firm, a report of an
examination of financial statements unless the examination of such statements and the
related records has been made by him or by a partner or an employee In his firm or by another
chartered accountant in practice.
The above clause restrains a member from subscribing to the report on a financial statement so long
as it has not been examined by him or by a partner or an employee of his firm or by another chartered
accountant in practice. It has been introduced to ensure that the work entrusted to him has been carried
out by the member either directly or under his supervision before he renders his report.
An exception however has been made in respect of an examination carried out by another chartered
accountant in practice. This enables two or more members to accept a joint assignment or enables
a member also to carry out the examination of financial statements by or with the assistance of all
or either any chartered accountant in practice.
Where the joint auditors are appointed, the work is normally divided among themselves in terms of
identifiable units or areas, or with reference to the items of liabilities, or income or expenditure or to
the period of time etc. Such division should be adequately documented and communicated to the
auditee.
In the course of his work, where a joint auditor comes across matters requiring discussion with or
application of judgement by the joint auditors, he must communicate to the other joint auditors before
submission of the report.
In respect of audit work divided among the joint auditors, each joint auditor is responsible only for
the work allocated to him, whether or not he has prepared a separate report on the work performed
by him. On the other hand, all the joint auditors are jointly and severally responsible in accordance
with SA 299 “Joint Audit of Financial Statements”:
Each joint auditor should decide for himself the appropriateness of using test checks or sampling,
the nature, timing and extent of audit procedures to be applied in relation to the work allotted to him.
Obtaining and evaluating the information and explanations from the management is the joint
responsibility of the joint auditors unless they agree upon a specific pattern of distribution of this
responsibility. In case of distribution of the responsibility, the liability of the joint auditors is limited
to the area allotted to that auditor.
Case Study
Mr. A, a Chartered Accountant was the auditor of 'A Limited'. During the financial year
2015-16, the investment appeared in the Balance Sheet of the company of ` 10 lakhs and was

the same amount as in the last year. Later on, it was found that the company's investments were
only ` 25,000, but the value of investments was inflated for the purpose of obtaining higher
amount of Bank loan.
Grossly Negligent in Conduct of Duties: As per Part I of Second Schedule to the Chartered
Accountants Act, 1949, a Chartered Accountant in practice shall be deemed to be guilty of
professional misconduct, if he, certifies or submits in his name or in the name of his firm, a
report of an examination of financial statements unless the examination of such statements and
the related records has been made by him or by a partner or an employee in his firm or by
another chartered accountant in practice, under Clause (2); does not exercise due diligence, or
is grossly negligent in the conduct of his professional duties, under Clause (7); or fails to obtain
sufficient information which is necessary for expression of an opinion or its exceptions are
sufficiently material to negate the expression of an opinion, under Clause (8).
The primary duty of physical verification and valuation of investments is of the management.
However, the auditor’s duty is also to verify the physical existence and valuation of investments
placed, at least on the last day of the accounting year. The auditor should verify the documentary
evidence for the cost/value and physical existence of the investments at the end of the year. He
should not blindly rely upon the Management’s representation.
In the instant case, such non-verification happened for two years. It also appears that auditors
failed to confirm the value of investments from any proper source. In case auditor has simply
relied on the management’s representation, the auditor has failed to perform his duty.
Conclusion: Accordingly, Mr. A, will be held liable for professional misconduct under Clauses
(2), (7) and (8) of Part I of the Second Schedule to the Chartered Accountants Act, 1949.
Clause (3) Permits his name or the name of his firm to be used in connection with an estimate
of earnings contingent upon future transactions in manner which may lead to the belief that
he vouches for the accuracy of the forecast.
The Council has issued Standard on Assurance Engagements (SAE) 3400, “The Examination of
Prospective Financial Information”, which is effective in relation to reports on projections/forecasts,
issued on or after April 1, 2007. Pursuant to the issuance of this Standard, the Guidance Note on
Accountant’s Report on Profit Forecasts and/or Financial Forecasts, issued in September, 1982
stands withdrawn. The guidance provided in this Standard is in line with the provisions of Clause (3)
of Part I of the Second Schedule to the Chartered Accountants Act, 1949. As per the opinion of the
Council while finalising the Guidance Note on Accountant’s Report on Profit Forecasts and/or
Financial Forecasts at its 100th meeting held on 22nd through 24th July 1982, a chartered accountant
can participate in the preparation of profit or financial forecasts and can review them, provided he
indicates clearly in his report the sources of information, the basis of forecasts and also the major
assumptions made in arriving at the forecasts and so long as he does not vouch for the accuracy of
the forecasts. The Council has further opined that the same opinion would also apply to projections
made on the basis of hypothetical assumptions about future events and management actions which
are not necessarily expected to take place so long as the auditor does not vouch for the accuracy

of the projection. Further, the attention of the members is drawn to “Guidance Note on Reports in
Company Prospectuses (Revised)” issued by the Council. This Guidance Note provides guidance
on compliance with the provisions of the Companies Act and the Securities and Exchange Board of
India (Disclosure and Investor Protection) Guidelines, relating to the reports required to be issued
by chartered accountants in prospectus/statement in lieu of prospectus issued by the companies for
the offerings made in India.
Clause (4) Expresses his opinion on financial statements of any business or enterprise in
which he, his firm, or a partner in his firm has a substantial interest.
In this connection attention of members is also invited to Chapter IV of Council Guidelines No. 1-
CA(7)/02/2008 dated 8th August, 2008. The said guidelines state that a member of the Institute shall
not express his opinion on financial statements of any business or enterprise in which one or more
persons, who are his “relatives” within the meaning of Accounting Standard (AS-18) has/have either
by themselves or in conjunction with such members, a substantial interest in the said business or
enterprise.
Many new areas of professional work have been added, e.g., Tax Audit, Concurrent Audit of Banks,
Concurrent Audit of Borrowers of Financial institutions, Audit of non-corporate borrowers of banks
and financial institutions, audit of stock exchange, brokers etc. The Council wishes to emphasize
that the aforesaid requirement of Clause (4) are equally applicable while performing all types of
attest functions by the members. Some of the situations which may arise in the applicability of Clause
(4) are discussed below for the guidance of members:
(1) Where the member, his firm or his partner or his relative has substantial interest in the
business or enterprise.
The independence of mind is a fundamental concept of audit and/or expression of opinion on
the financial statements in any form and, therefore, must always be maintained. Nothing can
substitute for the essential and fundamental requirements of independence. Therefore, the
Council’s views are clarified in the following circumstances.
(i) An enterprise/concern of which a member is either an owner or a partner. The holding
of interest in the business or enterprise by a member himself whether as sole-
proprietor or partner in a firm, in the opinion of the Council, would affect his
independence of mind in the performance of professional duties in conducting the audit
and/or expressing an opinion on financial statements of such enterprise. Therefore, a
member should not audit financial statements of such business or enterprise.
(ii) Where the partner or relative of a member has substantial interest: The holding of
substantial interest by the partner or relative of the member in the business or
enterprise of which the audit is to be carried out and opinion is to be expressed on the
financial statement, may also affect the independence of mind of the member, in the
opinion of Council, in the performance of professional duties. Therefore, the member

may, for the same reasons as not to compromise his independence, refrain from
undertaking the audit of financial statements of such business or enterprise.
(2) Where the member or his partner or relative is a director or in the employment of an officer
or an employee of the company.
Section 141 of the Companies Act, 2013 specifically prohibits a member from auditing the accounts
of a company in which he is an officer or employee. Although the provisions of the aforesaid section
are not specifically applicable in the context of audits performed under other statues, e.g. tax audit,
yet the underlying principle of independence of mind is equally applicable in those situations also.
Therefore, the Council’s views are clarified in the following situations.
In cases where the member is a director of a company the financial statements of which are to be
audited and/or opinion is to be expressed, he should not undertake such job and/or express opinion
on the financial statements of that company.
The Council has clarified that the members are not permitted to write books of account of their
auditee clients.
A statutory auditor of a company cannot also be its internal auditor, as it will not be possible for him
to give independent and objective report.
A member should satisfy himself before accepting an appointment as an auditor of an entity that his
appointment is in accordance with the statute governing the entity. In case the entity is constituted
under a trust deed / instrument, the member should satisfy whether his appointment is valid
according to the instrument constituting the entity and rules made hereunder. In case the
appointment is to be authorized by the regulatory authorities such as in the case of cooperative
societies, trusts etc. then the member must satisfy whether such regulatory authorities have
authorized the managing committee of the society / trust for appointment of the auditors. In a case
where any entity is being managed by a Managing Committee or Board of Trustees or Board of
Governors by whatever name called he should ensure that his appointment is duly made by a
resolution passed of such Managing Committee or Board of Trustees of Board of Governors. Even
in case of partnership or sole proprietary, the member must ensure that a letter of appointment/
engagement is given by a financial statement before he accepts the assignment.
Clause (5) fails to disclose a material fact known to him which is not disclosed in a financial
statement, but disclosure of which is necessary in making such financial statement not
misleading where he is concerned with that financial statement in a professional capacity.
It may be observed that this clause refers to failure to disclose a material fact, which is known to
him, in a financial statement reported on by the auditor. It is obvious, that before a member could
be held guilty of misconduct, materiality has to be established. The determination of materiality has
been provided in SA 320, “Materiality in Planning and Performing an Audit”.
It should be borne in mind that there may be cases where an item may not be material from the point
of view of the balance sheet, but may have material significance in relation to the profit and loss

account for that year and vice-versa. It is therefore essential that care should be taken to ensure
that the aspect of materiality should be judged in relation to both the balance sheet and the profit
and loss account.
The word “financial statements” used in this clause would cover both reports and certificate usually
given after an examination of the accounts or of financial statements under any statutory enactment,
or/for purposes of income tax assessments. This would not however, apply to cases where such
statements are prepared by members in employment purely for the information of their respective
employers in the normal course of their duties and not meant to be submitted to any outside
authority.
Some of the decisions of the Courts on this clause are briefly given below-
Where a Chartered Accountant failed to report to the shareholders of a company about the non-
creation of a sinking fund in accordance with the Debenture Trust Deed and did not make clear that
the amounts shown as towards sinking fund were borrowed from the managing agents of the
company-Held, that the chartered accountant was duty bound to see that the nature and subject
matter of the charge over a security and the nature and mode of valuation of the sinking fund
investment were disclosed in the Balance Sheet in accordance with Form F and he was found guilty
of misconduct. [Davar & Sons Ltd. vs M.S. Krishnaswamy (1952)]
Where a Chartered Accountant failed to examine how debts became bad and were written off-Held
he was guilty under Clause (5). [A. Doraiswami/ Naidu-vs. P.M. Raghavendra Rao (1965)]
Where a Chartered Accountant had not disclosed the fact that a large amount of loan have been
given out of the funds of an Employees Provident Fund to the Employer Company in contravention
of the Rules of the Provident Fund and had failed to report on the default in clearing the cheques
received in re-payment of the loan. Held by the High Court that he was not guilty of any
nondisclosure to the individual subscribers of the Provident Fund because he owed no duty to
disclose to them and he was well within his rights to have disclosed the irregularities to the trustees
themselves and to the company which had appointed him. Held by the Supreme Court on appeal
that it was no defence for the chartered accountant to say that he had disclosed the irregularities to
the company as it was his duty to have made a disclosure thereof to the beneficiaries of the Provident
Fund in the statement of accounts signed by him as the legal position of the auditor in the present
case was similar to that of the auditor appointed under the Companies Act. He was therefore guilty
of professional misconduct under Clause (5). [Kishori Lal Dutta vs-P.K. Mukherjee (1968)]
Case Study
Mr. Joe, a Chartered Accountant during the course of audit of M/s XYZ Ltd. came to know that
the company has taken a loan of ` 10 lakhs from Employees Provident Fund. The said loan was
not reflected in the books of account. However, the auditor ignored this information in his report.
Failure to Disclose Material Facts: As per Clause (5) of Part I of Second Schedule to the
Chartered Accountants Act, 1949, a chartered Accountant in practice will be held liable for

misconduct if he fails to disclose a material fact known to him, which is not disclosed in the
financial statements but disclosure of which is necessary to make the financial statements not
misleading. In this case, Mr. Joe has come across information that a loan of ` 10 lakhs has been
taken by the company from Employees Provident Fund. This is contravention of Rules and the
said loan has not been reflected in the books of accounts. Further, this material fact has also to
be disclosed in the financial statements. The very fact that Mr. Joe has failed to disclose this fact
in his report, he is attracted by the provisions of professional misconduct under Clause (5) of Part
I of Second Schedule to the Chartered Accountants Act, 1949.
Clause (6) Fails to report a material misstatement known to him to appear in a financial
statement with which he is concerned in a professional capacity.
This clause refers to failure on the part of a member to point out in his report a material misstatement
appearing in a financial statement and he has knowledge of the same. Here also, it is obvious, that
before a member could be held guilty of misconduct, materiality has to be established and the
observations made under the preceding Clause (5), in this connection, will equally apply to this
clause.
Some of the decisions of the Courts on this clause are briefly given below-
A Company did not provide for depreciation as required by Section 205 and Section 350 of the
Companies Act, 1956 (now Section 123 read with Schedule III of the Companies Act, 2013) and
although the Chartered Accountant was aware that the Company had underprovided depreciation,
he did not bring out this fact in his report- Held the Chartered Accountant was guilty of professional
misconduct under the clause. He had failed to disclose a material fact known to him but disclosure
of which was necessary to make the financial statement not misleading.
Where a Chartered Accountant prepared a balance sheet of a firm and subsequently prepared
statement regarding the state of affairs of the firm without taking into account the balance sheet
already prepared by him showing a lesser amount by way of opening stock and a lesser amount to
the credit of the proprietor and subsequently when he was called upon by his client to prepare a
fresh balance sheet and profit and loss account for the same year so that it should tally with the
statement of affairs prepared by him he did so without reference to the actual account books but on
instruction of the client, and as such it was a false and incorrect balance sheet. Held, he was guilty
under Clauses (5) & (6). [Attorney General of Kenya-vs-V.B. Joshi (1968)]
Case Study
A practicing Chartered Accountant was appointed to represent a company before the tax
authorities. He submitted on behalf of his clients certain information and explanations to the
authorities, which were found to be false and misleading.
Submitting Information as Authorised Representative: As per Clause (5) of Part I of Second
Schedule to the Chartered Accountant Act, 1949, if a member in practice fails to disclose a
material fact known to him which is not disclosed in a financial statement, but disclosure of which

is necessary to make the financial statement not misleading, where he is concerned with that
financial statement in a professional capacity, he will be held guilty under Clause (5). As per
Clause (6) of Part I of Second Schedule if he fails to report a material misstatement known to him
to appear in a financial statement with which he is concerned in a professional capacity, he will
be held guilty under Clause (6).
In given case, the Chartered Accountant had submitted the statements before the taxation
authorities. These statements are based on the data provided by the management of the
company. Although the statements prepared were based on incorrect facts and misleading, the
Chartered Accountant had only submitted them acting on the instructions of his client as his
authorized representative.
Conclusion: Hence the Chartered Accountant would not be held liable for professional
misconduct.
Clause (7) does not exercise due diligence, or is grossly negligent in the conduct of his
professional duties.
Though very simply worded, it is a vital clause which unusually gets attracted whenever it is
necessary to judge whether the accountant has honestly and reasonably discharged his duties. The
expression negligence covers a wide field and extends from the frontiers of fraud to collateral minor
negligence. The meaning and significance of this clause is well contained in the following passage
quoted from the Judgement of the Karnataka High Court in a disciplinary case which came before it
in 1977.
It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution
which a reasonably competent, careful, and cautious auditor would use. What is reasonable skill,
care and caution must depend on the particular circumstances of each case. An auditor is not bound
to be a detective, or, as was said, to approach his work with suspicion or with a foregone conclusion
that there is something wrong. He is a watchdog but not a bloodhound. If there is anything calculated
to excite suspicion he should probe it to the bottom; but in the absence of anything of that kind he
is only bound to be reasonably cautious and careful.
Professional misconduct is a term of fairly wide import but generally speaking, it implies fairly serious
cases of misconduct of gross negligence. Negligence per se would not amount to gross negligence
in the case of minor errors and lapses, which do not constitute professional misconduct and which,
therefore, don’t require a reference to the Disciplinary Committee, the Council would nevertheless
bring the matter to the attention of its members so that greater care may be taken in the future in
avoiding errors and lapses of a similar type”.
Case Study
CA Chiranjiv who conducted ABC audit of a Haryana daily ‘New Era’ certified the circulation
figures based on Management Information System Report (M.I.S Report) without examining the
books of Account.

