What is a bond?

A bond is a written promise by a corporation to pay back the principal on a loan, plus interest. When you
“buy” a bond, you are really lending money to the corporation and receiving in exchange a piece of paper (the bond) containing a promise to pay back the loan plus interest. The bond is, in effect, a professional form of what is commonly referred to as an “IOU.”

A bond is based upon a contract called an indenture, which specifies the various characteristics of the
bond. Such characteristics include the maturity date, rate of interest, and call provisions.

Several kinds of bonds are common today. Secured bonds are backed by collateral such as real estate or other investments, while unsecured bonds are not. A typical example of unsecured high-risk bonds is junk bonds. These pay a high rate of interest due to their high risk.

How manipulation in accounting may happen?

Sometimes the totals of a wage bill are inflated by over totalling the column in which the wages payable are entered. Such a fraud can be detected only if the totals of the wage bill are  checked.  Similarly,  a  cashier  may  misappropriate  receipts  from  customers  by  under-totalling the receipts column of the cash book. At times, shortages in cash have been also covered  up  by  over  totalling.  Such  frauds  can  be  detected  only  if  the  totals  of  the  cash book  and  the  general  ledger  are  checked.  

On  these  considerations,  where  totals  of  the cash book or the ledger are found to have been made in pencil, the book keeper should be  asked  to  ink  the  totals  before  their  verification  is  commenced.  This  would  deter  him from altering the totals on the totaling mistakes being discovered. 

Sometimes a fraud is committed in the following manner :
(a)  under-casting the receipt side of the cash book;
(b)  overcasting the payment side of the cash;
(c)  fictitious  entries  being  made  in  the  cash  column  to  show  that  amounts  have  been deposited in the account when, in fact, no deposit has been made;
(d)  posting an amount of cash sale to the credit of a party and subsequently withdrawing the amount; and
(e)  wrong totals or balances being carried forward in the cash book or in the ledger. Students, it is expected, will be able to think several other devices where amounts can be misappropriated  either  by  making  wrong  entries  or  by  failing  to  make  an  entry  in  the accounts.

Is Disclosure in the Final Accounts is mandatory?

Disclosure in the Final Accounts : The object of audit ultimately is that the statements of account prepared from books of account which have been checked should present a true and fair picture of the financial position of the entity. This particular objective should be kept in view while checking the grouping of accounts. The auditor must see that not only items of a like nature be grouped together but also the description of each account truly reflects  the  nature  of  the  amounts  accumulated  therein.  Unless  this  is  verified,  the classification  of  income  and  expenditure  and  that  of  assets  and  liabilities  would  be misleading. 

For example if director’s fee and salaries to staff have been added together or advances to directors have been covered up by being amalgamated with book debts, the nature of these payments would be obscured. Fundamentally, care should be taken to ensure that no material fact is suppressed or stated in a manner that it may mislead any one. If it is found that owing to costing or managerial requirements, certain items of expenditure  or  receipts  have  not  been  classified  by  the  company  in  the  way  as  would meet  the  requirements  of  the  Companies  Act,  1956  the  client’s  staff  at  the  end  of  the year  should  be  required  to  re-classify  them.  

Nevertheless  such  a  re-classification  of expenditure should be checked by the assistant of the auditor to confirm that it has been correctly made and that no item requiring  re-classification has been left out. In the case of  a company, Schedule IV  to the Companies  Act,  1956  has  laid down requirements in regard to the disclosure.

How validity of transactions are audited?

Validity of Transactions : It is also the function of audit to establish that payments have been made validly to persons who are shown to be recipients. For example, it must be verified  that  salaries  to  partners  were  paid  according  to  a  provision  contained  in  the partnership  deed  and  the  directors  fees  were  paid  according  to  the  provisions  in  that regard in the Articles of Association or the resolution passed by members of the company at a general meeting. For checking the validity of a transaction, it is usually necessary to refer to documentary evidence. It may exist in any of the following forms.

• The legal provisions, if any, having bearing on the accounts of the entity under audit.

