Auditing & Attestation

In the "Guidance Note on Terms used in Financial Statements" published by ICAI, "the expression "Sales Turnover" has been defined as: "The aggregate amount for which sales are effected or services rendered by an enterprises. The term `gross turnover/sales' and `net turnover/sales' are sometimes used to distinguish the sales aggregate before and after deduction of returns and trade discounts"

In the statement issued by ICAI on the companies (Auditors' Report) Order 2003 the word `turnover' has been defined as under-

"The term `turnover' for the purposes of this clause may be interpreted to mean the aggregate amount for which sales are effected or services rendered by an enterprises"

Whether sales tax and excise duty to be included in the sales/turnover: In our opinion same should be included even if Assessee is have not included the same in Profit and Loss account and shown the same as current Liability.

Section 145A of the Income Tax Act,1961  states that purchase , sale and inventory shall be valued by taking into account  the amount of any tax, duty, cess or fee . An extract of section 145A is as follows:

    145A. Notwithstanding anything to the contrary contained in section 145,

    (a) the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head Profits and gains of business or profession shall be

    (i) in accordance with the method of accounting regularly employed by the assessee; and

    (ii) further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation.

    Explanation.For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment.

Therefore , in my opinion ,  maintaining accounts of excise duty VAT separately is not correct in terms of section 145A of the I T Act. In that sense , for determining the meaning of the word "sales turnover" VAT or excise duty should also be considered for purpose determining  the  criteria for getting accounts audited u/s 44AB of the I T Act.

Sales of Scrap: Sales of scrap shown separately under the heading "Miscellaneous Income" will have to be included in the turnover.

Luxury Tax: Similarly a luxury tax collected by a hotelier also a trading receipt in his hand- Pandyan Hotels Ltd. v. CIT [2004] 266 ITR 172 (Mad.)

Trade Discount: Trade Discounts can be deducted from sales. Trade Discounts are generally allowed in the sales invoice, therefore the discount allowed in the sales invoice will reduce the sale price and therefore can be deducted from the turnover.

Cash Discount: Cash Discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing charge and a revenue receipt and is not related to turnover. Hence the same should not be deducted from turnover.

Commission on sales: Commission on sales included in the sales payable to the consignee/third person should not be deducted from the figure of turnover for the purpose of section 44AB.

Sales Returns: Price of goods returned should be deducted from the figure of turnover even if the returns are from the sales made in earlier years.

Sales proceeds of fixed assets: Sales proceeds of fixed assets would not form part of turnover for the purpose of section 44AB since the fixed assets are not held for resale.

Sales proceed of any investment: Sales proceed of any property held as investment in property will not form part of turnover for the purpose of tax audit. Similarly sale proceeds of any shares, securities and debentures etc. which are held as investment will not form part of turnover. However if shares, securities, debentures, etc are held as stock in trade, the sale proceeds there from will form part of turnover for the purpose of tax audit.

The Views expressed are only Personal Views based upon my studies and interpretation of law.

Amit Bajaj Advocate

The internal audit to be conducted on a half-yearly basis by chartered accountants, company secretaries or cost accountants, and will cover all aspects of CRA operations and procedures, including investor grievance redressal mechanism, the regulator said in its circular.

The report will have to state the methodology adopted, deficiencies observed and consideration of response of the management on the deficiencies. Besides a summary of operations and of the audit, covering the size of operations, number of transactions audited and the number of instances where violations were observed will also have to be stated.

SEBI also said the report would also have to comment on the adequacy of systems adopted by the CRA for compliance with the requirements of regulations. "The CRA will receive the report of theinternal audit within two months from the end of the half-year. The board of directors of the CRA will consider the report and take steps to rectify the deficiencies, if any, and the CRA will send an action taken report to SEBI within the next two months," the SEBI circular said.

For the half-year (October `09 to March `10), the CRA will receive the report of the internal audit by May 31, `10. Its board will have to consider the report and take appropriate measures to rectify the deficiencies and the rating agency will have to send the action taken report to SEBI by July 31, 2010.

Recently, the High-Level Coordination Committee on Financial Markets (HLCCFM) had discussed the functioning of credit rating agencies.

The history of credit ratings in India can be traced to 1987, with the setting up of Crisil. At present, there are five-registeredcredit rating agencies in India, including CARE, ICRA, Fitch, Crisil and Brickwork Ratings India.