According to Clause (7) of Part I of Second Schedule of Chartered Accountants Act, 1949, a
Chartered Accountant in practice is deemed to be guilty of professional misconduct if he “does
not exercise due diligence or is grossly negligent in the conduct of his professional duties”.
In the instant case, CA Chiranjiv did not exercise due diligence and is grossly negligent in the
conduct of his professional duties since he certified the circulation figures without examining the
books of accounts.
To ascertain the number of paid copies verification of remittances from the agents, credit allowed
to the agents for unsold copies returned, examination of books of account is essential. Further
certification of circulation figures based on statistical information without cross verification with
financial records amounts to gross negligence and failure to exercise due diligence.
Conclusion: Hence, CA Chiranjiv is guilty of professional misconduct as per Clause (7) of Part I
of Second Schedule of Chartered Accountants Act, 1949.
Some of the decisions of the DC/Courts on this clause are briefly mentioned below:
Where a Chartered Accountant failed to indicate the mode of valuation of investments in shares as
required by the Companies Act and also to draw attention to the inclusion of uniforms in the
depreciation account- Held that he was guilty under Clause (7). [M.C. Poddar vs-P.S. Sodhbans -
page 259 of Vol. I of the Disciplinary Cases and page 554 of March 1954 issue of the Institute’s
Journal-Judgement delivered on 1st April, 1954].
Where a Chartered Accountant certified the circulation of a newspaper based on the statistic record
but stated in his certificate that he had given it after examination of the books of account without
verifying that the books of account and the statistical records agreed and also without taking into
account the return of copies unsold. Held that he was guilty of gross negligence. [V.K. Madhava
Rao (1956)]
Where a certificate issued by a Chartered Accountant under Regulations 7(c) & 7(d) (i) of
Part I (d) the First Schedule to the Insurance Act, 1938 was not correct, as the company had granted
loans on policies which had already lapsed for non-payment of premium and also the claims in
respect of two policies which had matured were not included in estimated liability in respect of
outstanding claims shown in the Balance Sheet- Held he was guilty under Clauses (7) & (8).
[Controller of Insurance vs H. C. Das (1957)]
Where a Chartered Accountant, appointed as auditor of the Madras branch of a limited company in
Bombay was charged with failure to report to the Bombay office that some entries in the bank pass
book had not been passed through the cash book of the branch. Held he was guilty of gross
negligence. The High Court observed that a small fee paid to the respondent should not come in the
way of his doing duty without fear or favour, although it involved unpleasant consequence namely,
he might not be appointed again. [The Fairdeal Corporation Ltd. Bombay vs K. Gopalakrishna
(1957)]
A certificate issued by a Chartered Accountant to a proprietor of a firm in respect of the turnover of
betel nuts to enable the firm, which was not dealing in betel nuts, to obtain import license without

checking the books and documents himself, but relying on his articled clerk for its correctness. Held
he was guilty of gross negligence. [Sunder Lal Fatehpuria in Re: page 591 of Vol. Ill of the
Disciplinary Cases and page 224 of January, 1959 issue of the Institute’s Journal-Judgement
delivered on 14th November, 1958]
Where a Chartered Accountant failed in his duty to check the bank balances with the pass books of
the banks and failed to obtain certificates of balances from the bankers in respect of those balances.
The Council found him guilty of misconduct under Clauses (7) & (8) of Part I of the Second Schedule.
Held there being no proof of dishonesty or volume malafide on the part of the Chartered Accountant
and in view of the circumstances of the case, the High Court took no more serious view of the matter
than to express disapprobation of the conduct of the Chartered Accountant in the form of admonition.
[Company Law Administration-vs-D.B. Kulkarni (1960)]
In the course of some investigation of the affairs of a bank on liquidation, it was found that the
authorities of the bank failed to disclose the total indebtedness of the directors in the balance sheet
and to report on the numerous alterations and fictitious entries in the books of accounts of the bank.
Held that no auditor could escape from personal liability by taking shelter under the misconduct of
his own employees. There was nothing to indicate the status, qualifications or capacity of the
assistants. Under the circumstances, the conduct of the Chartered Accountant in abdicating his
functions to his subordinates amounted to gross negligence. [Superintendent of Police Madras vs
M. Rajamany (1961)]
Where a Chartered Accountant had placed implicit reliance on his paid assistant who took absolutely
no step whatsoever to check the cash balances facilitating and resulting, in serious defalcations.
Held he was guilty under Clauses (5), (7) (8) and (9). [D. C. Sopariwala (1968)]
Where a certificate issued by a Chartered Accountant to the Joint Chief Controller of Imports &
Exports, Calcutta stating that a firm had exported a certain quantity of onions during a certain period
contained false and inaccurate particulars in respect of three items of invoice value the particulars
themselves related to exports not by this firm but by two other firms. Held he was guilty of the charge
of gross negligence. [The Chief Controller of Exports vs-G.P. Acharya (1962)]
Where a Chartered Accountant signed the accounts of an institution subject to separate notes. Held
he was guilty of gross negligence. In the view of the High Court, the essential part was the separate
notes. Any one going through his report would at least assume that those notes when prepared and
were ready at the time when the report was signed by him. It could not be supposed that those notes
were not in existence at that time and were written at some later date on some facts, which were
still to be verified or ascertained. His act, though not suffering from bad or vicious intention, was still
an act of gross negligence. [Hitkarini Mahavidyalaya, Jabalpur vs P.C, Madan (1963)]
Where a chartered accountant gave clean reports on the balance sheets whereas the reports on the
special audit conducted subsequently revealed certain irregularities which amounted to failure to
examine the pass book and to verify the cash balance. Held he was guilty under Clause (7). [Director
of Accounts, Gujarat State, Ahmedabad vs K.D. Patel (1968)]

Where a Chartered Accountant had not completed his work relating to the audit of the accounts of
a company and had not submitted his audit report in due time to enable the company to comply with
the statutory requirement in this regard. Held, he was guilty of professional misconduct under Clause
(7). [Qaroon Trading & Finance Pvt. Ltd.- vs Luxmi Narain Saxena and Jitendera Mohan Chadha
(1969)]
Where a Chartered Accountant failed to exercise sufficient care and diligence in his professional
responsibilities in not checking the cash memos and not verifying the alterations in the trial balance
with the original books in respect of one company and in not checking the journal entries and the
final figures of the balance sheet with the general ledger in respect of another company. Held, he
was guilty under Clause (7). [Messrs. O. M. Agency Private Ltd. & Messers. Oriental Mercantile
Distributors Private Ltd. Surendra Sastry (1971)]
In his audit report of a school, the auditor failed to point out wrong and misleading entries and a sum
of ` 7,000/- on account of reserve fund did not find a place at all in the original statement sent to the
school. The correction slip alleged to be sent by the Chartered Accountant was never received by
the school. The Chartered Accountant had not proved that the correction slip was sent to the school.
Held the Chartered Accountant was guilty of gross negligence in the conduct of professional duties
and his conduct was quite unbecoming of a professional person entrusted with responsibility of
dealing with the accounts. [B.L. Shoulder vs-M.K. Deb (1976)]
A Chartered Accountant adopted arbitrary valuation of closing stock and no verification at all was
done by him. Further he accepted the capitalization of a large sum of expenditure which was in the
nature of revenue. He had merely adopted an ad-hoc basis in deciding upon capitalization of
expenditure and failed to apply his mind and bring to bear on the subject the due diligence and care
expected of a member of the profession. Held, the Chartered Accountant was guilty of gross
negligence in the performance of his duties. [B. Shantharam Rao (1977)]
A Chartered Accountant was charged under Clauses (5), (6), (7) and (8) of Part I of Second Schedule
in regard to a loss of ` 1.84 lakhs in a bank of sale of some investments out of which only a sum of
` 21,500 was written off by the bank. The value of investment in the balance sheet was inflated and
it did not exhibit the correct position and the profit and loss account did not show a true balance of
profit and loss. Held, the respondent was guilty of misconduct so as to render him unfit to be a
member of the institute. [B.S. Waierker (1957)]
Where a Chartered Accountant issued two different certificates of circulation of a daily for one and
the same period showing different figures in respect of the number of copies printed and circulated.
Held, he was guilty under Clauses (7) and (8). [Registrar of Newspapers for India vs P.K. Mukherji
(1971)]
A Chartered Accountant had failed to detect a fraud committed by the accountant of a canteen which
could have been detected if he had checked the castings of the cash books and also checked the
‘contra’ entries of the bank and cash columns of the cash books. Held, he was guilty of professional
misconduct under Clauses (7), (8) and (9). [Air Commodore Dilbagh Singh vs C.G. Apte (1976)]

Where a Chartered Accountant failed to make a reference in the “Income Certificates” prescribed by
the ABC to the report which he had separately submitted to the newspaper concerned which did
represent the correct state of affairs in all respects but which was not sent by the newspaper to the
Bureau. Held, he was guilty under Clauses (7) and (9). [Audit Bureau of Circulations Ltd., vs A.D.
Shinde (1968)]
The Committee noted that the audited accounts of the Company for the year ended 2004-05 and
2005-06 show an amount of Rs.53.44 lakhs as prior period adjustment from Shri Sushil Gupta. The
said amount is mentioned as an item of prior period adjustment amounts to Rs.53.44 lacs which
constitutes 58.02% of the total unsecured funds and 55.03% of the total liabilities of the Company
for the said year which itself speaks of its materiality with respect to the Financial Statement in
question. The Respondent being the statutory auditor of the Company for the said year was
statutorily required to determine 503 and consider the materiality of the said item for the purpose of
audit and reporting. Where a Chartered Accountant being the auditor has not only failed to exercise
due diligence and also failed to gather sufficient information to warrant an expression of opinion and
also failed to invite attention to any material departure from the generally accepted procedure of
audit applicable to the circumstances. Thus in conclusion, in the opinion of the Committee, the
Respondent is held guilty of professional misconduct falling within the meaning of Clauses (7), (8)
and (9) of Part I of the Second Schedule to the Chartered Accountants Act, 1949. [Shri J.K.Teotia
vs. CA. Gaurav Arora (2014)]
Case Study
Mr. D, a practicing Chartered Accountant, did not complete his work relating to the audit of the
accounts of a company and had not submitted his audit report in due time to enable the company
to comply with the statutory requirements.
Not Exercising Due Diligence: According to Clause (7) of Part I of Second Schedule of
Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of
professional misconduct if he does not exercise due diligence or is grossly negligent in the
conduct of his professional duties.
It is a vital clause which unusually gets attracted whenever it is necessary to judge whether the
accountant has honestly and reasonably discharged his duties. The expression negligence covers
a wide field and extends from the frontiers of fraud to collateral minor negligence.
Where a Chartered Accountant had not completed his work relating to the audit of the accounts
a company and had not submitted his audit report in due time to enable the company to comply
with the statutory requirement in this regard. He was guilty of professional misconduct under
Clause (7).
Since Mr. D has not completed his audit work in time and consequently could not submit audit
report in due time and consequently, company could not comply with the statutory requirements,
therefore, the auditor is guilty of professional misconduct under Clause (7) of Part I of the Second

Clause (8): Fails to obtain sufficient information which is necessary for expression of an
opinion or its exceptions are sufficiently material to negate the expression of an opinion.
It is expected of a Chartered Accountant to express his opinion on the truth and fairness of
statements of accounts after examining their authenticity with reference to information and
explanations given to him. A Chartered Accountant must determine the extent of information, which,
should be obtained by him before he expresses an opinion on the financial statements submitted to
him for report.
The accountant should not express an opinion before obtaining the required data and information.
The latter part of the clause enjoins that where due to inadequacy of information or data the report
has to be circumscribed to an extent that it would cease to be of any expression of a categorical
opinion, the auditor should clearly express his disclaimer in no uncertain terms. For example, if the
auditor has not seen any evidence of the existence and/or valuation of the investment which
constitute the only asset of a company, he should not say that:
“Subject to the verification of the existence and value of the investments the balance sheet shows a
true and fair view etc.”
On the other hand he should say that-
“As we have been unable to verify the existence and value of the investments of the company, we
are unable to state whether the balance sheet shows a true and fair view etc.”
Some of the decisions of the DC/Courts on this subject are briefly presented below:
A Chartered Accountant without examination of stock register and other relevant matters issued a
wrong consumption certificate on the basis of which licence of higher value, for which the unit was
not entitled, was issued by Controller of Imports & Exports. The examination done by the Chartered
Accountant was so restricted that he could not have obtained the information necessary to warrant
the expression of an opinion regarding consumption of raw material and components. Held the
chartered accountant was guilty of professional misconduct under Clause (8). [T.S. Vaidyanatha lyer
(1977)]
Where a Chartered Accountant relying on the work of the internal auditor of a company qualified his
report that the books of account and the supporting vouchers had been examined by the internal
auditor of the company, the Council taking the view that the qualification amounted to an exception
sufficiently material to negate the expression of an opinion, found him guilty, of misconduct under
the latter part of Clause (8). As a general rule, a statutory auditor would be guilty under this clause,
if he performed his work so recklessly as to give his report without looking into the books of account
of a company, on the basis of the work of the internal auditor whose opinion turned out to be false.
[J.C. Chandhok (1964)]
Where a Chartered Accountant issued a certificate of circulation of a periodical without going into
the most elementary details of how the circulation of a periodical was being maintained i.e. by not
looking into the financial records, bank statements or bank pass books, by not examining evidence

of actual payment of printers bills and by not caring to ascertain how many copies were sold and
paid for. Held he was guilty under Clause (8). [Registrar of Newspapers for India vs K. Rajinder
Singh (1971)]
“a certificate is a written confirmation of the accuracy of the facts stated therein and does not involve
any estimate or opinion.” A Chartered Accountant is required to clearly state his
limitations/assumptions in his certificates, while in the said matter, the Respondent in none of the
12 certificates either mentioned his limitation or assumptions. Though, in his written statements he
submitted that his job was not to verify the assets physically or verification of original bills or whether
promoters contribution have come in actually in the Bank account etc. If his assignment did not
include the same, he ought to have disclosed or mentioned in the certificates that while issuing the
certificate he had relied upon the following documents, so as not to mislead the users of the said
certificate(s). In the instant matter, the Respondent did not disclose any assumptions/limitations
whatsoever while issuing the certificates. Moreover, the Respondent in none of the certificates
issued by him had mentioned the basis/papers relied upon by him. Consequently, the same misled
the IDBI Bank in approving the loan based on such certificates which did not mention the basis of
issuance.
The Respondent while issuing the Certificates ought to have exercised diligence but he failed to do
so. Accordingly, the Committee is of the view that the Respondent was grossly negligent in conduct
of his professional duties and also failed to obtain sufficient information while issuing the
aforestated certificates. Thus, he was guilty under clause (7) and (8). [Shri R. Hitendra vs. Prakash
Ram Chandran(2012)]
The Committee noted that since the transaction of land took place between the Shivdarshan Firm
i.e., a partnership firm and Siddheshwari Developers, the same should have been reflected in the
books of Shivdarshan Firm and not in the books of Shivdarshan Construction which was a proprietary
concern. The Respondent being the auditor of Shivdarshan Construction failed to report the said
discrepancy in his audit report. Since, the amount of loan was material and the Respondent failed
to submit any evidence based on which he had chosen not to qualify the appearance of housing
loan from Navsarjan Industrial Co. Op. Bank Ltd in the financial statements, hence, the Committee
is of the view that the Respondent is guilty of professional misconduct falling within the meaning of
Clauses (6), (7) and (8) of Part I of the Second Schedule to the Chartered Accountants Act, 1949
[Shri Mukesh M. Kelawala vs. CA. Sukhdev Manilal Soni (2013)]
Case Study
Z, a practicing Chartered Accountant issued a certificate of circulation of a periodical without
going into the most elementary details of how the circulation of a periodical was being maintained
i.e. by not looking into the financial records, bank statements or bank pass books, by not
examining evidence of actual payment of printers bills and by not caring to ascertain how many
copies were sold and paid for.
Failure to Obtain Information: Clause (8) of Part I of Second Schedule to the Chartered