•  The rules or regulations  governing the internal working  of the organisation, e.g., the Articles of Association, Partnership Deed, Trust Deed, etc.

•   Minutes  of the proceedings of a meeting of members  of the company , that of thedirectors or that of the Managing committee

•   Copy of  an  agreement, e.g., Managing Director’s agreement,  Lease Deed, vendor’s agreement, agency agreement, contract with an employee, etc.

  An  auditor  should  have  a  clear  and  precise  knowledge  of  legal  provisions  under  which the concern was registered or is functioning, as well as those which constitutes the basis of  various  transactions  entered  into,  more  particularly  the  provisions  as  regards maintenance and audit of its accounts. He should also study the rules, if any, framed for regulating the internal management of the entity; these may be embodied in some of the documents mentioned above. If he has any doubt on any legal point, by way of guidance, he should call for legal opinion. However, unless he is convinced of the reasonableness of the legal opinion, he should not act on it.

Accounting principles those must be checked while auditing

Observance  of  accounting  principles  :  It  is  of  utmost  importance  that  the  transactions should  be  recorded  in  the  books  of  accounts  having  regard  to  the  principles  of accounting. The principles include :
(a)  Distinction being drawn between capital expenditure and revenue expenditure;
(b)  Distinction being drawn between capital receipts and revenue receipts;
(c)  The expenses or cost should be matched to the income or benefit;
(d)  The expenditure and income should be treated on accrual basis;
(e)  That the fixed assets should be depreciated on a consistent basis;
(f)  That book debts should be valued only at realisable amounts;
(g)  That fictitious assets are written off at the earliest; and
(h)  Outstanding assets and liabilities have been properly adjusted

How Correctness of book-keeping records is measured?

The  audit  of  cash  transactions  entails  detailed checking  of  the  record  of  transactions  for  verifying  that  entries  have  been  made  in  the books of account according to the system of accounting which is being regularly followed and the books of account balance as under : 
(a)  Vouching;
(b)  Posting;
(c)  Casting, cross-casting and tracing; and
(d)  Reconciliation, scrutiny, confirmation, etc.
  When  accounts  are  checked  in  the  foregoing  manner,  they  may  disclose  one  or  more mistakes or manipulations in the accounts of different types stated below. 

•   Errors of omission or commission which are accidental, e.g., failure to enter some sales invoices, mistakes made in computing amounts payable for purchase, etc.

•   Cases of deliberate omission or commission: 

♦  to  cover  up  a  defalcation  of  cash,  e.g.,  amount  received  from  X  having  been posted to the account of B and subsequently, the amount paid by Y having been misappropriated; or
♦  to overstate profit or assets, e.g., no provision having been made for outstanding liabilities  or the goods  already sold before the close  of the year  having been included in closing stock;
♦  to overstate liabilities and understate assets, with a view to providing a basis for effecting fictitious  payments in the former case and misappropriation  of the  sale proceeds in the latter case.
♦  Errors of principle such as revenue expenditure having been charged to capital.
♦  Compensation errors, e.g., “Furniture Account”, having been undercast by $500 and “Repairs Account” overcast by the same amount.

Steps in the verification of the system of Internal Control

Steps involved in the verification of the system of Internal Control :
(a)  Study  the  system  according  to  which  accounting  routines  are  being  carried  out  to ensure  that  these  do  not  leave  any  receipt  of  cash,  material  or  any  other  asset remaining  unaccounted  for,  permit  any  payment  of  money  being  made  without relevant goods or services having been received or tendered or any property being given away without its price having been received or being accounted for.

(b)  Examine  the  financial  power  vested  in  different  persons  and  the  conditions  under which they can exercise them.

(c)  Confirm whether the supervision over various managerial and accounting functions, exercised  by  different  members  of  the  staff  to  whom  these  duties  have  been assigned, is adequate.

(d)  Ascertain  whether  any  mechanical  aids  are  being  employed  to  ensure  proper accounting of receipts and prevention of pilferage of cash, stamps, etc.

(e)  Observe  the  working  of  the  accounting  system  and  routine  and  determine,  by application  of  procedural  tests,  whether  checks  and  counter-checks  envisaged  by the system of internal control are being properly applied.