ICICI Bank is accused of lending money for the purchase of some apartments in a housing project in a Mumbai suburb, and in some cases twice for the same set of apartments. According to the chartered accountant who spotted irregularities, the bank disbursed home loans for the purchase of 15 apartments in the Ritu Paradise Project developed by S R Developers in Mumbai's Mira Road. Documents available with ICAI and in SundayET's possession show that double loans were issued by the Bank on some flats.

These loans were part of the block of bad loans sold to ARCIL, which helps banks to free up capital by buying such loans and seeks to recover them. Although the loan amount for these 15 flats were only in the region of only Rs 2-3 crore, the accounting regulator is of the view that the bank bears responsibility for selling off these bad loans to ARCIL without verifying it.

A spokesman for ICICI Bank admitted that such an incident had taken place. "When this asset was sold to ARCIL, this was not identified as fraud. The builder fraudulently recreated the entire documentation and sought finance. Such frauds are a challenge to the industry," he said. On the issue of loans being issued twice for the same property, the ICICI spokesman said: "Since there is no central database, it is almost impossible to track whether any loan has already been given against a specific property."

But ICAI said this episode exposed holes in the bank's systems. "In four cases, double loans were issued by ICICI Bank itself. This shows the inability of the bank's IT set up and its due diligence mechanism," Mr Agarwal said.

RBI should appoint auditors

HE added that the appointment of auditors in private sector banks should also be done by RBI as in the case of public sector banks. "No autonomy should be given to the management of the private sector banks. In the past too, there were accounting issues and the recent example is the fall of Global Trust Bank", he said.

Annual reports would contain financial statements that fully satisfy the auditor's scrutiny. This far-reaching proposal has been cleared by a special group set up by ICAI, which has been asked by the government to submit recommendations for improving financial reporting of companies. The ICAI will shortly transmit its recommendations on the subject to the government. According to the proposal, a company that does not restate its accounts as suggested by the statutory auditor would be barred from paying dividends or raising loans.

At present, an auditor's scepticism about any portion of the accounts presented by a company is tagged along with the annual report and an investor has to work hard to correlate every auditor qualification with the number or numbers under challenge. If the ICAI special group's proposal goes through, this torture would be a thing of the past. Accounts would become more transparent, and the auditor would be taken far more seriously than at present by companies. The proposal forms part of a slew of measures to be suggested by the ICAI to the government so as to improve financial reporting standards in the country, said institute's president Uttam Prakash Agarwal. The proposals could be implemented through amendments to the ICAI Act, a move which has been mooted in the wake of the Satyam financial crisis.

Last year, RBI had made the proposal to the finance ministry, which forwarded it to the Ministry of Corporate Affairs (MCA), the nodal body for auditors.

The proposal was in line with the practice followed by private and foreign banks that function in the country.

RBI is not directly involved in selection of auditors for private and foreign banks, which, however, have to take prior approval of the central bank for the selection.

Banking sources close to the development say RBI has made the proposal as it wants to get out of its non-core functions.

As part of this, RBI has got out of handling various government businesses and is in the process of exiting direct management of public debt.

The selection of auditors for the public sector banks was a drain on the manpower since the process was tedious, given the importance of the job, said an official source.

Under the present system, the Institute of Chartered Accountants of India ( ICAI) sends RBI a list of auditors for empanelment as auditors for public sector banks. After this, RBI selects the auditors on the basis of their experience, nature of job and competence.

Sources said even if RBI got just an indirect role. the selection would continue to be handled by the government.

However, the government preferred to let RBI handle the selection and had intimated this to the central bank, they said.

Banking sources said the government had become cautious after the audit fiasco at Satyam and wanted the selection process of auditors to be made more stringent, not only for banks but for all companies, especially the listed ones.

Sebi, the stock markets regulator, has already appointed peer reviewers for auditors of companies that constitute the 30-share Sensitive Index of the Bombay Stock Exchange and the National Stock Exchange's 50-share Nifty

According to officials of ICAI, which regulates the profession of chartered accountancy, the plan is to include all listed companies in this system. In a few years, the scope of the review may be expanded to companies that intend to list, once they file the draft red herring prospectus with Sebi.

As ICAI gears up for peer review of all listed entities, Sebi officials said they would take up companies randomly.

The peer review would cover auditors' notes, which are not made public.

"We do not expect many problems, as our auditors have a good track record. If we do not find any major problems in the peer review process, we can confidently tell the world that Satyam was a one-off episode. The action against auditors will depend on the extent of the lacunae," a Sebi official said.