Accountants Act, 1949 states that if a Chartered Accountant in practice fails to obtain sufficient
information to warrant the expression of an opinion or his exceptions are sufficient material to
negate the expression of an opinion, the chartered accountant shall be deemed to be guilty of a
In the instant case Mr. Z, a practicing Chartered Accountant issued a certificate of circulation of
a periodical without going into the most elementary details of how the circulation of a periodical
was being maintained i.e, by not looking into the financial records, bank statements or bank pass
books, by not examining evidence of actual payment of printers bills and by not caring to ascertain
how many copies were sold and paid for.
The chartered accountant should not express his opinion before obtaining the required data and
information. As an auditor, Mr. Z ought to have verified the basic records to ensure the correctness
of circulation figures.
Conclusion: Thus, in the present case Mr. Z will be held guilty of professional misconduct as per
Clause (8) of Part I of Second Schedule to the Chartered Accountants Act, 1949.
Clause (9) Fails to invite attention to any material departure from the generally accepted
procedure of audit applicable to the circumstances.
This clause implies that the audit should be performed in accordance with “generally accepted
procedure of audit applicable to the circumstances” and if for any reason the auditor has not been
able to perform the audit in accordance with such procedure, his report should draw attention to the
material departures from such procedures. What constitutes “generally accepted audit procedure”
would depend upon the facts and circumstances of each case, but guidance is available in general
terms from the various pronouncements of the Institute is issued by way of statements and Guidance
Notes and SAs to members.
Members are also advised to refer to the ISA’s issued by the International Auditing Practices
Committee of IFAC.
An auditor of a company is appointed by the shareholders to perform certain statutory functions and
duties and it is expected of him that he will in fact, perform these functions and duties. The failure to
perform a statutory duty in the manner required is not excused merely by giving a qualification or
reservation in auditor’s report. For example, if an auditor fails to verify the cash balance in
circumstances where such verification was necessary, feasible and material, it is not sufficient for
him merely to state in his report that he did not verify the cash balance in circumstances when giving
any reservations or qualifications in the auditor’s report as required under this clause, a member
would be well advised to indicate clearly the reasons why he was unable to perform the audit in
accordance with generally accepted procedures and standards.
It is not possible to exhaustively deal with instances or accepted procedure of audit applicable to
special cases. Two instances of an audit requiring a special procedure are given below:
Very often members are required to certify the figures of circulation of newspapers, magazines etc.
by their clients on behalf of the Audit Bureau of Circulations Ltd. Members are normally supplied by

the ABC with the Rules and Regulations under which the certification of circulation is to be carried
out. Members are also asked to give their acceptance in writing that they will observe the rules of
procedure envisaged to report upon any lapse of such special requirements, even of an insignificant
nature.
Similarly, in the case of verification on behalf of banks, the rules or procedure for conducting such
audit are different from the normal rules applicable to audits under the Companies Act. Members
are required to be very familiar with the special procedure required in these matters and act
accordingly.
Some of the decisions of the DC/Courts on this subject are briefly summarised below:
Where a Chartered Accountant did not conduct sample checking of the bank accounts in relation to
the accounts of the company and did not carry out vouching with respect to the transactions reflected
in the accounts of the company and depended upon his assistant who was a Chartered Accountant
and experienced clerk who were entrusted with the auditing work. Held he was guilty under Clauses
(7), (8) and (9). [M.R. Ramanathan vs A. Utnatlath Rao (1968)]
Where a Chartered Accountant failed to verify the actual disbursement of the amount by examining
the various items of purchases and insisting for the bills to be produced in respect of the various
items before issuing his certificate as mere payment would not constitute utilization of the amount
for the purpose for which it was meant. Held he was guilty under Clauses (7), (8) and (9). [Punjab
State Govt. vs K.N. Chandla (1972)]
A Chartered Accountant had checked the cash book totals but not the bank column totals, had
verified all the transactions in the bank columns but not the contra-entries, had taken the casting
only of personal ledger and that too not of all accounts, had resorted to test check when there was
no system of internal check, had not seen the pay-in-slips, had not checked the bank reconciliation
statements for all the months. Held he was guilty of professional misconduct under Clauses (7), (8)
and (9). [Air Commodore Dilbagh Singh vs E.S. Venkataraman (1976)]
Where the form of the certificate prescribed by the Audit Bureau of circulation Ltd., did not permit
any alteration or explanation being given in the certificate itself, the Chartered Accountant had
recorded, in a separate report the true state of affairs which he had found. Except making a report
which explained the correct position he had no authority to indicate in the certificate itself the true
position. But the separate report which he had sent along with the “Income Certificate” to the
Newspaper concerned had not been forwarded by the newspaper to the Bureau. It was only later on
that the ABC introduced a change in the procedure of audit by permitting a report being sent along
with the “Income Certificate” in the various columns were subject to his separate report. Held he was
guilty under Clauses (7) and (9). [Audit Bureau of Circulations Ltd. v.s. M.L. Nanda (1968)]
Where a Chartered Accountant as a concurrent auditor of the Bank carried out his duties recklessly,
did not exercise due diligence, failed to obtain sufficient information and failed to invite attention to
the material departure from the accounting policies. Accordingly, the Committee is of the considered
view that the Respondent is guilty of professional misconduct falling within the 10 meaning of

Clauses (7), (8) and (9) of [Part I of Second Schedule to the Chartered Accountants Act [Tamilnadu
Mercantile Bank Ltd.vs.CA. V.U. Gangolli (2012)].
Clause (10) fails to keep moneys of his client other than fees or remuneration or money meant
to be expended in a separate banking account or to use such moneys for purposes for which
they are intended within a reasonable time.
In the course of his engagement as a professional accountant, a member may be entrusted with
moneys belonging to his client. If he should receive such funds, it would be his duty to deposit them
in a separate banking account, and to utilize such funds only in accordance with the instructions of
the client or for the purposes intended by the client. In this connection the Council has considered
some practical difficulties of the members and the following suggestions have been made to remove
these difficulties:
(i) An advance received by a Chartered Accountant against services to be rendered does not
fall under Clause (10) of Part I of the Second Schedule.
(ii) Moneys received for expenses to be incurred, for example, payment of prescribed statutory
fees, purchase of stamp paper etc., which are intended to be spent within a reasonably short
time need not be put in a separate bank account. For this purpose, the expression;
“reasonably time”, would depend upon the circumstances of each case.
(iii) Moneys received for expenses to be incurred which are not intended to be spent within a
reasonably short time as aforesaid, should be put in a separate bank account immediately.
(iv) Moneys received by a Chartered Accountant, in his capacity as trustee, executor liquidator,
etc. must be put in a separate bank account immediately.
The decision of the Court in this matter is briefly mentioned below:
A Chartered Accountant was found guilty of professional misconduct under Clauses (7) & (10) of
Part I of the Second Schedule to the Act for having failed to account satisfactorily for the various
amounts entrusted to him by the client and for failure to keep them in a separate bank account. A
refund voucher issued in the name of the client by the Income Tax Department was credited by him
to his account in the bank. (N.S. Chenoy v.s. K.V. Subba Rao - page 958 of Vol. IV of the Disciplinary
Cases and pages 207-214 of October, 1973, issue of the Institute’s Journal - Judgement delivered
on 6th April, 1973)
Case Study
A charitable institution entrusted ` 10 lakhs with its auditors M/s Ram and Co., a Chartered
Accountant firm, to invest in a specified securities. The auditors pending investment of the money,
deposited it in their Savings bank account and no investment was made in the next three months.
Failure to Keep Money in Separate Bank Account: If a Chartered Accountant in practice fails
to keep moneys of his clients in a separate bank account or fails to use such moneys for purposes
for which they are intended then his action would amount to professional misconduct under Clause
(10) of Part I of Second Schedule to the Chartered Accountants Act, 1949. In the course of his

engagement as a professional accountant, a member may be entrusted with moneys belonging

to his client. If he should receive such funds, it would be his duty to deposit them in a separate
banking account, and to utilise such funds only in accordance with the instructions of the client or
for the purposes intended by the client.
Conclusion: In the given case by depositing the client’s money by M/s Ram and Co., a firm of
Chartered Accountants, in their own savings bank account, the auditors have committed a
professional misconduct. Hence in the given case, M/s Ram & Co. will be held guilty of
PART II - Professional misconduct in relation to members of the Institute generally

misconduct, if he -
Clause (1) contravenes any of the provisions of this Act or the regulations made there under
or any guidelines issued by the Council.
This clause is very important. It requires every member of the Institute to act within the framework
of the Chartered Accountants Act and the Regulations made thereunder. Any violation either of the
Act or the Regulations by a member would amount to misconduct.
The Regulations under which cases of contravention have generally come to the notice of the
Council are the following:
Regulation 43 Engagement of Articled Assistant
Regulation 46 Registration of Articled Assistant
Regulation 47 Premium from Articled Assistant
Regulation 48 Stipend to Articled Assistant
Regulation 56 Termination or assignment of Articles
Regulation 65 Articled Assistant not to engage in any other occupation
Regulation 67 Complaint against the employer (from Articled Assistant)
Regulation 68 to 80 Audit Assistant
Regulation 190 Register of offices and firms
Regulation 190-A Chartered Accountants not to engage in any other business or occupation
Regulation 191 Part time employment's a Chartered Accountant may accept
Regulation 192 Restriction on fees

Some of the decisions of the Courts under this clause are mentioned below:
A Chartered Accountant certified in Form K-2 that an audit clerk was in service with him while
he was also, employed elsewhere with another employer between 11 A.M. and 5 P.M. and
attended the office of the Chartered Accountant thereafter until 8 P.M. The Chartered
Accountant suspended the audit clerk when the Institute brought this fact to the notice of the
Chartered Accountant. Held he was guilty of misconduct for making a misstatement to the
institute in regard to the discharge of his professional duties. [J.K. Ghosh in (1953)]
Where a Chartered Accountant agreed to take a person as an articled clerk in a vacancy shortly
to arise and received the premium for the purpose and made him believe, when he executed
the deed of articles that he was taking him in that vacancy, while, in fact, that vacancy had been
filled up by the Chartered Accountant earlier by taking another audit clerk. The audit clerk came
to know from the Institute that the deed of articles was not registered as that was forwarded with
a request for entertaining an extra articled clerk. Held that the Chartered Accountant was guilty
of serious misconduct for having contravened Regulation 58. [A.K. Basu v.s. P.K. Mukherjee
(1956)]
Where a Chartered Accountant after signing the Articles of Agreement, failed to forward the
articles for registration as required by Regulation 64 and the statement of particulars in the
prescribed form as required by Regulation 64 in spite of repeated enquiries from the articled
clerk and even failed to take notice of communications addressed to him in that behalf and
having two other articled clerks along with the present one who articles were not sent for
registration took up a fourth articled clerk without being entitled to do so. Held he was guilty for
breach of Regulation 46. [Mohan Sehwani vs. Sunderlal Fatehpuria (1968)]
A Chartered Accountant was found guilty of professional misconduct in terms of Clause (1) of
Part II of the Second Schedule to the Act for contravention of Section 6 of the Act for having
issued a certificate in respect of a consumption statement of a concern as a Chartered
Accountant in practice on a date when he had not even applied for a certificate of practice to
the Institute. [N.K. Ray Chowdhery in (1973)]
A Chartered Accountant issued a confidential and private circular to clients where, in addition
to, describing himself as “Chartered Accountant” he also described himself as “Investment
Consultant Public Accountant”. By this circular he introduced himself to the public and private
limited companies, which were accepting, fixed deposits and loans through him. Held he was
guilty of professional misconduct under Clause (1) of Part II of the Second Schedule. [B. M.
Lala (1976)]
A Chartered Accountant took loan from a firm in which the articled clerk and his father were
both Interested, against the provisions of the Chartered Accountants Regulations, 1988 which
prohibit ‘taking of loan or deposit etc. from the articled clerk. Held the Chartered Accountant
was guilty of professional misconduct under the clause. [M.K. Tripathi (1979)]

A Chartered Accountant did not pay stipend to his articled clerk, in accordance with Regulation
48 of the Chartered Accountants Regulations 1988, while to another articled clerk, he was
paying every month. The stipend was paid only after the articled clerk left him after working for
a months and complaint was lodged with the Institute. The plea of the Chartered Accountant
that he had an agreement with the articled clerk to pay stipend on annual basis was found to be
misconceived as the same should be against the provisions of Regulation 48. [Radhey Mohan
(1979)]
Three articled clerks of a Chartered Accountant informed Institute that the Chartered Accountant
had failed to make the payments of stipend to them every month in accordance with Regulation
48. Held the Chartered Accountant was guilty of professional misconduct under the clause as
he contravened Regulation 48 by not making the payment every month. The court rejected two
contentions put forward by the Chartered Accountant, viz, (i) that the declaration filed by the
articled clerks could not be regarded as ‘information’ in order to justify the commencement of
disciplinary proceedings (2) that under Regulation 48 the payments had to be made at a monthly
rate and not that the payments had to be made every month. The third contention that the
payments could not be made every month or regularly because of financial stringency was also
rejected particularly in view of the fact that the Chartered Accountant during the relevant period
had purchased a plot of land and constructed a house at the cost of more than 1 lakh of rupees
and he had in his employment throughout the relevant period a Chartered Accountant at a salary
of ` 500 Per Month. [R.C. Gupta (1980)]
The Chartered Accountant received ` 2000/- by way of security from the complainant’s father
as a consideration for taking him as an articled clerk. Held that he was guilty under the provision.
[Virender Kumar v.s. K.B. Madan (1980)]
A Chartered Accountant did not pay stipend to the articled clerk per month in accordance with
Regulation 32B of the Chartered Accountant Regulations, 1964 in view of the letter written by the
articled clerk to the effect that the stipend be not paid to him every month. This letter was purported
to have written at the time of commencement of training- Held the letter taken from the articled clerk
would not be relied upon as it was ante-dated and it was not written on the date it purported to be.
The Chartered Accountant was guilty of professional misconduct under the clause. It was observed
that it was very reprehensible that a practising Chartered Accountant should have tried to fabricate
evidence in support of the defence. [V.K. Mittal (1980)]
A Chartered Accountant did not pay stipend to the articled clerk in accordance with Regulation
32B of the Chartered Accountants Regulations, 1964 for the period during which the Article
Clerk worked with him. Also the Article Clerk was asked to work in excess of the prescribed
working hours in violation of Regulation 45 of the Chartered Accountants Regulations, 1964.
Held that he was guilty of professional misconduct under Clause (1) of Part II of Second
Schedule to the Chartered Accountants Act, 1949. [U.V. Benadikar vs. N.G. Kulkarni (2004)]

