CA Inter Audit & Ethics Notes

Chapter 5 – Audit of Items of Financial Statements

Part 1 – Introduction, Assertions & Audit of Share Capital

CHAPTER OVERVIEW

This chapter explains the substantive audit procedures performed by an auditor to verify items appearing in the financial statements.

The auditor verifies management assertions relating to:

Income Statement items
Balance Sheet items
Related disclosures

The objective is to obtain Sufficient Appropriate Audit Evidence (SAE) before expressing an audit opinion.

1. ASSERTIONS

Meaning

Assertion means representations made by management, explicitly or implicitly, in the financial statements regarding:

Assets
Liabilities
Equity
Income
Expenses
Disclosures

The auditor designs audit procedures to verify these assertions.

Example

If Building is shown at ₹50 lakh, management asserts that:

✔ Building exists.

✔ Company owns it.

✔ It is correctly valued.

✔ All buildings have been recorded.

TYPES OF ASSERTIONS

There are two categories.

A. Income Statement Assertions

(Remember: Revenue & Expenses)

1. Occurrence

Meaning

Recorded transactions actually occurred.

Example

Recorded sales actually took place.

Employee salaries relate to genuine employees.

2. Completeness

Meaning

No transaction has been omitted.

Example

All sales have been recorded.

All salary expenses have been accounted.

3. Cut-off

Meaning

Transactions are recorded in the correct accounting period.

Example

Sales before year-end included.

Sales after year-end excluded.

4. Measurement

Meaning

Transactions recorded at correct amount.

Example

Correct invoice amount
Correct discount
Correct TDS adjustment
Correct salary calculation

5. Presentation & Disclosure

Meaning

Transactions are:

properly classified
adequately disclosed
easy to understand

Example

Employee Benefits should disclose separately:

Salaries
PF Contribution
ESOP Expense
Staff Welfare

Mnemonic

O C C M P

O → Occurrence

C → Completeness

C → Cut-off

M → Measurement

P → Presentation & Disclosure

B. Balance Sheet Assertions

(Remember: Assets, Liabilities & Equity)

1. Existence

Meaning

Asset or liability exists on Balance Sheet date.

Example

Inventory actually exists.

2. Completeness

Meaning

Nothing omitted.

Example

Goods lying with third party (owned by company) are included.

Consignment stock belonging to others is excluded.

3. Cut-off

Meaning

Balances relate to correct year.

4. Valuation

Meaning

Assets and liabilities are properly valued.

Example

Inventory = Lower of:

Cost
NRV

(AS 2)

5. Rights & Obligations

Meaning

Company owns the assets.

Liabilities belong to company.

Example

Purchase invoice in company’s name.

6. Presentation & Disclosure

Meaning

Proper classification.

Adequate disclosure.

Correct accounting policy.

Mnemonic

E C C V R P

E → Existence

C → Completeness

C → Cut-off

V → Valuation

R → Rights & Obligations

P → Presentation & Disclosure

DIFFERENCE BETWEEN ASSERTIONS

Income Statement	Balance Sheet
Occurrence	Existence
Completeness	Completeness
Cut-off	Cut-off
Measurement	Valuation
Presentation	Presentation
—	Rights & Obligations

EXAM QUESTION

Company manufactures cloth using customers’ yarn.

Should customers’ yarn be included in inventory?

Answer

No.

Reason:

Company has no ownership.

Assertion verified:

Rights & Obligations

2. AUDIT OF SHARE CAPITAL

Assertions Covered

Existence
Completeness
Valuation
Presentation & Disclosure

Audit Procedures

A. Existence

Auditor should:

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

✔ Verify Authorised Capital from MOA.

✔ Obtain Board Resolution.

✔ Obtain Shareholders’ Resolution.

✔ Verify Paid-up Capital.

Fresh Issue of Shares

Auditor should verify compliance with:

Companies Act, 2013
Minimum Subscription
Return of Allotment
Separate Bank Account
Underwriting Commission
SEBI Guidelines

MCA Forms

Verify:

SH-7
- Alteration of Share Capital
PAS-3
- Return of Allotment

Foreign Investment

Verify

Form FC-GPR

Filed with RBI.

Completeness

Ensure

All shares issued recorded.
No issue omitted.
Paid-up Capital within Authorised Capital.

Valuation

Check

No shares issued at discount.

Exception

Only:

Sweat Equity
Debt conversion under RBI-approved restructuring.

Shares Issued at Premium

Section 52

Premium must be transferred to:

Securities Premium Account

Securities Premium can be used only for:

Bonus Shares
Preliminary Expenses
Share Issue Expenses
Premium on Redemption
Buy-back (Section 68)

Exam Mnemonic

B P E R B

Bonus

Preliminary expenses

Issue Expenses

Redemption Premium

Buy-back

Shares Issued at Discount

Section 53

General Rule

❌ Not allowed.

Exceptions

✔ Sweat Equity

✔ Debt converted into shares under RBI-approved restructuring.

Sweat Equity

Section 54

Issued:

at discount
OR
for consideration other than cash

to employees/directors for:

Know-how
Intellectual Property
Value Addition

Auditor should verify

Special Resolution
Number of shares
Market price
Consideration
SEBI Rules

Reduction of Share Capital

Section 66

Auditor verifies:

✔ Articles permit reduction.

✔ Special Resolution passed.

✔ Tribunal approval obtained.

✔ ROC filing completed.

✔ Entries correctly passed.

✔ New Share Certificates issued.

✔ MOA amended.

✔ No default in deposits.

Buy-back

Section 68

Reduction provisions do not apply to buy-back.

Separate compliance required.

DISCLOSURE REQUIREMENTS

Schedule III

Auditor verifies disclosure of:

Authorised Capital
Issued Capital
Paid-up Capital
Par Value
Reconciliation of Shares
Rights attached to shares
Holding Company shares
Shareholders >5%
Bonus Shares
Buy-back
Convertible Securities
Calls Unpaid
Forfeited Shares
Promoter Shareholding

EXAM MEMORY TABLE

Section	Topic
52	Securities Premium
53	Shares at Discount
54	Sweat Equity
66	Reduction of Share Capital
68	Buy-back

One-Day Revision

Income Statement Assertions

✔ Occurrence

✔ Completeness

✔ Cut-off

✔ Measurement

✔ Presentation

Balance Sheet Assertions

✔ Existence

✔ Completeness

✔ Cut-off

✔ Valuation

✔ Rights & Obligations

✔ Presentation

Share Capital Audit

Verify MOA
Verify Board Resolution
Verify Shareholder Resolution
Verify MCA Forms
Check SEBI Compliance
Check Premium (Sec. 52)
No Discount (Sec. 53)
Sweat Equity (Sec. 54)
Reduction (Sec. 66)
Buy-back (Sec. 68)
Check Schedule III Disclosures

Part 1 covers approximately pages 1–23 of the chapter. The next part will cover Reserves & Surplus and Borrowings in the same detailed exam-oriented format.