Source: Business-standard CAs face peer pressure

The large PSBs having balance sheet size (assets + liabilities) of above Rs. 1 lac crore each to exercise managerial autonomy in regard to appointment of SBAs also from the year 2008-09 onwards.  Thus, State Bank of India, Allahabad Bank, Bank of India, Bank of Baroda, Canara Bank, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce, Syndicate Bank, Punjab National Bank, UCO Bank and Union Bank of India would be required to select / appoint their SBAs from the year 2009-10, and Central Bank of India, Union Bank of India and Bank of Baroda have indicated their unwillingness to select their SBAs, all these banks would also be encouraged to select their SBAs from this year itself.

 For the remaining PSBs, the existing practice of RBI providing the list of audit firms to be appointed as SBAs would continue during the years 2008-09 and 2009-10.  During these two years, these banks would put in place an effective system of selection / appointment of SBAs on their own from the year 2010-11.

 Procedure as outlined by RBI.

 I.                   RBI to have panel from ICAI.

 II.               RBI will subject the panel to scrutiny to identify/ remove audit firms against whom adverse remarks/disciplinary proceedings are pending. RBI, thereafter, will forward the full and final list of all eligible auditors/audit firms to all PSBs.

 III.           SBAs appointed prior to 2006-07 will be completing their tenure of five years while those appointed during 2006-07 and afterwards will have tenure of four years. The appointment of SBAs will be made on an annual basis, subject to their fulfilling the eligibility norms prescribed by RBI from time to time and also subject to their suitability.

 IV.         While allotting branches, banks are advised to select auditors located in centres in which their offices are situated or branches located in centres which are in close proximity to their offices. Banks are also advised to have a suitable mix of various categories of auditors / audit firms while selecting the branch auditors keeping in view the size of the branches to be audited.

 V.             Banks should carry out branch audit in such a way that SCAs should audit the top 20 branches (to be selected strictly in order of the level of outstanding advances as at the end of March 31 of the previous year) to cover a minimum of 15% of total gross advances of the bank by SCAs.

 VI.             The number of eligible auditors / audit firms is more than the number of       branches to be audited at the following 33 centres (viz.  Mumbai, Kolhapur,             Pune, Solapur, Thane, Kolkata, Chennai, Coimbatore, Delhi/ New Delhi,      Ajmer, Bikaner, Jaipur, Kota, Udaipur, Ahmedabad, Vadodara, Surat,   Hyderabad, Chandigarh, Raipur, Faridabad, Gurgaon, Panchkula, Panipat,   Sonipat, Bangalore, Ernakulam, Indore, Nagpur, Ludhiana, Jodhpur,            Bhilwara, and Ghaziabad). In such centres, the auditors / audit firms will be        put to a period of compulsory rest for two years after completion of five / four years of continuous branch audit.

VII.         In other centres, where the number of eligible auditors / audit firms is less than the number of branches to be audited, the branch auditors on completion of five / four years of continuous branch audit will be subjected to the principle of rotation.

 VIII.    While continuing the practice of appointing one audit firm (as branch auditor) to one public sector bank, the banks will clearly advise the audit firms selected for consideration of appointment that one audit firm can take up audit assignment (branch audit) in one PSB only and also should give their consent in writing for consideration of appointment in the bank concerned for the particular year and the subsequent continuing years. The consent given by an audit firm will be treated as irrevocable and request, if any, from audit firms for changing the bank, after giving its consent to the bank concerned will not be entertained.

 IX.          After the selection of branch auditors, PSBs will be required to recommend the names of both continuing and new branch auditors to seek the approval from RBI before their actual appointment.

 X.             RBI will act as a facilitator to resolve problems/inconsistencies, if any, faced.

"One can expect severe action against any defaulting member. Based on the information that we have got today, we will initiate proceedings... This information (Chairman's letter) is good enough to initiate investigation on the matter. We need to collect all the relevant facts and will move fast," Mr Ved Jain, ICAI President, told Business Line.

Mr Jain said that the ICAI, which is the regulator of the auditing profession, could take action against members if there was any negligence on their part in their attest functions. Satyam Computer Services financial statements for the year-ended March 31, 2008 were audited by Price Waterhouse, a firm of chartered accountants.

In a statement, Price Waterhouse said : "We have learnt of the disclosure made by the Chairman of Satyam Computer Services and are currently examining the contents of the statement. We are not commenting further on this subject due to issues of client confidentiality."