Clause (2) being an employee of any company, firm or person, discloses confidential
information acquired in the course of his employment except as and when required by any
law for the time being in force or except as permitted by the employer.
This is an adaptation of the well-accepted principle of the law of agency. A member in the
forthcoming circumstance would be guilty of misconduct regardless of the fact that he was in whole
time or part-time employment or that he was carrying on practice of accountancy along with his
employment. Since as employee, a member may have access to a confidential information, hence
for maintaining the status and dignity of the profession in general, he should treat such information
as having been provided to him only to facilitate the performance of his duties as an employee. In
order to keep the confidence of the people, Chartered Accountants, should take special care not to
divulge such information.
Clause (3) Includes in any information, statement, return or form to be submitted to the
Institute, Council or any of its Committees, Director (Discipline), Board of Discipline.
Disciplinary Committee, Quality Review Board or the Appellate Authority any particulars
knowing them to be false.
If a Chartered Accountant includes in any information, statement, return or form to be submitted to
the Institute Council etc. any particular knowing it to be false, he will be held guilty of misconduct.
Clause (4) Defalcates or embezzles money received in his professional capacity.
Defalcation and embezzlement of moneys received in professional capacity amounts to fraud
(Covered in SA-240) and such member will be deemed to be guilty of professional misconduct under
this clause.
Part III - Other misconduct in relation to members of the Institute generally
misconduct, if he is held guilty by any civil or criminal court for an offence which is
punishable with imprisonment for a term exceeding six months.
Imprisonment awarded for a term exceeding six months in any civil/criminal matter treated as a major
offence under ‘other misconduct’ is included in this Schedule.
9 COUNCIL GUIDELINES
The relevant extracts of the Council General Guidelines, 2008 are given below:
Chapter I
Preliminary
1.0 Short title, commencement, etc.
(a) These Guidelines have been issued by the Council of the Institute of Chartered

Accountants of India under the provisions of The Chartered Accountants Act, 1949, as
amended by The Chartered Accountants (Amendment) Act 2006, in supersession of
the Notifications issued by the Council under erstwhile Clause (2) of Part II of the
Second Schedule to the Chartered Accountants Act, 1949. These Guidelines be called
the ‘Council General Guidelines, 2008’.
(b) These guidelines shall be applicable to all the Members of the Institute whether in
practice or not wherever the context so requires.
Chapter II
Conduct of a Member being an employee
A member of the Institute who is an employee shall exercise due diligence and shall not be grossly
negligent in the conduct of his duties.
Chapter III
Appointment of a Member as Cost auditor
A member of the Institute shall not accept-
(i) The appointment as Cost auditor of a Company under Section 233B* of the Companies Act,
1956 while he-
(a) is an auditor of the Company appointed under Section 224 of the Companies Act; or
(b) is an officer or employee of the Company; or
(c) is a partner, of any employee or officer of the Company; or
(d) is a partner or is in the employment of the Company’s auditor appointed under Section
224 of the Companies Act, 1956; or
(e) is indebted to the Company for an amount exceeding one thousand rupees, or has
given any guarantee or provided any security in connection with the indebtedness of
any third person to the Company for an amount exceeding one thousand rupees;
OR
(ii) After his appointment as Cost Auditor, he becomes subject to any of the disabilities stated in
items (i) (a) to (e) above and continues to function as a cost auditor thereafter.
A member of the Institute in practice shall not accept the appointment as auditor of a Company under
Section 224 of the Companies Act, 1956, while he is an employee of the cost auditor of the Company
appointed under Section 233B* of the Companies Act, 1956.
* [Students may note that Section 233B of the Companies Act, 1956 on Cost Audit has been
replaced with Section 148 of the Companies Act, 2013.]

Chapter IV
Opinion on financial statements when there is substantial interest
A member of the Institute shall not express his opinion on financial statements of any business or
enterprise in which one or more persons who are his “relatives” within the meaning of *Accounting
Standard (AS-18) has/have, either by themselves or in conjunction with such member, a substantial
interest in the said business or enterprise.
Explanation: For this purpose and for the purpose of compliance of Clause (4) of Part I of the
Second Schedule to the Chartered Accountants Act, 1949, the expression “substantial interest” shall
have the same meaning as is assigned thereto under Appendix (9) to the Chartered Accountants
Regulations, 1988.
[ *In terms of its decision taken at the 299th Meeting of the Council held on 27th – 28th October,
2010, it has been decided that the term “relative” for the purpose of Chapter-IV of Council General
Guidelines, 2008 (Opinion on Financial Statements when there is substantial interest) will have the
same meaning as assigned to it in AS-18.]
Chapter V
Maintenance of books of account
A member of the Institute in practice or the firm of Chartered Accountants of which he is a partner,
shall maintain and keep in respect of his / its professional practice, proper books of account including
the following-
(i) a Cash Book;
(ii) a Ledger.
Case Study
L, a chartered accountant did not maintain books of account for his professional earnings on the
ground that his income is less than the limits prescribed u/s 44AA of the Income Tax Act, 1961.
Maintenance of Books of Account: As per the Council General Guidelines 2008, under Chapter
5 on maintenance of books of accounts, it is specified that if a chartered accountant in practice
or the firm of Chartered Accountants of which he is a partner fails to maintain and keep in respect
of his/its professional practice, proper books of account including the Cash Book and Ledger, he
is deemed to be guilty of professional misconduct. Accordingly, it does not matter whether section
44AA of the Income Tax Act, 1961 applies or not.
Conclusion: Hence, Mr. L is guilty of professional misconduct.
Chapter VI
Tax Audit assignments under Section 44 AB of the Income-tax Act, 1961
A member of the Institute in practice shall not accept, in a financial year, more than the “specified
number of tax audit assignments” under Section 44AB of the Income-tax Act, 1961.

Provided that in the case of a firm of Chartered Accountants in practice, the “specified number of
tax audit assignments” shall be construed as the specified number of tax audit assignments for every
partner of the firm.
Provided further that where any partner of the firm is also a partner of any other firm or firms of
Chartered Accountants in practice, the number of tax audit assignments which may be taken for all
the firms together in relation to such partner shall not exceed the “specified number of tax audit
assignments” in the aggregate.
Provided further that where any partner of a firm of Chartered Accountants in practice accepts one
or more tax audit assignments in his individual capacity, the total number of such assignments which
may be accepted by him shall not exceed the “specified number of tax audit assignments” in the
aggregate.
Provided also that the audits conducted under Section 44AD, 44AE and 44AF of the Income Tax
Act, 1961 shall not be taken into account for the purpose of reckoning the “specified number of tax
audit assignments”.
Explanation:
For the above purpose, “the specified number of tax audit assignments” means -
(a) in the case of a Chartered Accountant in practice or a proprietary firm of Chartered
Accountant, **60 tax audit assignments, in a financial year, whether in respect of corporate
or non-corporate assesses.
(b) in the case of firm of Chartered Accountants in practice, **60 tax audit assignments per
partner in the firm, in a financial year, whether in respect of corporate or non-corporate
assesses.
According to a clarification on Tax Audit Assignments by Committee on Ethical Standards
Board) of the Institute, if there are 10 partners in a firm of Chartered Accountants in practice,
then all the partners of the firm can collectively sign 600 tax audit reports. This maximum limit
of 600 tax audit assignments may be distributed between the partners in any manner
whatsoever. For instance, 1 partner can individually sign 600 tax audit reports in case
remaining 9 partners are not signing any tax audit report.
In computing the “specified number of tax audit assignments” each year’s audit would be taken as
a separate assignment.
In computing the “specified number of tax audit assignments”, the number of such assignments,
which he or any partner of his firm has accepted whether singly or in combination with any other
Chartered Accountant in practice or firm of such Chartered Accountants, shall be taken into account.
The audit of the head office and branch offices of a concern shall be regarded as one tax audit
assignment.

The audit of one or more branches of the same concern by one Chartered Accountant in practice
shall be construed as only one tax audit assignment.
A Chartered Accountant being a part time practicing partner of a firm shall not be taken into account
for the purpose of reckoning the tax audit assignments of the firm.
A Chartered Accountant in practice shall maintain a record of the tax audit assignments accepted
by him in each financial year in the format as may be prescribed by the Council.
Case Study
A member of the institute shall not accept in a year more than the specified number of tax audits
under section 44AB of the Income Tax Act.
Mr. Gaurav is a partner in M/s. XYZ & Co., a firm of Chartered Accountants with 6 partners.
During the assessment year 2015-16, Mr. Gaurav alone had signed 290 tax audit reports
consisting of both corporate and non-corporate assesses.
Ceiling limit for signing the Tax Audit Reports: As per Council General Guidelines 2008, a
member of the Institute in practice shall not accept, in a financial year, more than the “specified
number of tax audit assignments” under Section 44AB of the Income-tax Act, 1961. It is also
provided further that where any partner of a firm of Chartered Accountants in practice accepts
one or more tax audit assignments in his individual capacity, the total number of such
assignments which may be accepted by him shall not exceed the “specified number of tax audit
assignments” in the aggregate.
In the case of firm of Chartered Accountants in practice “the specified number of tax audit
assignments” means, 60 tax audit assignments per partner in the firm, in a financial year,
whether in respect of corporate or non-corporate assesses.
Further, as per clarification issued by the Institute on Tax Audit Assignments, tax audit reports
may be signed by the partners in any manner whosoever in accordance with specified audit
limits. Thus, one partner can individually sign all the tax audit reports subject to specified tax
audit assignment limits on behalf of all the partners in the firm of Chartered Accountants in
practice or all the partners of the firm can collectively sign the tax audit reports.
In the instant case, there are 6 partners in M/s XYZ & Co., a Chartered Accountants firm,
accordingly specified ceiling limit for the firm will be (60 tax audit assignments per partner X 6
partners) = 360. Therefore, all the 6 partners of the firm can collectively sign 360 tax audit
reports. This maximum limit of 360 tax audit assignments may be distributed between the
partners in any manner whatsoever. For instance, 1 partner can individually sign 360 tax audit
reports in case remaining 5 partners are not signing any tax audit report.
Assuming Mr. Gaurav has signed 290 tax audit reports consisting of both corporate and non-
corporate assesse on behalf of firm and remaining partners are signing audit reports within the
specified number of tax audit assignments u/s 44AB i.e. upto 70.
Conclusion: Hence, Mr. Gaurav shall not be deemed to guilty of professional misconduct
provided total number of tax audit reports on behalf of firm do not exceeds 360.

Chapter VII
Appointment of an Auditor in case of non-payment of undisputed fees
A member of the Institute in practice shall not accept the appointment as auditor of an entity in case
the undisputed audit fee of another Chartered Accountant for carrying out the statutory audit under the
Companies Act, 1956 (now Companies Act, 2013) or various other statutes has not been paid:
Provided that in the case of sick unit, the above prohibition of acceptance shall not apply.
Explanation 1:For this purpose, the provision for audit fee in accounts signed by both - the auditee
and the auditor shall be considered as “undisputed” audit fee.
Explanation 2:For this purpose, “sick unit” shall mean where the net worth is negative.
Case Study
Mr. C accepted the statutory audit of M/s PSU Ltd., whose net worth is negative for the year
2014-15. The audit was to be conducted for the year 2015-16. The audited accounts for the year
2015-16 showed liability for payment of tax audit fees of ` 15,000 in favour of Mr. E, the previous
auditor.
Accepting Appointment as an Auditor: As per Chapter 7 of Council General Guidelines 2008,
a member of the Institute of Chartered Accountants of India in practice shall be deemed to be
guilty of professional misconduct if he accepts appointment as auditor of an entity in case the
undisputed audit fee of another chartered accountant for carrying out the statutory audit under
Companies Act or various other statutes has not been paid.
As per the proviso, such prohibition shall not apply in case of a sick unit where a sick unit is
defined to mean “where the net worth is negative”.
Conclusion: In the instant case, though the undisputed fees are unpaid, Mr. C would still not
be guilty of professional misconduct since the M/s PSU Ltd. is a sick unit having negative net
worth for the year 2014-15.
Chapter VIII
Specified number of audit assignments
A member of the Institute in practice shall not hold at any time appointment of more than the
“specified number of audit assignments” of Companies under Section 224 and/or Section 228 of the
Companies Act, 1956.
Provided that in the case of a firm of Chartered Accountants in practice, the “specified number of
audit assignments” shall be construed as the specific number of audit assignments for every partner
of the firm.
Provided further that where any partner of the firm of Chartered Accountants in practice is also a
partner of any other firm or firms of Chartered Accountants in practice, the number of audit

assignments which may be taken for all the firms together in relation to such partner shall not exceed
the “specified number of audit assignments” in the aggregate.
Provided further where any partner of a firm or firms of Chartered Accountants in practice accepts
one or more audit of Companies in his individual capacity, or in the name of his proprietary firm, the
total number of such assignments which may be accepted by all firms in relation to such Chartered
Accountant and by him shall not exceed the “specified number of audit assignments” in the
aggregate.
In computing the “specified number of audit assignments”-
(a) the number of audit of such Companies, which he or any partner of his firm has accepted
whether singly or in combination with any other Chartered Accountant in practice or firm of
such Chartered Accountants, shall be taken into account.
(b) the audit of the head office and branch offices of a Company by one Chartered Accountant
or firm of such Chartered Accountants in practice shall be regarded as one audit assignment.
(c) the audit of one or more branches of the same Company by one Chartered Accountant in
practice or by firm of Chartered Accountants in practice in which he is a partner shall be
construed as one audit assignment only.
(d) the number of partners of a firm on the date of acceptance of audit assignment shall be taken
into account.
A Chartered Accountant in practice, whether in full-time or part time employment elsewhere, shall
not be counted for the purpose of determination of “specified number of audit of Companies” by firms
of Chartered Accountants.
A Chartered Accountant being a part time practicing partner of a firm shall not be taken into account
for the purpose of reckoning the audit assignments of the firm.
A Chartered Accountant in practice as well as firm of Chartered Accountants in practice shall
maintain a record of the audit assignments accepted by him or by the firm of Chartered Accountants,
or by any of the partners of the firm in his individual name or as a partner of any other firm, as far
as possible in the prescribed format.
* [Students may note that Section 224 and/or Section 228 of the Companies Act, 1956 has
been replaced with Section 139 and/or Section 143(8) read with Section 141(3)(g) of the
Companies Act, 2013.]
Chapter IX
Appointment as Statutory auditor
A member of the Institute in practice shall not accept the appointment as statutory auditor of Public
Sector Undertaking(s)/ Government Company(ies)/Listed Company(ies) and other Public
Company(ies) having turnover of ` 50 crores or more in a year where he accepts any other work(s)
or assignment(s) or service(s) in regard to the same Undertaking(s)/ Company(ies) on a

remuneration which in total exceeds the fee payable for carrying out the statutory audit of the same
Undertaking/company.
Provided that in case appointing authority(ies)/regulatory body(ies) specify(ies) more stringent
condition(s)/restriction(s), the same shall apply instead of the conditions/restrictions specified under
these Guidelines.
The above restrictions shall apply in respect of fees for other work(s) or service(s) or assignment(s)
payable to the statutory auditors and their associate concern(s) put together.
For the above purpose,