(f)  Confirm that there is a system according to which the physical existence of different forms of assets is being periodically reconciled with their balances in the books of account or stores records and discrepancies noticed are reported and adjusted; also that balance of customers, creditors, bankers and persons with whom securities are deposited  are  reconciled  periodically.  Further,  that  persons  who  are  in  custody  of valuable  assets,  have  furnished  bonds  of  adequate  value  which  would  protect  the company  in  the  event  of  any  misappropriation  or  misapplication  thereof  by  such persons.

(g)  Ascertain  that  the  system  of  internal  control  is  reviewed  periodically  and,  where necessary, a change in procedures made to plug in any loopholes which might have been observed on such a review. Also, that policy decisions which are taken from time to time are translated into actual practice.
 

How to verify cash transactions?

To  verify  cash  transactions,  more  than  anything  else,  it  is  necessary  that  the  system  of accounting and internal control operating in the organisation should be reviewed; also the recording  of  each  transaction  should  be  checked.  It  should  also  be  seen  that  each relevant  voucher  has  documentary  evidence  which  is  valid  and  that  the  statement  is authorised by a competent official. 

(i)  Internal Control System : It is a combination of several procedures adopted by an entity designed:
(a)  to give protection against losses through fraud, waste, mistakes, etc.,
(b)  to ensure that the transactions entered into shall be correctly recorded; and
(c)  to enable the concern to take policy decision as regards planning and operation of the business at the appropriate time.

(ii) Correctness  of  book-keeping  records  :  The  audit  of  cash  transactions  entails  detailed checking  of  the  record  of  transactions  for  verifying  that  entries  have  been  made  in  the books of account according to the system of accounting which is being regularly followed and the books of account balance 

(iii)  Observance  of  accounting  principles  :  It  is  of  utmost  importance  that  the  transactions should  be  recorded  in  the  books  of  accounts  having  regard  to  the  principles  of accounting.

(iv)  Evidence of Transactions : Entries in the account books are usually made on the basis of some kind of documentary evidence. It generally exists in a variety of forms e.g., payee’s receipts,  suppliers’  invoices,  statements  of  account  of  parties,  minutes  of  Board  of Directors  or  of  the  shareholders,  contracts,  documents  of  title,  entries  in  subsidiary ledger,etc.  The  process  of  verification  of  entries  in  the  books  of  account  with  the documentary  evidence  is  referred  to  as  vouching.

The auditor, obviously, should endeavour in the course of his examination to get as much external  evidence  as  possible  since  such  evidence  ordinarily  provides  confirmation. When, however, it is not possible to obtain external evidence and he is obliged to accept internal evidence, he should first satisfy himself on a careful consideration of the position whether the evidence which has been produced to him, can be reasonably assumed to have come into existence in the normal course of working of the business and that there exists a system of internal check which would act as a safeguard against its being altered subsequently. However, every evidence ‘whether internal or external’ should be  subjected  to  appropriate  scrutiny  and  corroboration  should  be  obtained,  if  possible. The auditor will always keep in mind the circumstances of the case and see whether the evidence is prima facie authentic and correct.

(v)  Validity of Transactions : It is also the function of audit to establish that payments have been made validly to persons who are shown to be recipients. For example, it must be verified  that  salaries  to  partners  were  paid  according  to  a  provision  contained  in  the partnership  deed  and  the  directors  fees  were  paid  according  to  the  provisions  in  that regard in the Articles of Association or the resolution passed by members of the company at a general meeting. 

(vi)  Disclosure in the Final Accounts : The object of audit ultimately is that the statements of account prepared from books of account which have been checked should present a true and fair picture of the financial position of the entity. This particular objective should be kept in view while checking the grouping of accounts. The auditor must see that not only items of a like nature be grouped together but also the description of each account truly reflects  the  nature  of  the  amounts  accumulated  therein.  Unless  this  is  verified,  the classification  of  income  and  expenditure  and  that  of  assets  and  liabilities  would  be misleading.