The legal position is that no formal complaint was required for ICAI to initiate disciplinary proceedings and it could be done on the basis of information available with the public through the media . "The confession letter of Satyam Chairman is 100 per cent fit case for reference to the Board of Discipline of the institute," sources in the chartered accountants fraternity said.

Mr Jain said that the ICAI has initiated the process of collecting information on the Satyam case and sent letters in this regard to get all the facts.

The ICAI is yet to dispose of the matter relating to PriceWaterhouse's role as auditor in the Global Trust Bank (GTB) matter. GTB was amalgamated with Oriental Bank of Commerce at the instance of the Reserve Bank of India (RBI). "The inquiry on the matter is still on. We will take it to its logical end," Mr Ved Jain said.

Many chartered accountants and industry captains expressed shock over Satyam Chairman Mr Raju's admission that the balance sheet as on September 30, 2008 carried inflated (non existent) cash and bank balances of Rs 5,040 crore (as against Rs 5,361 crore reflected in the books).

They also noted that it was normal practice for auditors to do surprise verification of cash at least once in a financial year. In respect of bank balances, auditors independently take confirmation from banks for balances at the end of an accounting period, they added.

On how easy would it be for software companies to inflate revenues, sources said that it could happen through number of ways including showing consignment sales as regular revenues or recognising revenues on incomplete projects .

http://www.thehindubusinessline.com/2009/01/08/stories/2009010851220300.htm

PwC's fate Hangs in Balance
Enron & Worldcom had changed the world of auditing from `Big 5' to `Big 4'. The brazen fraud at Satyam has the to  
shrink it to `Big 3', at least in India. The falsification of accounts by Satyam for the past several years has put a question mark on the very survival of its auditor, PricewaterhouseCoopers (PwC).

PwC had audited about 139 companies in India in the last fiscal. Of this, 97 are listed and 45 are part of BSE 500 Index. A few of these companies are already reviewing their relationship. For instance, Glenmark Pharma has said its board will decide on January 27 on whether to propose a change in the auditor.

Some other large companies audited by PwC include Maruti Suzuki, United Breweries, United Spirits, GMR Infra, Piramal Healthcare and Marico.

The Institute of Chartered Accountants of India (ICAI), an apex body of chartered accountants, is likely to take a strict stand on the issue. ICAI said any member firm found guilty in the Satyam case would be severely punished and the auditors could even be barred from practising for lifetime. Although there is no rule in India to penalise audit firms such as PwC on accounting fraud, a senior ICAI member said tainted auditors can be pulled up.

In 2007, ICAI had found partners of PwC guilty of professional negligence in underproviding for non-performing assets in the now-defunct Global Trust Bank (GTB). But this was only after RBI had blacklisted the firm when a string of irregularities surfaced at GTB. In July 2006, PwC's Japanese affiliate Chuo Aoyama was handed a two-month ban on auditing by Japan's Financial Services Agency, for allegedly certifying false accounts of consumer products major Kanebo.

Senior partners at PwC went into a huddle on Wednesday and remained incommunicado for most part of the day. Late in the day, the firm sent a terse statement: "We have learnt of the disclosure made by the chairman of Satyam Computer Services (Ramalinga Raju) and are currently examining the contents of the statement. We are not commenting further on this subject due to issues of client confidentiality."

Partners at other Big Four firms were cautious in their assessment, as investigations by authorities were yet to commence. "There would be an investigation by ICAI to find out whether there was an audit failure," said Richard Rekhy, head of KPMG India, an arch rival of PwC. "The ICAI's council has its own disciplinary committee that will see whether adequate due diligence was ensured by the concerned auditor," he added. Traditionally, most companies appoint one of the Big Four firms -- that includes KPMG, Ernst & Young and Deloitte -- to do the statutory audit, as it implies that the company's accounts are above scrutiny.

"This is a major loss of reputation for the auditing profession," said a senior partner at Deloitte India. "The Satyam issue will now put the entire profession in an unpleasant light."

An executive for the 170-member PwC said the statement was delayed as it had to be approved by the global parent firm in the US also. Satyam is  
NYSE-listed and any statement from PwC would be examined carefully by the SEC. "We are perplexed as to how a fraud of this magnitude could take place," said one senior PwC executive. "We usually check corporate transactions on a test basis. But this is not a small amount. Frankly speaking, the sheer size of it has left us clueless," he told ET on condition of anonymity. The firm is likely to undertake an internal investigation on its own, he added.