(i) the term “other work(s)” or “service(s)” or “assignment(s)” shall include Management
Consultancy and all other professional services permitted by the Council pursuant to Section
2(2)(iv) of the Chartered Accountants Act, 1949 but shall not include:-
(a) audit under any other statute;
(b) certification work required to be done by the statutory auditors; and
(c) any representation before an authority;
(ii) the term “associate concern” means any corporate body or partnership firm which renders
the Management Consultancy and all other professional services permitted by the Council
wherein the proprietor and/or partner(s) of the statutory auditor firm and/or their “relative(s)”
is/are Director/s or partner/s and/or jointly or severally hold “substantial interest” in the said
corporate body or partnership;
(iii) the terms “relative” and “substantial interest” shall have the same meaning as are assigned
thereto under Appendix (9) to the Chartered Accountants Regulations, 1988.
In regard to taking up other work(s) or service(s) or assignment(s) of the undertaking/company

referred to above, it shall be open to such associate concern or corporate body to render such
work(s) or service(s) or assignment(s) so long as aggregate remuneration for such other work(s) or
service(s) or assignment(s) payable to the statutory auditor/s together with fees payable to its
associate concern(s) or corporate body(ies) do/does not exceed the aggregate of fee payable for
carrying out the statutory audit.
A is the auditor of Z Ltd., which has a turnover of ` 200 crore. The audit fee for the
year is fixed at ` 50 lakhs. During the year, the company offers A an assignment of
management consultancy within the meaning of Section 2(2)(iv) of the CA Act, 1949
for a remuneration of ` 1 crore. A seeks your advice on accepting the assignment.
Appointment as a Statutory Auditor of a PSUs’/Govt Company(ies)/Listed Company(ies)
and Other Public Company(ies): As per the Council General Guidelines 2008, under Chapter
IX on appointment as statutory auditor a member of the Institute in practice shall not accepts the
appointment as a statutory auditor of a PSUs’/Govt company(ies)/Listed company(ies) and other
public company(ies) having a turnover of ` 50 crores or more in a year and where he accepts

any other work(s) or assignment(s) or service(s) in regard to same undertaking(s) on a

remuneration which in total exceeds the fee payable for carrying out the statutory audit of the same
undertaking. For this purpose the other work/services includes Management Consultancy and all
other professional services permitted by Council excluding audit under any other statute,
Certification work required to be done by the statutory auditor and any representation before an
authority.
Conclusion: In view of the above position it would be a misconduct on A’s part if he accepts the
management consultancy assignment for a fee of ` 1 crore.
Chapter X
Appointment of an auditor when he is indebted to a concern
A member of the Institute in practice or a partner of a firm in practice or a firm shall not accept
appointment as auditor of a concern while indebted to the concern or given any guarantee or
provided any security in connection with the indebtedness of any third person to the concern, for
limits fixed in the statute and in other cases for amount exceeding ` 10,000/-
D, who conducts the tax audit u/s 44AB of the Income Tax Act, 1961 of M/s ABC, a
partnership firm, has received the audit fees of ` 25,000 on progressive basis in
respect of the tax audit for the year ended 31.3.2016. The audit report was, however,
signed on 25.5.2016.
Entire Audit Fees Received in Advance: As per Chapter X of Council General Guidelines, 2008
a member of the Institute in practice or a partner of a firm in practice or a firm shall not accept
appointment as auditor of a concern while indebted to the concern or given any guarantee or
provided any security in connection with the indebtedness of any third person to the concern, for
limits fixed in the statute and in other cases for amount exceeding ` 10,000/-.
However, the Research Committee of the ICAI has expressed the opinion that where in
accordance with the terms of engagement of auditor by a client, the auditor recovers his fees on
a progressive basis as and when a part of the work is done without waiting for the completion of
the whole job, he cannot be said to be indebted to the company at any stage.
Conclusion: In the instant case, Mr. D is appointed to conduct a tax audit u/s 44AB of the Income Tax
Act, 1961. He has received the audit fees of ` 25,000 in respect of the tax audit for the year ended
31.3.2016 which is on progressive basis. Therefore, Mr. D will not be held guilty for misconduct.
Chapter XI
Directions in case of unjustified removal of auditors
A member of the Institute in practice shall follow the direction given, by the Council or an appropriate
Committee or on behalf of any of them, to him being the incoming auditor(s) not to accept the
appointment as auditor(s), in the case of unjustified removal of the earlier auditor(s).

10 RECOMMENDED SELF-REGULATORY MEASURES

As the members are aware, the Council has decided upon certain self-regulatory measures in order
to ensure a healthy growth of the profession and an equitable flow of professional work among the
members. These measures are reviewed from time to time and are published in the Journal of the
Institute for observance by the members. The self-regulatory measures are recommendatory.
However, considering the spirit underlying these measures, the Council expects that each and every
member will effectively implement them. The Council earnestly believes that implementation of these
measures would go a long way in ensuring equitable flow of work among the members and would
also further enhance the prestige of the profession in the society.
The more important of these recommendations are as under:
10.1 Branch Audits
The branch audits of a company should not be conducted by its statutory auditors consisting of ten
or more members, but should be conducted by the local firms of auditors consisting of less than ten
members. This should not be understood to mean any restriction on the right of the statutory auditors
to have access over branch accounts conferred under the Companies Act, 1956 (now Companies
Act, 2013). This restriction may not apply in the following cases.
(i) where the accounting records of the branches are maintained at the head office of the
respective companies, and
(ii) where significant operations of an undertaking or a company are carried out at its branch office.
10.2 Joint Audit
In the case of large companies the practice of associating a practicing firm with less than five
members as Joint auditors should be encouraged. Where a client desires to appoint such a firm as
joint auditor, the senior firm should not object to the same.
10.3 Ratio Between Qualified and Unqualified Staff
In the Council’s view, a practicing firm of Chartered Accountants engaged in audit work should have
at least one member for every five non-qualified members of the staff, excluding articled and audit
clerks, typists, peons and other persons not engaged directly in such professional work.
10.4 Disclosure of Interest by Auditors in other Firms
The Council has decided that as a good and healthy practice, auditors should make a disclosure of
the payments received by them for other services through the medium of a different firm or firms in
which the said auditor may be either a partner or proprietor.
[Important Note: Students may note that, in view of the fact that with effect from 01.04.2014, the
Companies Act, 1956 has been replaced with Companies Act, 2013, the “Code of Ethics” issued
by ICAI is under revision. Till the time the “Code of Ethics” gets amended in accordance with
Companies Act, 2013, students may quote revised provisions along with the old provisions.]

ANNEXURE – 1
The Chartered Accountants Act, 1949
The Chartered Accountants Act, 1949 (No. 38 of 1949) came into force on the 1st day of July, 1949.
Later in the year 1959, certain amendments were made therein through the Chartered Accountants
(Amendment) Act, 1959 (No.15 of 1959). After about 47 years extensive changes have been made
in the Act through the Chartered Accountants (Amendment) Act, 2006 (No.9 of 2006) which have
been notified by the Central Government in the Gazette of India (Extra Ordinary) dated 23rd March,
2006. Further, few insertions were made to the principle Act through the Chartered Accountants
(Amendment) Act, 2011 (No. 3 of 2012).
The entire Act is divided in nine chapters [Including chapter VIIA inserted by Chartered Accountants
(Amendment) Act, 2006].
The Complete enumeration of Contents is given below:
Chapter I - Preliminary
1. Short title, Extent and Commencement
2. Interpretation
This Chapter contains preliminary aspects of the Act like applicability of the Act, definition of various
terms like, Chartered Accountant, Council, holder of a restricted certificate, Registered Accountant,
etc.
Chapter II - The Institute of Chartered Accountants of India
3. Incorporation of the Institute
4. Entry of names in the Register
5. Fellows and Associates
6. Certificate of Practice
7. Members to be known as Chartered Accountants
8. Disabilities
This chapter deals with various things like who shall be entitled to have his name entered in the
register of members of the Institute, who shall be deemed to have become an associate member of
the Institute, who shall be entered in the Register as a fellow of the Institute. This Chapter also deals
with issues relating to certificate of practice and disabilities of a person for having his name entered
in the Register.
Chapter III - Council of the Institute
9. Constitution of the Council of the Institute

10. Re-election or re-nomination to Council [Substituted by Chartered Accountants (Amendment)

Act, 2006]
10A. Settlement of dispute regarding election [Inserted by Chartered Accountants (Amendment)
Act, 2006]
10B. Establishment of Tribunal [Inserted by Chartered Accountants (Amendment) Act, 2006]
11. Nomination in default of election or nomination
12. President and Vice-President
13. Resignation of Membership and casual vacancies
14. Duration and dissolution of the Council
15. Function of the Council
15A. Imparting education by Universities and Other bodies [Inserted by Chartered Accountants
(Amendment) Act, 2006]
16. Officers and employees, salary, allowances etc. [substituted by Chartered Accountants
17. Committees of the Council
18. Finances of the Council
This Chapter deals with various issues like composition of Council of the Institute, manner of
conducting election to the Council, mode of tendering resignation from the membership of the
Council mode of filling a casual vacancy, various duties of the Council. This Chapter also deals with
the permission accorded to any University established by law or any Body affiliated to the Institute
to impact education on the subjects covered by the academic courses of the Institute.
Chapter IV - Register of Members
19. Register of Members
20. Removal from the Register
This chapter deals with the matters relating to register of members and removal from the register
the name of any member. The Council has to maintain a Register of Members of the Institute. This
Register shall include name, date of birth, domicile, residential and professional address,
qualification etc. Also, the Council may remove from the Register the name of any member in certain
circumstances like in case of death of the member or if the member does not pay the prescribed
fees, or when a member has become subject to any of the disabilities mentioned in section 8.
Chapter V - Misconduct
21. Disciplinary Directorate [Substituted by Chartered Accountants (Amendment) Act, 2006]
21A. Board of Discipline [Inserted by Chartered Accountants (Amendment) Act, 2006]

21B. Disciplinary Committee [Inserted by Chartered Accountants (Amendment) Act, 2006]

21C. Authority, Disciplinary Committee, Board of Discipline and Director (Discipline) to have
powers of civil court [Inserted by Chartered Accountants (Amendment) Act, 2006]
21D. Transitional provisions [Inserted by Chartered Accountants (Amendment) Act, 2006]
22. Professional or other misconduct defined [Substituted by Chartered Accountants
22A. Constitution of Appellate Authority [Substituted by Chartered Accountants (Amendment) Act,
2006]
22B. Term of office of Chairperson and members of Authority [Inserted by Chartered Accountants
(Amendment) Act, 2006].
22C. Allowances and conditions of service of Chairperson and Members of Authority (Inserted by
Chartered Accountants (Amendment) Act, 2006)
22D. Procedure to be regulated by Authority [Inserted by Chartered Accountants (Amendment)
Act, 2006]
22E. Officers and other staff of Authority [Inserted by Chartered Accountants (Amendment) Act,
2006]
22F. Resignation and removal of Chairperson and Members [Inserted by Chartered Accountants
(Amendment) Act, 2006)]
22G. Appeal to Authority [Inserted by Chartered Accountants (Amendment) Act, 2006]
In this chapter professional and other misconduct has been defined. As per section 22 of the Act,
the expression “professional or other misconduct " shall be deemed to include any act or omission
provided in any of the Schedules. In this chapter, Section 21, 22 and 22A have been substituted by
new sections 21, 22 and 22A. Other sections (Section 21A, 21B, 21C, 21D, 22B, 22C, 22D, 22E,
22F and 22G) have been inserted by Chartered Accountants (Amendment) Act, 2006. These
Sections along with the Schedules deal with the new Disciplinary Mechanism.
Chapter VI - Regional Councils
23. Constitution and Functions of Regional Councils
The Councils may constitute such Regional Councils for the purpose of advising and assisting it on
matters concerning its functions. The Regional councils shall exercise prescribed functions.
Chapter VII - Penalties
24. Penalty for falsely claiming to be a member etc.
24A. Penalty for using name of the Council, awarding degree of Chartered Accountancy etc.
25. Companies not to engage in accountancy

26. Unqualified persons not to sign documents

27. Maintenance of branch offices
28. Sanction to prosecute
This chapter lists penalties in various cases like, if a person who is not a member of the Institute
and represents himself as a member of the Institute or uses the designation Chartered Accountant,
he shall be punishable with fine which may extend to one thousand rupees (on first conviction) and
with imprisonment which may extend to six months or with fine which may extend to five thousand
rupees or with both (on subsequent conviction). Other provisions regarding penalties that are
included in this chapter provide that a Company (Incorporated in or outside India) shall not practice
as Chartered Accountant, a person other than a member of the Institute shall not sign any document
an behalf of a Chartered Accountant in practice or a firm of such Chartered Accountants in his or its
professional capacity, etc.
Chapter VII A Quality Review Board
[Inserted by Chartered Accountants (Amendment) Act, 2006]
28A. Establishment of Quality Review Board
28B. Functions of Board
28C. Procedure of Board
28D. Terms and conditions of services of Chairperson and Members of Board and its expenditure
After Chapter VII, the Chapter VIIA has been inserted by the Chartered Accountants (Amendment)
Act, 2006. It empowers the Central Government to constitute a Quality Review Board outside the
framework of the Institute. It will perform the functions like, to make recommendations to the Council
with regard to the quality of services provided by the members of the Institute, to review the quality
of services provided by the members of the Institute including audit services and to guide the
members of the Institute to improve the quality of services and adherence to the various statutory
and other regulatory requirements.
Chapter VIII – Miscellaneous
29. Reciprocity
29A. Power of Central Government to make rules.
30. Power to make regulations
30A. Powers of the Central Government to direct regulation to be made or to make or amend
regulations
30B. Rules, Regulations and notification to be laid before Parliament [Substituted by Chartered
Accountants (Amendment) Act, 2006]

30C. Power of Central Government to issue directions [Inserted by Chartered Accountants

