Professional skepticism in audit

It is a requirement of ISA 200 that, when planning and performing an audit, the auditor should adopt an attitude of professional skepticism.  Professional skepticism is defined by ISA 200 as:

“An attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence”.

This does not mean that the auditors should disbelieve everything they are told, but they should view what they are told with a skepticism attitude, and consider whether it appears reasonable and whether it conflicts with any other evidence. In other words, they must not simply believe everything management tells them.

Different levels of assurance

The degree of assurance that can be provided about the reliability of the financial statements of a company will depend on: 

• The amount of work performed in carrying out the assurance process, and  
• The results of that work. 

The resulting assurance falls into one of two categories:

Reasonable Assurance 

A high (but not absolute) level of assurance provided by the practitioner’s conclusion expressed in a positive form. E.g. “In our opinion the accounts are true and fair”. The objective of a statutory audit is to provide reasonable assurance.

Limited Assurance

A moderate level of assurance provided by the practitioner’s conclusion expressed in a negative form. E.g. “Based on our review, nothing has come to our attention that causes us to believe that the accompanying financial statements do not give a true and fair view”. The objective of a review engagement is often to provide limited assurance.

Treatment of Partners’ capital

Each partner contributes capital to the business and shares in the profit (or loss) of the business. The capital of each partner must be identified separately. The capital of each partner is usually contained in two accounts.

•   Capital account 
•  Current account 

Capital account 

The partnership agreement usually specifies that each partner must contribute a minimum amount of ‘fixed’ capital and that partners cannot draw out any of their fixed capital. In addition, each partner might retain some of his or her share of accumulated profits in the business. 

The partnership agreement should allow partners to draw out their share of accumulated profits, if they wish to do so. The capital account records the fixed capital or long-term capital of the partner that the partner must retain in the business and cannot take out in drawings. The balance on this account does not change very often. 

Current account

A current account is used to record the accumulated profits of the partner and the partner’s drawings. 

• The profits of the business are shared between the partners. The share of each partner is credited to (added to) his or her current account. 
• Each partner may take drawings out of the business. Drawings are a withdrawal of profit. These are recorded by debiting the current account of the partner (and crediting the Bank account). 

Different types of errors in the double entry accounting system

Errors can occur in a book-keeping system, because individuals make mistakes. The types of error that will appear in the accounting records can be classified into four broad categories these are:

1. Errors of transposition
2. Errors of omission 
3. Errors of commission
4. Errors of principle     

Errors of transposition (transposition errors)

This involves getting the digits in a number the wrong way round, for example recording Rs. 9,700 as Rs. 7,900. Sometimes the error will be made in both the debit and the credit entries in the ledger. For example a purchase invoice might be recorded as Rs. 1,650 instead of Rs. 1,560 in both the purchases account and the payable ledger control account. The trial balance will not reveal this sort of error. Sometimes the error of transposition will be made in one account but not the other. For example, a payment of Rs. 1,980 from a customer might be recorded correctly in the cash book but posted incorrectly as Rs. 1,890 in the receivables ledger control account.

Errors of omission

This is where a transaction or entry is missed out. Sometimes a transaction is missed out of the ledger entirely because the bookkeeper forgets about it or is not informed about it. A transaction may be omitted from one location only. 

Errors of commission.

This means putting an entry in the wrong account, for example recording a telephone expense in the electricity expenses account. Similarly, discounts received might be recorded incorrectly in the discounts allowed account. 

Errors of principle. This is where an entry is recorded in the wrong type of account, e.g. recording capital expenditure as revenue expenditure. For example the purchase of a machine might be entered in the machinery repairs and maintenance account. Unless corrected, this error will result in an incorrect computation of depreciation charges, running costs and profit for the period. 

Types of cash book

The cashbook records all the transactions that involve receipts and payments of cash and deposits in and withdrawals from the bank in a chronological order. The debit side represents the receipts side and the credit side represents the payments side. 

There are four basic types of a cash book.

• Single column cash book
• Two column cash book
• Triple column cash book 
• Petty cash book

Who are the users of Financial Statements

Financial statements are used by different types of users for different purposes like by investors they use financial statements to seek the performance of the entity. The following are the details of users and their purposes to use financial statements.