Statutory auditors are typically appointed by a company to audit the balance sheet and to verify whether the accounts presented are a true and fair view of the financial state of affairs. Their appointment is ratified at the annual general meeting (AGM) and is typically valid for one year. The accounting firm can be re-appointed following an approval at each AGM. According to RSM Astute India chairman Suresh Surana: "It needs to be ascertained whether any documentary evidence was presented to the auditors and whether that was forged. This episode also shows that there is too much focus on the short-term performance of a company."

For a new project, monies may be brought in by promoters and raised by way of loans. An interesting issue, which arises for determination is whether the interest payable on the loans received would be deductible under section 57 of the Act against the interest earned on the temporary parking of surplus funds.

In CIT v Karnataka Power Corporation (247 ITR 268), it was held by the apex Court that interest receipts/hire charges received during pre-production period is on a capital account. In Tuticorin Alkali Chemicals and Fertilizers Ltd v CIT (227 ITR 172), the Supreme Court considered the investment of borrowed funds prior to commencement of business and held that the interest earnable was taxable.

In CIT v Bokaro Steel Ltd (236 ITR 315), a government company, which during the period of construction of the plant had advanced monies to contractors on which it was earning interest, received rent from quarters let out to employees. It also received hire charges on plant let out to contractors and received royalty on stones removed from its land.

The Supreme Court considered all these activities to be intricately connected with the construction activity and accordingly held that interest received, rent received, hire charges and royalty, etc, would be reduced from the cost of the assets. Such receipts would not be treated as income. A similar view was expressed by the Supreme Court in CIT v Kamal Co-operative Sugar Mills Ltd (243 ITR 2). An identical view was also taken by the Supreme Court in Bongaigaon Refinery and Petrochemicals Ltd v CIT (251 ITR 329) and CIT v Karnataka Power Corporation (247 ITR 268).

This point was considered by the Madras High Court in CIT v VGR Foundations (298 ITR 132). The facts in this case were that the assessee was a partnership firm engaged in the real estate business. For assessment years 1997-98 and 1998-99, a survey under section 133-A of the Act was conducted and noticeS  under section 148 were issued.

The assessee filed "nil" returns of income and also filed letters stating that the returns filed vide acknowledgment No 8869, dated February 14, 2000, for the assessment year 1997-98 and acknowledgment No 8871, dated February 14, 2000, for the assessment year 1998-99, have to be treated as the returns in response to the notices issued under section 148 of the Act. Further, notices under section 143(2) were issued on November 20, 2001. The assessing officer noticed that the statements filed along with the returns of income revealed that the assessee had incurred expenses prior to commencement of business and the assessee had also earned interest income on fixed deposits with the bank. Such income had been set off against the expenses.

The assessing officer was of the view that the interest received on short-term deposits in the bank during the pre-production stage was assessable as income from other sources. Aggrieved by the orders, the assessee filed appeals to the commissioner of income tax (appeals). The commissioner dismissed the appeals and confirmed the orders of the assessing officer. Aggrieved, the assessee filed appeals to the income tax appellate tribunal. The tribunal allowed the assessee's appeals and set aside the orders of the commissioner of income tax (appeals).

Counsel appearing for the revenue submitted before the Madras High Court that the assessee had set off interest earned, prior to the commencement of the business operation, against the expenses. The assessee was wrong in setting off the interest prior to the commencement of the business operation, against the expenses. The interest income earned prior to the commencement of the business has to be assessed under the head "income from other sources". Hence, the assessing officer was right in assessing the interest income under the head "income from other sources" and not allowing expenses as a deduction.

Real estate developers enter into agreements to sell the real estate before they have completed or, at times, even begun construction. Each buyer enters into an agreement to acquire a specified unit when it is ready for occupation.

Typically, the buyer pays a deposit and makes progressive payments as the real estate is being constructed. Real estate sale may take various forms. For example, they may relate to commercial/industrial development, a flat in a building, or a villa that is being exclusive constructed to the specification of the buyer.

The accounting of real estate sales is a contentious issue not only in India but also globally.
AS-7 or AS-9

The question often faced by developers is whether the development is a construction contract and hence percentage of completion method under AS-7 should be applied or whether the sale of the real estate is a product sale to which the requirements of AS-9 relating to sale of product should be applied.

If AS-9 is applied then the sale is recognised on delivery of the product at which time the risk and rewards are also transferred to the buyer.