(Amendment) Act, 2006)]
30D. Protection of action taken in good faith [Inserted by Chartered Accountants (Amendment) Act,
2006)]
30E. Members etc. to be public servants [Inserted by Chartered Accountants (Amendment) Act,
2006)]
31. Construction of References
32. Act not to affect right of accountants to practice as such in Acceding States.
33. [Repealed]
This Chapter contains miscellaneous provisions. It empowers the Council to prescribe the conditions
subject to which foreign qualifications relating to accountancy shall be recognized for the purpose
of entry in the Register. It also empowers the Council to make regulations for the purpose of carrying
out the objects of this Act. It also empowers the Central Government to direct the Council to make
any regulations or to amend or revoke any regulations already made. Section 30C, 30D, and 30E
have been inserted by Chartered Accountants (Amendment) Act, 2006. Section 30C empowers the
Central Government to issue directions in the event of non-compliance by the Council of any
provisions of the Act. Section 30D protects Central Government, Council, Authority Disciplinary
Committee, Tribunal, Board, Board of Discipline, Disciplinary Directorate or any officer thereof, for
anything which is in good faith done or intended to be done under this Act or any rule, regulation,
notification, direction or order made there under. Section 30E says that the Chairperson, Presiding
officer, Members and other officers and employees of the Authority, Disciplinary Committee,
Tribunal, Board, Board of Discipline or the Disciplinary Directorate shall be deemed to be public
servants within the meaning of Section 21 of the Indian Penal Code.
ANNEXURE – 2
Relevant sections of the Chartered Accountants Act, 1949 with respect to disciplinary
procedure are provided below:
Section 21. Disciplinary Directorate –
(1) The Council shall, by notification, establish a Disciplinary Directorate headed by an officer of
the Institute designated as Director (Discipline) and such other employees for making
investigations in respect of any information or complaint received by it.
(2) On receipt of any information or complaint along with the prescribed fee, the Director
(Discipline) shall arrive at a prima facie opinion on the occurrence of the alleged misconduct.
(3) Where the Director (Discipline) is of the opinion that a member is guilty of any professional
or other misconduct mentioned in the First Schedule, he shall place the matter before the

Board of Discipline and where the Director (Discipline) is of the opinion that a member is
guilty of any professional or other misconduct mentioned in the Second Schedule or in both
the Schedules, he shall place the matter before the Disciplinary Committee.
(4) In order to make investigations under the provisions of this Act, the Disciplinary Directorate
shall follow such procedure as may be specified.
(5) Where a complainant withdraws the complaint, the Director (Discipline) shall place such
withdrawal before the Board of Discipline or, as the case may be, the Disciplinary Committee,
and the said Board or Committee may, if it is of the view that the circumstances so warrant,
permit the withdrawal at any stage.
Section 21A. Board of Discipline –
(1) The Council shall constitute a Board of Discipline consisting of -
(a) a person with experience in law and having knowledge of disciplinary matters and the
profession, to be its presiding officer;
(b) two members one of whom shall be a member of the Council elected by the Council
and the other member shall be nominated by the Central Government from amongst
the persons of eminence having experience in the field of law, economics, business,
finance or accountancy;
(c) the Director (Discipline) shall function as the Secretary of the Board.
(2) The Board of Discipline shall follow summary disposal procedure in dealing with all cases
before it.
(3) Where the Board of Discipline is of the opinion that a member is guilty of a professional or
other misconduct mentioned in the First Schedule, it shall afford to the member an opportunity
of being heard before making any order against him and may thereafter take any one or more
of the following actions, namely:
(a) reprimand the member;
(b) remove the name of the member from the Register up to a period of three months;
(c) impose such fine as it may think fit, which may extend to rupees one lakh.
(4) The Director (Discipline) shall submit before the Board of Discipline all information and
complaints where he is of the opinion that there is no prima facie case and the Board of
Discipline may, if it agrees with the opinion of the Director (Discipline), close the matter or in
case of disagreement, may advise the Director (Discipline) to further investigate the matter.
Section 21B. Disciplinary Committee –
(1) The Council shall constitute a Disciplinary Committee consisting of the President or the Vice-
President of the Council as the Presiding Officer and two members to be elected from

amongst the members of the Council and two members to be nominated by the Central
Government from amongst the persons of eminence having experience in the field of law,
economics, business, finance or accountancy.
Provided that the Council may constitute more Disciplinary Committees as and when it
considers necessary.
(2) The Disciplinary Committee, while considering the cases placed before it shall follow such
procedure as may be specified.
(3) Where the Disciplinary Committee is of the opinion that a member is guilty of a professional
or other misconduct mentioned in the Second Schedule or both the First Schedule and the
Second Schedule, it shall afford to the member an opportunity of being heard before making
any order against him and may thereafter take any one or more of the following actions,
namely:
(a) reprimand the member;
(b) remove the name of the member from the Register permanently or for such period, as
it thinks fit;
(c) impose such fine as it may think fit, which may extend to rupees five lakh.
(4) The allowances payable to the members nominated by the Central Government shall be such
as may be specified.
Section 21C. Authority, Disciplinary Committee, Board of Discipline and Director (Discipline)
to have powers of civil court – For the purposes of an inquiry under the provisions of this Act, the
Authority, the Disciplinary Committee, Board of Discipline and the Director (Discipline) shall have
the same powers as are vested in a civil court under the Code of Civil Procedure, 1908 (5 of 1908),
in respect of the following matters, namely:
(a) summoning and enforcing the attendance of any person and examining him on oath;
(b) the discovery and production of any document; and
(c) receiving evidence on affidavit.
Explanation: for the purposes of sections 21, 21A, 21B, 21C and 22, “member of the Institute”
includes a person who was a member of the Institute on the date of the alleged misconduct although
he has ceased to be a member of the Institute at the time of the inquiry.
Section 21D. Transitional provisions – All complaints pending before the Council or any inquiry
initiated by the Disciplinary Committee or any reference or appeal made to a High Court prior to the
commencement of the Chartered Accountants (Amendment) Act, 2006, shall continue to be
governed by the provisions of this Act, as if this Act had not been amended by the Chartered
Accountants (Amendment) Act, 2006.

Section 22. Professional or other misconduct defined – For the purposes of this Act, the
expression “professional or other misconduct” shall be deemed to include any act or omission
provided in any of the Schedules, but nothing in this section shall be construed to limit or abridge in
any way the power conferred or duty cast on the Director (Discipline) under sub-section (1) of section
21 to inquire into the conduct of any member of the Institute under any other circumstances.
Section 22A. Constitution of Appellate Authority –
(1) The Central Government shall, by notification, constitute an Appellate Authority consisting of -
(a) a person who is or has been a judge of a High Court, to be its Chairperson;
(b) two members to be appointed from amongst the persons who have been members of
the Council for at least one full term and who are not sitting members of the Council;
(c) two members to be nominated by the Central Government from amongst persons
having knowledge and practical experience in the field of law, economics, business,
finance or accountancy.
(2) The Chairperson and other members shall be part-time members.
Section 22B. Term of office of Chairperson and members of Authority –
(1) A person appointed the Chairperson shall hold office for a term of three years from the date
on which he enters upon his office or until he attains the age of sixty-five years, whichever is
earlier.
(2) A person appointed as a member shall hold office for a term of three years from the date on
which he enters upon his office or until he attains the age of sixty-two years, whichever is
earlier.
Section 22C. Allowances and conditions of service of Chairperson and members of Authority
– The allowances payable to, and other terms and conditions of service of, the Chairperson and
members and the manner of meeting expenditure of the Authority by the Council and such other
authorities shall be such as may be specified.
Section 22D. Procedure to be regulated by Authority –
(1) The office of the Authority shall be at Delhi.
(2) The Authority shall regulate its own procedure.
(3) All orders and decisions of the Authority shall be authenticated by an officer duly authorised
by the Chairperson in this behalf.
Section 22E. Officers and other staff of Authority –
(1) The Council shall make available to the Authority such officers and other staff members as
may be necessary for the efficient performance of the functions of the Authority.

(2) The salaries and allowances and conditions of service of the officers and other staff members
of the Authority shall be such as may be prescribed.
Section 22F. Resignation and removal of Chairperson and members –
(1) The Chairperson or a member may, by notice in writing under his hand addressed to the
Central Government, resign his office.
Provided that the Chairperson or a member shall, unless he is permitted by the Central
Government to relinquish his office sooner, continue to hold office until the expiry of three
months from the date of receipt of such notice or until a person duly appointed as his
successor enters upon his office or until the expiry of term of office, whichever is earlier.
(2) The Chairperson or a member shall not be removed from his office except by an order of the
Central Government on the ground of proved misbehaviour or incapacity after an inquiry
made by such person as the Central Government may appoint for this purpose in which the
Chairperson or a member concerned has been informed of the charges against him and given
a reasonable opportunity of being heard in respect of such charges.
Section 22G. Appeal to Authority –
(1) Any member of the Institute aggrieved by any order of the Board of Discipline or the
Disciplinary Committee imposing on him any of the penalties referred to in sub-section (3) of
section 21A and sub-section (3) of section 21B, may within ninety days of the date on which
the order is communicated to him, prefer an appeal to the Authority.
Provided that the Director (Discipline) may also appeal against the decision of the Board of
Discipline or the Disciplinary Committee to the Authority, if so authorised by the Council,
within ninety days.
Provided further that the Authority may entertain any such appeal after the expiry of the said
period of ninety days, if it is satisfied that there was sufficient cause for not filing the appeal
in time.
(2) The Authority may, after calling for the records of any case, revise any order made by the
Board of Discipline or the Disciplinary Committee under sub-section (3) of section 21A and
sub-section (3) of section 21B and may -
(a) confirm, modify or set aside the order;
(b) impose any penalty or set aside, reduce, or enhance the penalty imposed by the order;
(c) remit the case to the Board of Discipline or Disciplinary Committee for such further
enquiry as the Authority considers proper in the circumstances of the case; or
(d) pass such other order as the Authority thinks fit:
Provided that the Authority shall give an opportunity of being heard to the parties concerned before
passing any order.

ANNEXURE – 3
SCHEDULES TO THE ACT

Acts or omissions which comprise professional misconduct within the meaning of Section 22 of the
Chartered Accountants Act are defined in two Schedules viz. the First Schedule and the Second
Schedule.
The First Schedule is divided into four parts, Part I of the First Schedule deals with the misconduct
of a member in practice which would have the effect generally of compromising his position as an
independent person. Part II deals with misconduct of members in services. Part-III deals with the
misconduct of members generally and part IV deals with other misconduct in relation to members of
the institute generally. The Second Schedule is divided into three parts. Part I deals with misconduct
in relation to a member in practice, Part II deals with misconduct of members generally and part III
deals with other misconduct in relation to members of the Institute generally. The implication of the
different clauses in the schedules are discussed below:
The First Schedule
PART I - Professional misconduct in relation to Chartered Accountants

in practice
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if he:
Clause (1) allows any person to practice in his name as a chartered accountant unless such person
is also a chartered accountant in practice and is in partnership with or employed by him.
Clause (2) pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or
brokerage in the fees or profits of his professional business, to any person other than a member of
the Institute or a partner or a retired partner or the legal representative of a deceased partner, or a
member of any other professional body or with such other persons having such qualification as may
be prescribed, for the purpose of rendering such professional services from time to time in or outside
India.
Clause (3) accepts or agrees to accept any part of the profits of the professional work of a person
who is not a member of the Institute.
Clause (4) enters into partnership, in or outside India, with any person other then Chartered
Accountant in practice or such other person who is a member of any other professional body having
such qualifications as may be prescribed, including a resident who but for his residence abroad
would be entitled to be registered as a member under close (V) of sub-section (1) of section 4 or
whose qualifications are recognized by the Central Government or the Council for the purpose of
permitting such partnerships.

Clause (5) Secures either through the services of a person who is not an employee of such Chartered
Accountant or who is not his partner or by means which are not open to a Chartered Accountant,
any professional business.
Provided that nothing herein contained shall be construed as prohibiting any agreement permitted
in terms of item (2), (3) and (4) of this part.
Clause (6) Solicits clients or professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means.
Provided that nothing herein contained shall be construed as preventing or prohibiting -
(i) Any Chartered Accountant from applying or requesting for or inviting or securing professional
work from another chartered accountant in practice; or
(ii) A member from responding to tenders or enquiries issued by various users of professional
services or organizations from time to time and securing professional work as a consequence.
However, as per the guideline issued by the Council of the Institute of Chartered Accountants
of India, a member of the Institute in practice shall not respond to any tender issued by an
organization or user of professional services in areas of services which are exclusively
reserved for chartered accountants, such as audit and attestation services. However, such
restriction shall not be applicable where minimum fee of the assignment is prescribed in the
tender document itself or where the areas are open to other professionals along with the
Chartered Accountants.
Clause (7) Advertises his professional attainments or services, or uses any designation or
expressions other than the Chartered Accountant on professional documents, visiting cards, letter
heads or sign boards unless it be a degree of a University established by law in India or recognized
by the Central Government or a title indicating membership of the Institute of Chartered Accountants
or of any other institution that has been recognized by the Central Government or may be recognized
by the Council.
Provided that a member in practice may advertise through a write up, setting out the service provided
by him or his firm and particulars of his firm subject to such guidelines as may be issued by the
Council.
Clause (8) Accepts a position as auditor previously held by another chartered accountant or a
certified auditor who has been Issued certificate under the Restricted Certificate Rules, 1932 without
first communicating with him in writing.
Clause (9) Accepts an appointment as auditor of a company without first ascertaining from it whether
the requirements of Section 225 of the Companies Act, 1956, in respect of such appointment have
been duly complied with.
(Now Section 139 and 140 read with Section 141 of the Companies Act, 2013. Students may note
that till the time Code of Ethics etc. bare documents get updated from Ethical Standard Board of

ICAI in pursuance of the Companies Act, 2013, students are required to understand the basic nature
of the provision and quote the same along with the new corresponding provisions.)
Clause (10) Charges or offers to charge, accepts or offers to accept In respect of any professional
employment fees which are based on a percentage of profits or which are contingent upon the
findings, or results of such employment, except as permitted under any regulations made under this
Act.
The Council of the Institute has however framed Regulation 192 which exempts members from the
operation of this clause in certain professional services. The said Regulation 192 is reproduced -
192. Restriction on fees - No Chartered Accountant in practice shall charge or offer to charge,
accept or offer to accept, in respect of any professional work, fees which are based on a percentage
of profits, or which are contingent upon the findings or results of such work, provided that
(a) In the case of a receiver or a liquidator, the fees may be based on a percentage of the
realization or disbursement of the assets;
(b) In the case of an auditor of a co-operative society, the fees may be based on a percentage
of the paid up capital or the working capital or the gross or net income or profits;
(c) In the case of a valuer for the purposes of direct taxes and duties, the fees may be based on
a percentage of the value of property valued;
(d) in the case of certain management consultancy services as may be decided by the resolution
of the Council from time to time, the fees may be based on percentage basis which may be
contingent upon the findings, or results of such work;
(e) in the case of certain fund raising services, the fees may be based on a percentage of the
fund raised;
(f) in the case of debt recovery services, the fees may be based on a percentage of the debt
recovered;
(g) in the case of services related to cost optimisation, the fees may be based on a percentage
of the benefit derived; and
(h) any other service or audit as may be decided by the Council.
Clause (11) Engages in any business or occupation other than the profession of chartered
accountant unless permitted by the Council so to engage.
Provided that nothing contained herein shall disentitle a chartered accountant from being a director
of a company (Not being managing director or a whole time director) unless he or any of his partners
is interested in such company as an auditor.
Clause (12) Allows a person not being a member of the institute in practice or a member not being
his partner to sign on his behalf or on behalf of his firm, any balance sheet, profit and loss account,
report or financial statements.