Investors
Investors in a business entity are the providers of risk capital. Unless they are managers as well as owners, they invest in order to obtain a financial return on their investment. They need information that will help them to make investment decisions.  In the case of shareholders in a company, these decisions will often involve whether to buy, hold or sell shares in the company. Their decision might be based on an analysis of the past financial performance of the company and its financial position, and trying to predict from the past what might happen to the company in the future. Financial statements also give some indication of the ability of a company to pay dividends to its shareholders out of profits.

Lenders

Lenders , such as banks, are interested in financial information about businesses that borrow from them. Financial statements can help lenders to assess the continuing ability of the borrower to pay interest, and its ability to repay the loan principal at maturity.

Suppliers

Suppliers and other trade creditors Financial information about an entity is also useful for suppliers who provide goods on credit to a business entity, and ‘other trade creditors’ who are owed money by the entity as a result of debts incurred in its business operations (such as money owned for rent or electricity or telephone charges). They can use the financial statements to assess how much credit they might safely allow to the entity.

The public

In some cases, members of the general public might have an interest in the financial statements of a company. The IASB Framework comments: ‘For example, entities may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers.’

Customers

Customers might be interested in the financial strength of an entity, especially if they rely on that entity for the long-term supply of key goods or services.

Employees

Employees need information about the financial stability and profitability of their employer. An assessment of profitability can help employees to reach a view on the ability of the employer to pay higher wages, or provide more job opportunities in the future.

Government

The government and government agencies are interested in the financial statements of business entities. They might use this information for the purpose of business regulation or deciding taxation policies.

What is difference Between Income & Expenses

Income consists of followings:

• Revenue from the sale of goods or services
• Other items of income such as interest received from investments
• Gains from disposing of non-current assets for more than the amount at which they are carried in the records (carrying amount).
• For example, if a machine is sold for Rs. 15,000 when its value in the statement of financial position is Rs. 10,000, there is a gain on disposal of Rs. 5,000. The term ‘revenue’ means income earned in the course of normal business operations. In a statement of comprehensive income , revenue and ‘other income’ are reported as separate items.

Expenses consist of followings:

• Expenses arising in the ordinary course of activities
• Including the cost of sales
• Wages and salaries
• The cost of the depletion of non-current assets,
• Interest payable on loans and so on losses arising from disasters such as fire and flood, and also losses from disposing of non-current assets for less than their carrying value in the statement of financial position.

COMPONENTS OF FINANCIAL STATEMENTS

A full set of financial statements would include the following:


1. A statement of financial position. (balance sheet)
2. A statement of comprehensive income.( Profit & Loss account)
3. A statement of changes in equity.
4. A statement of cash flows.
5. Notes to the financial statements.

What is Accounting systems (Book-keeping )

Business entities operate a system to record business transactions in accounting records. This system is called a book-keeping system. All large businesses (and many small ones) have a book-keeping system for recording the financial details of their business transactions on a regular basis. The bookkeeping records of a business are often referred to as the accounts of the business. The content of financial statements might vary depending on whether a business is a sole trader, partnership of company. However, the basic process used to record transactions is similar for all types of entity. The techniques used is called double entry bookkeeping.

What is the difference between Capital & Revenue expenditure

Capital expenditure is expenditure made to acquire or improve long term assets that are used by the business. Examples include the following:

1. Purchase of property,
2. Plant and equipment,
3. Office equipment;
4. Motor vehicles; 
5. Installation costs associated with new equipment; 
6. Improvements and additions to existing non-current assets (for example, building extensions, installation of air-conditioning etc.)
7. Fees paid to raise long term finance are also deemed to be capital in nature.
8. 
   
   To pay fees associated with raising long term finance 

Revenue expenditure is expenditure on day-to-day operating expenses. Examples include:

1.Purchase of goods meant for resale in the normal course of business.
2.Purchase of raw materials and components used to manufacture goods for resale in the normal     course of business.
3.Expenditures made to meet the day to day running costs of a business (for example, rent, energy, 4.wages etc.)
5.Expenditures made to repair non-current assets.
6.Expenditures made to distribute goods to customers.

7.Costs of administering a business (for example, accounting services, license fees etc.)
8.Revenue expenditure is reported as expenditure in the statement of comprehensive income.