This question has been addressed in the "Guidance Note on Recognition of Revenue by Real Estate Developers", issued by the ICAI. It may be noted that the interpretation contained in the Guidance Note is different from a recently issued proposed interpretation under IFRS.
Different interpretation

As per the Guidance Note, in the case of real estate sales, all significant risks and rewards of ownership are normally transferred when legal title passes to the buyer (for example, at the time of the registration in the name of the buyer) or if there is a legally enforceable agreement for sale and (a) the significant risks (price risk, for instance) have been transferred to the buyer (b) the buyer has a legal right to sell or transfer his interest in the property, without any material impediment.

Once the seller has transferred all the significant risks and rewards of ownership to the buyer, any further acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor.

Accordingly, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognised by applying the percentage of completion method in the manner explained in AS 7, Construction Contracts.

Under the IFRS framework, the International Financial Reporting Interpretations Committee (IFRIC) has prepared a draft IFRIC interpretation "D-21 Real Estate Sales" in the light of divergent revenue recognition practices for sales of units by real estate developers.

The draft IFRIC interpretation concluded that a construction contract is `a contract specifically negotiated for the construction of an asset or a combination of assets ...' A sale agreement meets this definition if it is an agreement for the seller to provide construction services to the buyer's specifications.

Features that, individually or in combination, may indicate that an agreement is for the seller to provide construction services to the buyer's specifications, include:

the buyer being able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not); and

the seller transferring to the buyer control and the significant risks and rewards of ownership of the work-in-progress in its current state as construction progresses.

Indications that the seller transfers control of the work-in-progress this way may include, for example:

the construction taking place on land that is owned or leased by the buyer;

the buyer having a right to take over the work-in-progress (albeit with a penalty) during construction -- for example, to engage a different contractor to complete the construction;

in the event of the agreement being terminated before construction is complete, the buyer retaining the work-in-progress and the seller having the right to be paid for work performed (subject to buyer acceptance).
Sale of goods

Conversely, features that, individually or in combination, may indicate that an agreement is for the sale of goods (completed real estate) include:

the negotiation between the buyer and seller primarily concerning the amount and timing of payments, with the buyer having only limited ability to specify the design of the real estate, for example, to select a design from a range of options or specify minor variations to the basic design;

the agreement giving the buyer only a right to acquire the completed real estate at a later date, with the seller retaining control and the significant risks and rewards of ownership of the underlying work-in-progress until that date.

If a sale agreement is for the sale of goods, revenue shall be recognised if the entity has transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold.

These conditions shall be applied to the underlying real estate in its current state, not to the buyer's right to acquire the fully constructed real estate at a later date. This effectively means that revenue on real estate sales is recognised when the real estate is constructed and delivered to the buyer.

Stage of completion

The rationale for applying the stage of completion method to construction contracts is not just that it recognises the value of the entity's activity in the period. Rather it also recognises the economic benefits that the entity has delivered (via continuous transfer of control and risks and rewards of ownership) to the buyer as construction progresses.

This continuous transfer is often not a feature of agreements for the sale of real estate units -- control of the unit tends to pass from seller to buyer at a single point in time, usually when the unit is ready for occupation.

Going by D-21, if the real estate developer is constructing a villa for a purchaser, with the purchaser having control over that construction and the villa is to the specification of the purchaser, then the construction of the villa would be a construction contract and the same would be accounted using the percentage of completion method.

If the real estate developer is constructing a multi-storey building and a purchaser is buying a flat in the building, with little control over the technical specification of the flat and no control over the construction, the sale of the flat would be accounted for as a product sale. In other words, the sale would be recognised by the real estate developer when the purchaser is given the possession of the flat.

Clarity to interpretation

To make the above interpretation clear, the IFRIC has included the proposed new guidance on applying IAS 18 within D-21 and has proposed the withdrawal of Example 9 from the appendix to IAS 18, which was creating some confusion, relating to accounting for real estate sales.

The IFRIC noted that a binding agreement for the sale of real estate -- like other forms of binding customer order -- gives the buyer an asset in the form of a right to acquire, use and sell the completed real estate at a later date. The buyer controls this right and obtains risks and rewards associated with it, such as movements in the market value of the completed real estate.

However, an agreement for the sale of a real estate unit typically does not give the buyer control of the underlying real estate in its existing partially-constructed state. The seller typically retains significant risks of ownership, such as construction risk and risk of damage or default. The seller also typically retains the right to use -- that is, continue development of the work-in-progress. The seller is likely to retain these rights until the buyer obtains possession, usually at contractual completion.