PART II - Professional misconduct in relation to members of the Institute

in service
A member of the Institute (other than a member in practice) shall be deemed to be guilty of
professional misconduct, if he being an employee of any company, firm or person:
Clause (1) pays or allows or agrees to pay directly or indirectly to any person any share in the
emoluments of the employment undertaken by him.
Clause (2) accepts or agrees to accept any part of fees, profits or gains from a lawyer, a chartered
accountant or broker engaged by such company, firm or person or agent or customer of such
company, firm or person by way of commission or gratification.
[Note: A member in the foregoing circumstances would be guilty of misconduct regardless of the fact
that he was in whole-time or part-time employment or that he was holding Certificate of Practice
along with his employment.]
PART III - Professional misconduct in relation to members of the Institute
generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of
professional misconduct, if he:
misconduct, if he:
Clause (1) not being a fellow of the Institute, acts as a fellow of the Institute.
Clause (2) does not supply the information called for, or does not comply with the requirements
asked for, by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline,
Disciplinary Committee, Quality Review Board or the Appellate Authority.
Clause (3) while inviting professional work from another chartered accountant or while responding
to tenders or enquiries or while advertising through a write up, or anything as provided for in items
(6) and (7) of Part I of this Schedule, gives information knowing it to be false.
PART IV- Other misconduct in relation to members of the Institute
generally
misconduct, if he:
(1) is held guilty by any civil or criminal court for an offence which is punishable with
imprisonment for a term not exceeding six months.
(2) in the opinion of the Council, brings disrepute to the profession or the Institute as a result of
his action whether or not related to his professional work.

These clause (1) & (2) are self explanatory and any of the member of the Institute is found guilty by
any civil or criminal court and prosecuted for an imprisonment in an offence involving moral turpitude
or his acts bring disrepute to the profession or the Institute, irrespective of the fact whether such
acts are related to profession or not, such member will be deemed to be guilty of other misconduct
in Part IV of Schedule I.
The important point to note is that if imprisonment tenure exceeds six months, this case will be
covered in the clause of Part III of Schedule II.
The Second Schedule
PART I -Professional misconduct in relation to chartered Accountant in

practice
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct,
if he:
Clause (1) Discloses Information acquired in the course of his professional engagement to any
person other than his client so engaging him without the consent of his client or otherwise than as
required by any law for the time being in force.
Clause (2) If he certifies or submits in his name or in the name of his firm, a report of an examination
of financial statements unless the examination of such statements and the related records has been
made by him or by a partner or an employee In his firm or by another chartered accountant in
practice.
Clause (3) Permits his name or the name of his firm to be used in connection with an estimate of
earnings contingent upon future transactions in manner which may lead to the belief that he vouches
for the accuracy of the forecast.
Clause (4) Expresses his opinion on financial statements of any business or enterprise in which he,
his firm, or a partner in his firm has a substantial interest.
Clause (5) Fails to disclose a material fact known to him which is not disclosed in a financial
statement, but disclosure of which is necessary in making such financial statement not misleading
where he is concerned with that financial statement in a professional capacity.
Clause (6) Fails to report a material misstatement known to him to appear in a financial statement
with which he is concerned in a professional capacity.
Clause (7) Does not exercise due diligence, or is grossly negligent in the conduct of his professional
duties.
Clause (8) Fails to obtain sufficient information which is necessary for expression of an opinion or
its exceptions are sufficiently material to negate the expression of an opinion.
Clause (9) Fails to invite attention to any material departure from the generally accepted procedure
of audit applicable to the circumstances.

Clause (10) Fails to keep moneys of his client other than fees or remuneration or money meant to
be expended in a separate banking account or to use such moneys for purposes for which they are
intended within a reasonable time.
PART II - Professional misconduct in relation to members of the Institute
generally
misconduct, if he:
Clause (1) contravenes any of the provisions of this Act or the regulations made there under or any
guidelines issued by the Council.
Clause (2) being an employee of any company, firm or person, discloses confidential information
acquired in the course of his employment except as and when required by any law for the time being
in force or except as permitted by the employer.
Clause (3) Includes in any information, statement, return or form to be submitted to the Institute,
Council or any of its Committees, Director (Discipline), Board of Discipline. Disciplinary Committee,
Quality Review Board or the Appellate Authority any particulars knowing them to be false.
Clause (4) Defalcates or embezzles money received in his professional capacity.
Part III - Other misconduct in relation to members of the Institute

generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other mis-
conduct, if he is held guilty by any civil or criminal court for an offence which is punishable with
imprisonment for a term exceeding six months.
Imprisonment awarded for a term exceeding six months in any civil/criminal matter treated as a major
offence under ‘other misconduct’ is included in this Schedule.
Where the Director (Discipline) is of the opinion that a member is guilty of any professional or other
misconduct mentioned in the second schedule or in both the Schedule, he shall place the matter
before the Disciplinary Committee.
Recent Decisions of Ethical Standards Board
1. A Chartered Accountant in practice may be an equity research adviser, but he cannot publish
retail report, as it would amount to other business or occupation.
2. A Chartered Accountant, who is a member of a Trust, cannot be the auditor of the said trust.
3. A Chartered Accountant in practice may engage himself as Registration Authority (RA) for
obtaining digital signatures for clients.

4. A Chartered accountant can hold the credit card of a bank when he is also the auditor of the
bank, provided the outstanding balance on the said card does not exceed rupees 10000
beyond the prescribed credit period limit on credit card given to him.
5. A Chartered Accountant in practice can act as mediator in Court, since acting as a “mediator”
would be deemed to be covered within the meaning of “arbitrator’; which is inter-alia permitted
to members in practice as per Regulation 191 of the Chartered Accountants Regulations,
1988.
6. A Chartered Accountant in practice is not permitted to accept audit assignment of a bank in
case he has taken loan against a Fixed Deposit held by him in that bank.
7. The Ethical Standards Board in 2013 generally apply the stipulations contained in the then
amended Rule 11U of Income Tax generally, wherein statutory auditor /tax auditor cannot be
the valuer of unquoted equity shares of the same entity.
The Board has at its recent Meeting (January, 2017) has reviewed the above, and decided
that where law prohibits for instance in the Income Tax Act and the rules framed thereunder,
such prohibition on statutory auditor/tax auditor to be the valuer will continue, but where there
is no specific restriction under any law, the said eventuality will be permissible, subject to
compliance with the provisions, as contained in the Code of Ethics relating to independence.
8. The Ethical Standards Board had in 2011 decided that it is not permissible for a member who
has been Director of a Company, upon resignation from the Company to be appointed as an
auditor of the said Company, and the cooling period for the same may be 2 years.
The Board has at its recent Meeting (January, 2017) has reviewed the above, and noted that
the Section 141 of Companies Act, 2013 on disqualification of auditors does not mention such
prohibition; though threats pertaining to the said eventuality have been mentioned in Code of
Ethics.
Further, the Board was of the view that a member may take decision in such situation based
on the provisions of Companies Act, 2013 and provisions of Code of Ethics.
9. A chartered accountant in practice cannot become Financial Advisors and receive
fees/commission from Financial Institutions such as Mutual Funds, Insurance Companies,
NBFCs etc.
10. A chartered accountant cannot exercise lien over the client documents/records for non-
payment of his fees.
11. It is not permissible for CA Firm to print its vision and values behind the visiting cards, as it
would result in solicitation and therefore would be violative of the provisions of Clause (6) of
Part-I of First Schedule to the Chartered Accountants Act, 1949.
12. It is not permissible for chartered accountants in practice to take agencies of UTI, GIC or
NSDL.

13. It is permissible for a member in practice to be a settlor of a trust.

14. A member in practice cannot hold Customs Brokers Licence under section 146 of the
Customs Act, 1962 read with Customs Brokers Licensing Regulations, 2013 in terms of the
provisions of Code of Ethics.
15. A Chartered accountant in service may appear as tax representative before tax authorities
on behalf of his employer, but not on behalf of other employees of the employer.
16. A chartered accountant who is the statutory auditor of a bank cannot for the same financial
year accept stock audit of the same branch of the bank or any of the branches of the same
bank or sister concern of the bank, for the same financial year.
17. A CA Firm which has been appointed as the internal auditor of a PF Trust by a Government
Company cannot be appointed as its Statutory Auditor.
18. A concurrent auditor of a bank ‘X’ cannot be appointed as statutory auditor of bank ‘Y’, which
is sponsored by ‘X’.
19. A CA/CA Firm can act as the internal auditor of a company & statutory auditor of its employees
PF Fund under the new Companies Act (2013).
20. The Ethical Standards Board while noting that there is requirement for a Director u/s 149(3)
of the Companies Act, 2013 to reside in India for a minimum period of 182 days in the previous
calendar year, decided that such a Director would be within the scope of Director Simplicitor
(which is generally permitted as per ICAI norms), if he is non – executive director, required
in the Board Meetings only, and not paid any remuneration except for attending such Board
Meetings.
21. Internal Auditor not to undertake GST Audit simultaneously .

TEST YOUR KNOWLEDGE

1. P, a Chartered Accountant in practice provides management consultancy and other services
to his clients. During 2019, looking to the growing needs of his clients to invest in the stock
markets, he also advised them on Portfolio Management Services whereby he managed
portfolios of some of his clients.
2. Mr. G, a Chartered Accountant in practice as a sole proprietor has an office in Mumbai near
Church Gate. Due to increase in professional work, he opens another office in a suburb of
Mumbai which is approximately 80 kilometers away from the municipal limits of the city. For
running the new office, he employs three retired Income-tax Officers.
3. Write a short note on Other Misconduct.
4. Mr. K, a practicing Chartered Accountant gave 50% of the audit fees received by him to a
non-Chartered Accountant, Mr. L, under the nomenclature of office allowance and such an
arrangement continued for a number of years.
5. Mr. X who passed his CA examination of ICAI on 18th July, 2017 and started his practice
from August 15, 2017. On 16th August 2017, one female candidate approached him for
articleship. In addition to monthly stipend, Mr. X also offered her 1 % profits of his CA firm.
She agreed to take both 1 % profits of the CA firm and stipend as per the rate prescribed by
the ICAI. The Institute of Chartered Accountants of India sent a letter to Mr. X objecting the
payment of 1 % profits. Mr. X replies to the ICAI stating that he is paying 1 % profits of his
firm over and above the stipend to help the articled clerk as the financial position of the
articled clerk is very weak. Is Mr. X Liable to professional misconduct?
6. M/s XYZ, a firm in practice, develops a website “xyz.com”. The colour chosen for the website
was a very bright green and the web-site was to run on a “push” technology where the names
of the partners of the firm and the major clients were to be displayed on the web-site without
any disclosure obligation from any regulator.
7. A partner of a firm of chartered accountants during a T.V. interview handed over a bio-data
of his firm to the chairperson. Such bio-data detailed the standing of the international firm
with which the firm was associated. It also detailed the achievements of the concerned partner
and his recognition as an expert in the field of taxation in the country. The chairperson read
out the said bio-data during the interview. Discuss whether this action by the Chartered
Accountant would amount to misconduct or not.
8. (a) An advertisement was published in a Newspaper containing the photograph of Mr. X, a
member of the institute wherein he was congratulated on the occasion of the opening
ceremony of his office.

(b) Mr. X, a Chartered Accountant and the proprietor of X & Co., wrote several letters to
the Assistant Registrar of Co-operative Societies stating that though his firm was on
the panel of auditors, no audit work was allotted to the firm and further requested him
to look into the matter.
9. A practising Chartered Accountant uses a visiting card in which he designates himself,
besides as Chartered Accountant, Cost Accountant.
10. Mr. Nigal, a Chartered Accountant in practice, delivered a speech in the national conference
organized by the Ministry of Textiles. While delivering the speech, he told to the audience
that he is a management expert and his firm provides services of taxation and audit at
reasonable rates. He also requested the audience to approach his firm of chartered
accountants for these services and at the request of audience he also distributed his business
cards and telephone number of his firm to those in the audience. Comment.
11. Mr. 'A' is a practicing Chartered Accountant working as proprietor of M/s A & Co. He went
abroad for 3 months. He delegated the authority to Mr. 'Y' a Chartered Accountant his
employee for taking care of routine matters of his office. During his absence Mr. 'Y' has
conducted the under mentioned jobs in the name of M/s A & Co.
(i) He issued the audit queries to client which were raised during the course of audit.
(ii) He issued production certificate to a client under GST Act, 1944.
(iii) He attended the Income Tax proceedings for a client as authorized representative before
Income Tax Authorities.
Please comment on eligibility of Mr. 'Y' for conducting such jobs in name of M/s A & Co. and
liability of Mr. 'A' under the Chartered Accountants Act, 1949.
12. XYZ Co. Ltd. has applied to a bank for loan facilities. The bank on studying the financial
statements of the company notices that you are the auditor and requests you to call at the
bank for a discussion. In the course of discussions, the bank asks for your opinion regarding
the company and also asks for detailed information regarding a few items in the financial
statements. The information is available in your working paper file. What should be your
response and why?
1. AJ & Co LLP is a firm of Chartered Accountants. The firm has 10 Partners. The firm has a
good portfolio of clients for statutory audits, but the same clients had some other firms as
their tax auditors. In the current year (FY 2019-20), many existing clients for whom AJ & Co
LLP happens to be the statutory auditor have requested the firm to carry out their tax audits
as well. The firm is expecting the no of tax audits to increase significantly this year. One of
the partners of the firm has also raised a point that the firm can accepts tax audits upto a
maximum limit. However, other partners are of the strong view that limits on audits is

applicable in case of statutory audits and not for tax audits. This needs to be decided as soon
as possible so that the appointment formalities can also be completed.
You are requested to advise the firm in this matter.
(a) There is no limit on no of tax audits in case of LLP.
(b) All the partners of the firm can collectively sign 450 tax audit reports.
(c) All the partners of the firm can collectively sign 600 tax audit reports.
(d) All the partners of the firm can collectively sign 450 tax audit reports. However, one
partner can individually sign maximum 60 tax audit reports.
2. CA. D, a chartered accountant in practice availed of a loan against his personal investments
from a bank. He issued 2 cheques towards repayment of the said loan as per the instalments
due. However, both the cheques were returned back by the bank with the remarks
"Insufficient funds". As per Chartered Accountants Act, 1949, under which clause CA D is
liable for misconduct .
(a) Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949
(b) Clause (4) of Part I of the Second Schedule to the Chartered Accountants Act, 1949
(c) Clause (12) of Part I of the First Schedule to the Chartered Accountants Act, 1949
(d) Clause (2) of Part IV of the First Schedule to the Chartered Accountants Act, 1949
3. CA. Intelligent, a Chartered Accountant in practice, provides part-time tutorship under the
coaching organization of the Institute. On 30th June, 2019, he was awarded ‘Best Faculty of
the year’ as gratitude from the Institute. Later on, CA. Intelligent posted his framed
photograph on his website wherein he was receiving the said award from the Institute. As per
Chartered Accountants Act, 1949, under which clause Intelligent is liable for misconduct .
(a) Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949
(c) Clause (7) of Part I of the First Schedule to the Chartered Accountants Act, 1949
(d) Clause (8) of Part I of the Second Schedule to the Chartered Accountants Act, 1949
4. Mr. Hopeful, an aspiring student of ICAI, approached Mr. Witty, a practicing Chartered
Accountant, for the purpose of articleship. Mr. Witty, the principal, offered him stipend at the
rate of ` 2,000 per month to be paid every sixth month along with interest at the rate of 10%
per annum compounded monthly to compensate such late payment on plea that cycle of
professional receipts from clients is six months. Mr. Hopeful agreed for such late payment in
the hope of getting extra stipend in the form of interest. Mr. Witty, however, used to disburse
salary to all of his employees on time. As per Chartered Accountants Act, 1949, under which
clause Mr. Witty is liable for misconduct.

