CA Inter Audit & Ethics Notes

Chapter 5 – Audit of Items of Financial Statements

Part 2 – Audit of Reserves & Surplus and Borrowings

3.2 AUDIT OF RESERVES & SURPLUS

Meaning of Reserves

Reserves are appropriations of profits that are not intended to meet any known liability, contingency, commitment or diminution in value of assets.

They strengthen the financial position of the company and provide internal financing.

Types of Reserves

A. Revenue Reserve

Created out of operating profits.

Purpose

Distribution of dividend
Business expansion
Increase working capital
Meet lean years
Strengthen financial position

Examples

General Reserve
Retained Earnings

B. Capital Reserve

Created out of capital profits.

Not available for dividend.

Examples

Profit on sale of fixed assets
Profit on sale of investments
Securities Premium
Capital Redemption Reserve

Important Point

Capital Reserve can generally be used for:

Writing off capital losses
Writing off fictitious assets
Bonus issue (if realised)

However,

Securities Premium and Capital Redemption Reserve can be utilised only for purposes specified in the Companies Act, 2013.

Assertions Covered

Existence
Completeness
Valuation
Presentation & Disclosure

Audit Procedures

A. Existence

Auditor should

✔ Trace opening balance with previous year’s audited financial statements.

✔ Verify additions and utilisations during the year.

Profit & Loss Balance

Verify:

Movement in Statement of Profit & Loss
Statement of Changes in Equity
Board Resolution recommending dividend
Shareholders’ Resolution approving dividend

Important Exam Point

AS 4 (Revised) / Ind AS 10

Dividend declared after Balance Sheet Date

➡ Not recognised as liability

Only disclosed in Notes to Accounts.

Exam Favourite

Securities Premium

Verify:

Shares issued above face value
Board Resolution
Transfer to Securities Premium Account

Ensure utilisation is only as permitted under Section 52.

Valuation

Auditor ensures:

Reserve balances correctly computed.
Movements correctly recorded.
Securities Premium not misused.

Presentation & Disclosure

Schedule III requires classification into:

Capital Reserve
Capital Redemption Reserve
Securities Premium
Debenture Redemption Reserve
Revaluation Reserve
Share Options Outstanding Account
Other Reserves
Surplus

Important Disclosure

For every reserve:

Show

Opening Balance
Additions
Deductions
Closing Balance

Debit Balance of P&L

Shown as negative Surplus.

Remember

Reserve represented by earmarked investments is called a

Fund

Example:

Sinking Fund

Quick Revision Table

Assertion	Audit Procedure
Existence	Compare opening balances
Completeness	Verify additions & utilisation
Valuation	Check computation
Disclosure	Schedule III compliance

3.3 AUDIT OF BORROWINGS

Meaning

Borrowings are funds obtained from external sources.

Examples

Bank Loan
Cash Credit
Debentures
Public Deposits
Term Loan
Financial Institutions

Why Important?

If liabilities are:

omitted
understated
overstated

Financial Statements will not show a True & Fair View.

Assertions Covered

Existence
Completeness
Valuation
Presentation & Disclosure

A. Existence

Auditor should verify

Board Approval

Check Board Minutes for

New loans
Debentures
Lending agreements

Loan Agreement

Verify

Interest Rate
Repayment Terms
Security
Borrowing Limits

Balance Confirmation

Obtain direct confirmation from

Banks
Financial Institutions

(SA 505)

Hire Purchase

Verify agreement.

Debentures

Check Trust Deed for

Redemption
Interest
Covenants
Restrictions

Loan Repaid

Ensure

Charge on assets has been released.

Written Representation

Obtain representation from Management that

All liabilities recorded are genuine.

B. Completeness

Auditor should obtain

Schedule of

Long-term Borrowings
Short-term Borrowings

containing

Opening Balance
Fresh Loans
Repayment
Closing Balance

Verify

Compare closing balances with General Ledger.