The IFRIC notes that it is necessary to distinguish a right to acquire goods from the underlying goods themselves -- for recognising the sale the entity should have transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold, not the right to acquire the goods. Hence, a binding agreement for the sale of a real estate unit is usually insufficient to satisfy the conditions for revenue recognition.

As can be seen from the discussion, the revenue recognition criterion under the "Guidance Note on Recognition of Revenue by Real Estate Developers", and D-21 are different. The interpretation in D-21 as to what is a product and what is a construction contract, and the time when risks and rewards are transferred, are far more acceptable considering the core principles of the standards on revenue recognition and contract accounting.

The Indian Guidance Note is fundamentally flawed and may lead to totally unintended conclusions if applied as a general principle, for example, revenue recognition under the Guidance Note would commence on entering into non-cancellable purchase orders, rather than at the time of delivery of goods. Consequently, the Indian Guidance note is ripe for a revision.

Apart from the usual pressures of not being able to meet the financial budgets that a firm has set up for itself (whether by means of a well-defined budget and business plan or through a hazy and unfocussed set of targets), there are also by the very nature of the profession risks that one has to be alive to.

High risk profile

Add to this melange of variables, the recent phenomenon of employee-attrition and the high levels of salary expectations, we now have a very difficult set of circumstances within which the profession has to function. Further, costs having risen at a pace faster than revenues and due to the dearth of manpower, it is not always possible to get the best of resources required.

The profession has a high risk profile. Often the sins of the clients visit the CAs for no fault of their own except that the CA happened to be at the wrong place at the wrong time. It therefore becomes essential for a CA to evaluate the client list periodically in order to mitigate the risks and to maximise the income. This should be done in a systematic manner. Such an evaluation will enable the CA to pinpoint the areas where he/she needs to concentrate. An illustrative template is provided (see Table), which is self-explanatory. This will also help in the peer-review process.

Three qualitative criteria have been used in the template. The greater the number of the qualitative criteria that is employed, the greater will be the options and choices available, apart from making them better and more narrowly defined. Therefore, one can tailor-make the template based on one's experience to make it more relevant for personal needs rather than have a generic model.
Defined Values

It is possible that each CA has his/her own answers to the various situations thrown up by the template. While the comments are only examples, each CA can modify according to own perceptions. Therefore, the comments are not to be taken as answers but as suggestions.

What the template does is help one focus on client rating and articulate what has been hitherto unarticulated. It is absolutely imperative that the CA has a list of defined values and categories into which each client is placed and that the CA examines each client periodically and move the client up and down in the category list on the basis of experience. Once a client is placed in "to watch list" or some equivalent category (according to the internal practices), the client should be monitored carefully.

As one's practice grows larger, one acquires the power to say no and walk away from a deal, if the situation so warrants, which is a sign of maturity. In matters such as this, instinct is a great judge although giving up a client purely because the fees is not adequate may not always be the right decision, since the particular client may refer other clients or may present other opportunities.

Choose with care

However, there is a point at which it may not be worth retaining even such clients since more work at low fee will not help a CA. Pruning down a client list will definitely affect the gross revenues although at the net income level it may not have much impact. This is worth bearing in mind. Being aware of the fact that a new entrant is not always in a position to pick and choose the `right' client, it must be understood that new clients are like investment opportunities and therefore must be chosen with great care.

Q1: Give your views on the

   following:

a) After conducting the audit of a branch of a nationalised bank, the branch auditor purchases shares of this bank from the secondary market soon after releasing his audit report. (5 marks)

b) A company was producing chewing tobacco, which is banned by the Government. The company starts manufacturing energy drinks, but holds the machinery used for producing chewing tobacco and charges depreciation on this machinery. (4)

c) It is the practice of the company to price its issue of stores for production on LIFO basis. The company claims that the provisions of Accounting Standard 2 apply only to closing stock but has no applicability to pricing the issues to production. (5)

d) A company files papers with the Ministry of Company Affairs for change of its name and starts using the new name immediately thereafter. (4)