(a) Clause (1) of Part II of the Second Schedule to the Chartered Accountants Act, 1949
(c) Mr. Witty is paying interest thus he is not liable for misconduct
(d) Clause (10) of Part I of the Second Schedule to the Chartered Accountants Act, 1949
5. CA Ram is practicing in the field of financial management planning for over
12 years. He has gained expertise in this domain over others. Mr. Ratan, a student of
Chartered Accountancy course, is very much impressed with the knowledge of CA. Ram. He
approached CA. Ram to take guidance on some topics of financial management subject
related to his course. CA. Ram, on request, decided to spare some time and started providing
private tutorship to Mr. Ratan along with some other aspirants for 3 days in a week and for 2
hours in a day. However, he forgot to take specific permission for such private tutorship from
the Council. Later on, he came to know that the Council has passed a Resolution under
Regulation 190A granting general permission (for private tutorship, and part-time tutorship
under Coaching organization of the Institute) and specific permission (for part-time or full time
tutorship under any educational institution other than Coaching organization of the Institute).
Such general and specific permission granted is subject to the condition that the direct
teaching hours devoted to such activities taken together should _______________ in order
to be able to undertake attest functions.
(a) not exceed 25 hours a week
(b) not exceed 21 hours a week
(c) not exceed 25 hours a month
(d) not exceed 21 hours a month

1. Advising on Portfolio Management Services: The Council of the Institute of Chartered
Accountants of India (ICAI) pursuant to Section 2(2)(iv) of the Chartered Accountants Act,
1949 has passed a resolution permitting “Management Consultancy and other Services” by
a Chartered Accountant in practice. A clause of the aforesaid resolution allows Chartered
Accountants in practice to act as advisor or consultant to an issue of securities including such
matters as drafting of prospectus, filing of documents with SEBI, preparation of publicity
budgets, advice regarding selection of brokers, etc. It is, however, specifically stated that
Chartered Accountants in practice are not permitted to undertake the activities of broking,
underwriting and portfolio management services. Thus, a chartered accountant in practice is
not permitted to manage portfolios of his clients.
Conclusion: In view of this, P would be guilty of misconduct under the Chartered Accountants
Act, 1949.

2. In terms of section 27 of the Chartered Accountants Act, 1949, if a chartered accountant in

practice has more than one office in India, each one of these offices should be in the separate
charge of a member of the Institute. There is however an exemption for the above if the
second office is located in the same premises, in which the first office is located; or the second
office is located in the same city, in which the first office is located; or the second office is
located within a distance of 50 kms from the municipal limits of a city, in which the first office
is located. Since the second office is situated beyond 50 kms of municipal limits of Mumbai
city, he would be liable for committing a professional misconduct.
3. Refer Para 7.2
4. Sharing of Audit Fees with Non-Member: As per Clause (2) of Part I of First Schedule to
the Chartered Accountants Act, 1949 a member shall be held guilty if a Chartered Accountant
in practice pays or allows or agrees to pay or allow, directly or indirectly, any share,
commission or brokerage in the fees or profits of his professional business, to any person
other than a member of the Institute or a partner or a retired partner or the legal representative
of a deceased partner, or a member of any other professional body or with such other persons
having such qualification as may be prescribed, for the purpose of rendering such
professional services from time to time in or outside India.
In the instant case, Mr. K, a practising Chartered Accountant gave 50% of the audit fees
received by him to a non-Chartered Accountant, Mr. L, under the nomenclature of office
allowance and such an arrangement continued for a number of years. In this case, it is not
the nomenclature to a transaction that is material but it is the substance of the transaction,
which has to be looked into.
The Chartered Accountant had shared his profits and, therefore, Mr. K will be held guilty of
professional misconduct under the Clause (2) of Part I of First Schedule to the Chartered
5. Sharing Fees with an Articled Clerk: As per Clause (2) of Part I of First Schedule to the
Chartered Accountants Act 1949, a Chartered Accountant in practice shall be deemed to be
guilty of professional misconduct if he pays or allows or agrees to pay or allow, directly or
indirectly, any share, commission or brokerage in the fees or profits of his professional
business, to any person other than a member of the Institute or a partner or a retired partner
or the legal representative of a deceased partner, or a member of any other professional body
or with such other persons having such qualification as may be prescribed, for the purpose
of rendering such professional services from time to time in or outside India.
In view of the above, the objections of the Institute of Chartered Accountants of India, as
given in the case, are correct and reply of Mr. X, stating that he is paying 1 % profits of his
firm over and above the stipend to help the articled clerk as the position of the articled clerk
is weak is not tenable.

Hence, Mr. X is guilty of professional misconduct in terms of Clause (2) of Part I of First
Schedule to the Chartered Accountants Act 1949.
6. Posting of Particulars on Website: The Council of the Institute had approved posting of
particulars on website by Chartered Accountants in practice under Clause (6) of Part I of First
Schedule to the Chartered Accountants Act, 1949 subject to the prescribed guidelines. The
relevant guidelines in the context of the website hosted by M/s XYZ are:
♦ No restriction on the colours used in the website;
♦ The websites are run on a “pull” technology and not a “push” technology;
♦ Names of clients and fees charged not to be given.
However, disclosure of names of clients and/or fees charged, on the website is permissible
only where it is required by a regulator, whether or not constituted under a statute, in India or
outside India, provided that such disclosure is only to the extent of requirement of the
regulator. Where such disclosure of names of clients and/or fees charged is made on the
website, the member/ firm shall ensure that it is mentioned on the website [in italics], below
such disclosure itself, that “This disclosure is in terms of the requirement of [name of the
regulator] having jurisdiction in [name of the country/area where such regulator has
jurisdiction] vide [Rule/ Directive etc. under which the disclosure is required by the Regulator].
In view of the above, M/s XYZ would have no restriction on the colours used in the website
but failed to satisfy the other two guidelines. Thus, the firm would be liable for professional
misconduct since it would amount to soliciting work by advertisement.
7. Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 prohibits
solicitation of client or professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means since it shall constitute
professional misconduct. The bio-data was handed over to the chairperson during the T.V.
interview by the Chartered Accountant which included details about the firm and the
achievements of the partner as an expert in the field of taxation. The chairperson simply read
out the same in detail about association with the international firm as also the achievements
of the partner and his recognition as an expert in the field of taxation. Such an act would
definitely lead to the promotion of the firms’ name and publicity thereof as well as of the
partner and as such the handing over of bio-data cannot be approved. The partner would be
held guilty of professional miscount under Clause (6) of Part I of the First Schedule to the
8. (a) Publishing an Advertisement Containing Photograph: As per Clause (6) of Part I of
the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in
practice shall be deemed to be guilty of misconduct if he solicits clients or professional
work either directly or indirectly by a circular, advertisement, personal communication or
interview or by any other means.

In the given case, Mr. X published an advertisement in a Newspaper containing his

photograph on the occasion of the opening ceremony of his office. On this context, it
may be noted that the advertisement which had been put in by the member is quite
prominent. If soliciting of work is allowed, the independence and forthrightness of a
Chartered Accountant in the discharge of duties cannot be maintained.
The above therefore amounts to soliciting professional work by advertisement directly
or indirectly. Mr. X would be therefore held guilty under Clause (6) of Part I of the First
(b) Soliciting Professional Work: As per Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed
to be guilty of misconduct if he solicits clients or professional work either directly or
indirectly by a circular, advertisement, personal communication or interview or by any
other means.
In the given case, Mr. X, a Chartered Accountant and proprietor of M/s X and Co.,
wrote several letters to the Assistant Registrar of Co-operative Societies, requesting
for allotment of audit work. In similar cases, it was held that the Chartered Accountant
would be guilty of professional misconduct under Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949. The writing of continuous letter to
ascertain the reasons for not getting the work is quite alright but in case such either
amount to request for allowing the work then Mr. X will be liable for professional
misconduct.
Consequently, Mr. X would therefore be held guilty under Clause (6) of Part I of the
First Schedule to the Chartered Accountants Act, 1949.
9. Cost Accountant: As stated in the case study given in clause 7 with reference to tax
consultant, this would also constitute misconduct under section 7 of the Act read with Clause
(7) of Part I of the First Schedule to the Chartered Accountants Act, 1949. A chartered
accountant in practice cannot use any other designation than that of a chartered accountant.
Nevertheless, a member in practice may use any other letters or descriptions indicating
membership of accountancy bodies which have been approved by the Council. Thus, it is
improper for a chartered accountant to state in his documents that he is a “Cost Accountant”.
However as per the Chartered Accountants Act, 1949, the Council has resolved that the
members are permitted to use letters indicating membership of the Institute of Cost and Works
Accountants but not the designation "Cost Accountant".
10. Using Designation Other Than a CA and Providing Details of Services Offered:
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 states that
a Chartered Accountant in practice shall be deemed to be guilty of misconduct if he solicits
clients or professional work either directly or indirectly by a circular, advertisement, personal
communication or interview or by any other means. Such a restraint has been put so that the

members maintain their independence of judgment and may be able to command respect
from their prospective clients.
Section 7 of the Chartered Accountants Act, 1949 read with Clause (7) of Part I of the First
Schedule to the said Act prohibits advertising of professional attainments or services of a
member. It also restrains a member from using any designation or expression other than that
of a chartered accountant in documents through which the professional attainments of the
member would come to the notice of the public. Under the clause, use of any designation or
expression other than chartered accountant for a chartered accountant in practice, on
professional documents, visiting cards, etc. amounts to a misconduct unless it be a degree
of a university or a title indicating membership of any other professional body recognised by
the Central Government or the Council.
Member may appear on television and films and agree to broadcast in the Radio or give
lectures at forums and may give their names and describe themselves as Chartered
Accountants. Special qualifications or specialized knowledge directly relevant to the subject
matter of the programme may also be given but no reference should be made, in the case of
practicing member to the name and address or services of his firm. What he may say or write
must not be promotional of his or his firm but must be an objective professional view of the
topic under consideration.
Thus, it is improper to use designation "Management Expert" since neither it is a degree of a
University established by law in India or recognised by the Central Government nor it is a
recognised professional membership by the Central Government or the Council. Therefore,
he is deemed to be guilty of professional misconduct under both Clause (6) and Clause (7)
as he has used the designation “Management Expert” in his speech and also he has made
reference to the services provided by his firm of Chartered Accountants at reasonable rates.
Distribution of cards to audience is also a misconduct in terms of Clause (6).
11. Delegation of Authority to the Employee: As per Clause (12) of Part I of the First Schedule
of the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be
guilty of professional misconduct “if he allows a person not being a member of the Institute in
practice or a member not being his partner to sign on his behalf or on behalf of his firm, any
balance sheet, profit and loss account, report or financial statements”.
In this case CA. ‘A’ proprietor of M/s A & Co., went to abroad and delegated the authority to
another Chartered Accountant Mr. Y, his employee, for taking care of routine matters of his
office who is not a partner but a member of the Institute of Chartered Accountants
The Council has clarified that the power to sign routine documents on which a professional
opinion or authentication is not required to be expressed may be delegated and such
delegation will not attract provisions of this clause like issue of audit queries during the course
of audit, asking for information or issue of questionnaire, attending to routing matters in tax
practice, subject to provisions of Section 288 of Income Tax Act etc.

(i) In the given case, Mr. ‘Y’, a chartered accountant being employee of M/s A & Co. has
issued audit queries which were raised during the course of audit. Here “Y” is right in
issuing the query, since the same falls under routine work which can be delegated by
the auditor. Therefore, there is no misconduct in this case as per Clause (12) of Part I
of First schedule to the Act.
(ii) Further, issuance of production certificate to a client under GST Act, 1944 by Mr. “Y”
being an employee of M/s A & Co. (an audit firm), is not a routine work and it is outside
his authorities. Thus, CA. ‘A’ is guilty of professional misconduct under Clause (12) of
Part I of First Schedule of the Chartered Accountants Act, 1949.
(iii) In this instance, Mr. “Y”, CA employee of the audit firm M/s A & Co. has attended the
Income tax proceedings for a client as authorized representative before Income Tax
Authorities. Since the council has allowed the delegation of such work, the chartered
accountant employee can attend to routine matter in tax practice as decided by the
council, subject to provisions of Section 288 of the Income Tax Act. Therefore, there
is no misconduct in this case as per Clause (12) of Part I of First schedule to the Act.
12. Clause (1) of Part I of the Second Schedule to the Chartered Accountants Act, 1949 states
that a chartered accountant in practice shall be deemed to be guilty of professional
misconduct if he discloses information acquired in the course of his professional engagement
to any person other than his client, without the consent of the client or otherwise than as
required by law for the time being in force. SA 200 on " Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Standards on Auditing" also reiterates
that, "the auditor should respect the confidentiality of information acquired in the course of
his work and should not disclose any such information to a third party without specific
authority or unless there is a legal or professional duty to disclose". In the instant case, the
bank has asked the auditor for detailed information regarding few items in the financial
statements available in his working papers. Having regard to the position stated earlier, the
auditor cannot disclose the information in his possession without specific permission of the
client. As far as working papers are concerned, working papers are the property of the auditor.
The auditor may at his discretion, make portions of or extracts from his working papers
available to his client". Thus, there is no requirement compelling the auditor to divulge
information obtained in the course of audit and included in the working papers to any outside
agency except as and when required by any law.
1. (c) 2. (d) 3. (a) 4. (a) 5. (a)

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Final Course

(Revised Scheme of Education and Training)

Advanced Auditing and

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Edition : August, 2019

Committee/ : Board of Studies

Price (All Modules) : `

Published by : The Publication Department on behalf of The Institute of Chartered

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

DETAILED CONTENTS MODULE - 3

CHAPTER 13: AUDIT OF PUBLIC SECTOR UNDERTAKINGS

LEARNING OUTCOMES ......................................................................................................... 13.1

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CHAPTER 14: LIABILITIES OF AUDITOR

LEARNING OUTCOMES ......................................................................................................... 14.1

CHAPTER 15: INTERNAL AUDIT MANAGEMENT AND OPERATION AUDIT

LEARNING OUTCOMES ......................................................................................................... 15.1

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6. Relationship between Internal and External Auditors ................................................ 15.16

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CHAPTER 16-DUE DILIGENCE, INVESTIGATION & FORENSIC AUDIT

LEARNING OUTCOMES ......................................................................................................... 16.1

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UNIT 3: FORENSIC AUDIT

CHAPTER 17: PEER REVIEW & QUALITY REVIEW

LEARNING OUTCOMES ......................................................................................................... 17.1

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7.2 Planning ..................................................................................................... 17.10

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CHAPTER 18: PROFESSIONAL ETHICS

LEARNING OUTCOMES ......................................................................................................... 18.1

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8. Schedules to the Act ..................................................................................................... 18.29

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AUDIT OF PUBLIC SECTOR

After studying this chapter, you will be able to:

Audit of Public Sector

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Categories for Government companies and

Corporations set up under For example,

2. FRAMEWORK FOR GOVERNMENT AUDIT

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Any State Government Partly by the Central Government and

In India, audit of the above government companies is performed by an independent constitutional

• Appointment of C&AG by the President.

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3. OBJECTIVE AND SCOPE OF PUBLIC ENTERPRISES

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Audit Conducted by C&AG

Financial Compliance Performance

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(b) Subject matter, criteria and subject matter information.

• This refers to the information, condition or activity that is

(c) Types of engagement - Attestation Engagements and Direct Reporting Engagement.

Direct Reporting Engagement:

In direct reporting engagements, it is the auditor who measures or evaluates the

3.2 Principles of PSU Audits

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