Review

Subsequent transactions after year-end

Purpose

To detect

Unrecorded Liabilities

Direct Confirmation

Obtain confirmation from lenders.

Verify

Interest Rate
Security
Due Date
Outstanding Balance

If no reply

Perform alternative procedures

Example

Examine bank statements
Loan agreements
Payment records

C. Valuation

Auditor should verify

Accounting Policy

Consistently followed.

Interest

Recalculate interest.

Premium / Discount

Recompute amortisation.

Foreign Currency Loan

Restate as per

AS 11

Loan Covenants

Verify compliance.

If breached,

Check whether loan becomes Current Liability.

If waiver received,

Obtain lender confirmation.

Classification

Verify

Long-term vs Short-term.

Current Maturity

Installments due within next 12 months

Must be separately disclosed.

Restrictive Covenants

Verify proper disclosure.

Registration of Charges

Verify charge created and registered with ROC.

Security Value

If security value is less than loan,

Loan secured only to the extent of security.

Related Party Loans

Verify compliance with

AS 18
Ind AS 24

Bills Discounted

Ensure proper disclosure.

Borrowing Powers

Check

Companies Act Compliance

Verify compliance with

Section 180 – Restrictions on Board Powers
Section 185 – Loans to Directors
Section 186 – Loans & Investments

Purpose Test

Ensure

Loan used only for authorised business purposes.

Public Deposits

Verify RBI directions.

D. Presentation & Disclosure

Long-term Borrowings

Classify into

Debentures
Term Loans
Deferred Payment Liabilities
Deposits
Related Party Loans
Finance Lease Obligations
Other Loans

Further Classification

Secured
Unsecured

Nature of security must be disclosed.

Also disclose

Director Guarantee
Interest Rate
Redemption Terms
Repayment Terms
Defaults
Current Maturity

Short-term Borrowings

Disclose

Demand Loans
Related Party Loans
Deposits
Other Loans

Separate

Secured
Unsecured

Additional Regulatory Information

1. Borrowings against Current Assets

Company must disclose

Whether quarterly statements submitted to banks agree with books.

If not,

Provide reconciliation.

2. Wilful Defaulter

Disclose

Date
Nature of default
Amount

3. Charges pending Registration

Disclose

Reasons and details.

4. Utilisation of Borrowed Funds

If money routed through intermediaries,

Company must disclose

Date
Amount
Ultimate Beneficiary
FEMA compliance
PMLA compliance

Exam Case

Cash Credit ₹2 Crore

Secured by

Stock
Debtors

Guaranteed by Directors.

Disclosure

Short-term Borrowings

↓

Secured Loan

↓

Nature of Security

↓

Director Guarantee

↓

Default (if any)

One-Day Revision

Reserves

✔ Revenue Reserve

✔ Capital Reserve

✔ Securities Premium

✔ Dividend after BS Date → Only Disclosure

✔ Schedule III

Borrowings

Verify

✔ Board Resolution

✔ Loan Agreement

✔ Bank Confirmation

✔ Interest

✔ Loan Covenants

✔ Foreign Currency Loan

✔ ROC Charge

✔ Sections 180, 185, 186

✔ Schedule III Disclosure

✔ Additional Regulatory Information

Important Sections for Exam

Section	Topic
52	Securities Premium
180	Restriction on Board Powers
185	Loans to Directors
186	Loans & Investments
SA 505	External Confirmations
AS 11	Foreign Currency Borrowings
AS 4 / Ind AS 10	Dividend after Balance Sheet Date

Memory Mnemonics

Audit of Borrowings (E-C-V-D)

E → Existence (Board, Loan Agreement, Confirmation)

C → Completeness (Loan Schedule, Subsequent Events)

V → Valuation (Interest, AS 11, Covenants)

D → Disclosure (Schedule III, Charges, Defaults)

Part 2 covers approximately pages 24–37 of the chapter. The next part will cover Trade Receivables and Cash & Cash Equivalents, which are among the most important topics for ICAI examinations.