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Home » » Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(iv)

Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(iv)

Written By Admin on Sunday, 1 April 2012 | Sunday, April 01, 2012

Clause 4(iv)

is there an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory and fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control system.

1) The clause requires the auditor to comment whether there is an adequate internal control system commensurate with the size of the company and the nature of its business, for the purchase of inventory, fixed assets and sale of goods and services. Further, the clause also requires the auditor to report whether there is a continuing failure by the company to correct major weaknesses in the internal control system in regard to purchase of inventory, fixed assets and the sale of goods and services.

2) Obtaining an understanding of internal control systems is a normal audit procedure. While the requirement of the Order is confined only to internal control procedures regarding purchase of inventory, fixed assets and sale of goods and services, it does not mean that the duty of the auditor to examine internal control with regard to other areas is in any way diminished. It only means that special emphasis has to be given by the auditor on internal control system with regard to the items specified in the clause as aforesaid.

3) “Internal Control System” means all the policies and procedures (internal controls) adopted by the management of an entity to assist in achieving management’s objective of ensuring, as far as practicable, the orderly and efficient conduct of its business, including adherence to management policies, the safeguarding of assets, prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.

4) Different techniques may be used to document information relating to internal control systems. Selection of a particular technique is a matter of auditor’s judgement. Common techniques, used alone or in combination, are narrative descriptions, flow-charts, questionnaires, check lists, etc. Use of any one of these methods does not preclude the use of the other and the auditor is free to select any one or more of the methods that he considers best suited to the circumstances of the case. Irrespective of the method selected, it is necessary that the auditor maintains sufficient documentation regarding his study and evaluation of the internal control system. Further, in a computer information systems environment, the auditor may find it necessary, or may prefer, to use computer assisted audit techniques, for example, file interrogation tools or audit test data, may be appropriate when the accounting and internal control systems provide no visible evidence for evaluating the internal controls which are programmed into a computerised accounting system. In this regard, attention is invited to the Auditing and Assurance Standard (AAS) 6, “Risk Assessments and Internal Control” issued by the Institute. 

5) In making the evaluation, the auditor has to give due regard not merely to the size of the company and the nature of its business but also to the organisational structure. This suggests that whereas detailed internal control procedures may be absolutely essential for a large company with a diversified business operating at several locations, internal control may be less formal in an “owner-managed” or a small company where there is a greater degree of personal supervision. Reference in this regard may also be made to paragraph 49 of the Auditing and Assurance Standard (AAS) 6, “Risk Assessments and Internal Control”. 

6) The clause also requires the auditor to comment whether there is a continuing failure to correct major weaknesses in internal control system. The auditor, for reporting on this clause, would have to ascertain the weaknesses in the internal controls in regard to purchase of inventory, fixed assets and sale of goods and services and then examine whether there Such cases may point out the instances where there is a continuing failure to correct a major weakness in internal control system. The auditor should also review his previous years’ working papers to determine the weaknesses in the internal control system, if any, already communicated to the management.

7) It may be noted that paragraph 50 of Auditing and Assurance Standard (AAS) 6, “Risk Assessments and Internal Control” requires that the auditor should make management aware, as soon as practical and at an appropriate level of responsibility, of material weaknesses in the design or operation of the accounting and internal control systems, which have come to the auditor's attention during the course of the audit. The auditor should examine the follow-up actions taken by the management in response to weaknesses communicated to the management. However, determination of continuing failure in correcting major weaknesses in internal controls is required to be done by the auditor and commented upon by him in his report irrespective of the existence of the internal audit function. 

8) The auditor while making an evaluation of the internal controls in regard to purchase of inventory, fixed assets and sale of goods and services while carrying out the procedures mentioned at (i) above might come across a weakness in those internal controls. The auditor should, in such circumstances, exercise his professional judgement to determine whether the weakness noted by him is a major weakness in the internal control. The auditor while commenting on the clause, makes an assessment whether the major weakness noted by him has been corrected by the management as at the balance sheet date. If the auditor is of the opinion that the weakness has not been corrected, then the auditor should report the fact while commenting upon the clause. Apart from stating that there has been a continuing failure to correct major weakness, the auditor should report the weakness and the steps taken by the management to correct the weakness, if any. Where the management has not taken any steps for correcting the weakness, the auditor’s report should also state this fact. It may also happen that the weakness is corrected by the date on which the auditor issues the audit report. In such a case, the auditor’s report should state the fact that although as at the balance sheet date, there was a continuing failure to correct a major weakness on the date of the financial statements, the weakness has been corrected by the date the auditor issued his report. It may, however, be noted that the existence of continuing failure is important for reporting on this clause. Even if the management has taken reasonable steps to correct the weakness but the weakness continues, the auditor is required to report the same under this clause.

9) In case there is a continuing failure on the part of the company to correct major weakness in the internal control system, the auditor should also make a re-assessment of the control risk, at the assertion level, for each material account balance or class of transactions related to purchase of inventory, fixed assets and sale of goods and services so that appropriate audit procedures can be designed to reduce the overall risk to an acceptably low level. Further, if the auditor is of the opinion that the major weaknesses in the internal control system have serious implications on the adequacy or reliability of the books of account of the company, the auditor should consider modifying his audit report on the financial statements. Where the auditor decides to do so, he should comply with the requirements of the Auditing and Assurance Standard (AAS) 28, “The Auditor’s Report on the Financial Statements” in this regard. 

10) It is also important to understand that the requirements in regard to adequacy of internal controls and continuing failure to correct major weakness(es) are not inter related. These are two distinct aspects of the clause. The first requires the auditor to comment on the adequacy of the internal controls in regard to purchase of inventories, purchase of fixed assets and sale of goods and services whereas the second aspect requires the auditor to comment whether there was a continuing failure to correct a major weakness in such internal controls. Since these two aspects are not related to each other, it cannot be concluded that if no major weakness was reported during the period covered by the audit report, the internal control system is adequate.

 
 
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