Q2: Examine if the following situations constitute professional misconduct:

a) During the course of audit of a couple of branches of a nationalised bank, an auditor finds that the NPA classification was not properly made. He writes to the Reserve Bank of India on this matter stating it is his responsibility to bring it to the regulatory authority. (5)

b) A member in practice joins a listed company as an independent professional director and also continues his practice. (4)

c) A member is the Director (Finance) for some of the private limited companies and he is appointed as auditor for other private limited companies having the same composition of shareholders and directors. (5)

d) A member signs a contract with a corporate educational institution to visit the institution for 15 days at a stretch and cover the auditing syllabus of CA examinations in 100 hours. (4)

Q3: (a) What are the requirements of tax audit in respect of deduction of tax at source? (6)

b) What is the list of books required to be maintained by stock brokers? (10)

Q4: (a) What are the possible situations (regarding attitudes of the management and workers) the auditor is likely to encounter in a management audit. (8)

b) What are the different types of reinsurance possible? (8)

Q5: (a) When is a computerised information systems environment said to exist? How does it impact the work of an auditor? (10)

b) What are the powers of the Comptroller and Auditor General (C&AG) in the audit of public sector undertakings. (6)

Q6: (a) What various points do you look in to while carrying out environment audit? (8)

b) What aspects are covered in a due diligence audit? (8)

Q7: How do concurrent audit, internal audit and operations audit differ from each other? (16)

The work of formulating down accounting standards for the companies operating in India was initiated when the Institute of Chartered Accountants of India (ICAI), a statutory body regulating the accounting profession in the country, first took up this task in 1977. However, the accounting standards prepared and issued by the ICAI were mandatory only for its members, who, while discharging their audit function, were required to examine whether the said standards of accounting were complied with. With the amendment of the Companies Act, 1956 through the Companies (Amendment) Act, 1999, accounting standards as well as the manner in which they were to be prescribed, were provided a statutory backing.

Today, in pursuance of the statutory mandate provided under the Companies Act, 1956, the Central Government prescribes accounting standards in consultation with the National Advisory Committee on Accounting Standards (NACAS), also established under the Companies Act, 1956. NACAS, a body of experts including representatives of various regulatory bodies and Government agencies, has been engaged in the exercise of examining Accounting Standards prepared by ICAI for use by Indian corporate entities, since its constitution in 2001. In this exercise, it has adapted the international norms established by the International Financial Reporting Standards issued by the International Accounting Standards Board.

The Central Government notified 28 Accounting Standards (AS 1 to 7 and AS 9 to 29) in December 2006 in the form of Companies (Accounting Standard) Rules, 2006, after receiving recommendations of NACAS. These Accounting Standards are to be applied with effect from company financial year 2007-08, the accounts with respect to which are to be finalised during 2008-09. In notifying the Accounting Standards, the Government has adopted a policy of enabling disclosure of company accounts in a transparent manner at par with widely accepted international practices, through a process of convergence with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). In doing so, the requirements of the companies functioning in the country are being kept in view. The initiative for harmonization of the Indian accounting standards with IFRS, taken up by NACAS in 2001 and implemented through notification of accounting standards by the Central Government in 2006, would be continued by the Government with the intention of achieving convergence with IFRS by 2011.

Consistent with international practices, the accounting standards are prepared in India in context of the issues concerning large publicly held and listed corporate entities so as to enable the widest possible coverage of financial issues concerning a corporate entity. Consequently, some of the requirements of accounting standards may prove to be onerous for Small and Medium Companies (SMCs), who may not have the necessary resources to apply these requirements and incur associated compliance costs. Also, users of financial statements of the SMCs and their information requirements may also have limited requirements. Keeping this in view, necessary exemptions and relaxations to SMCs have been incorporated in the accounting standards on the recommendation of NACAS to enable them to apply the broad framework of the Accounting Standards in a simple manner.

The accounting and financial reporting practices need to change and evolve with the changing business and economic situation. Accounting practices prevailing in the country would also need to develop likewise. The institutional arrangements under the Companies Act, 1956 enable such developments through the efforts of NACAS and with inputs from ICAI and other quarters to meet the requirements of a changing economy. In this context, ICAI would continue to prepare and hold public consultation on standards of accounting for general application to various entities. It may also issue advice and guidance to its members to consider following certain practices approved by it in pursuance of prudence. The Government would examine further accounting standards to be followed by companies, on the basis of the standards proposed by ICAI, subject to the recommendations of NACAS thereon, for notification in accordance with the procedure laid down under the Companies Act, 1956. In the process, the approach of convergence with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB), being increasingly accepted as a common standard internationally, would be continued so that the financial information disclosed by Indian companies compares well with that disclosed by non-Indian companies in compliance with IFRS. This would not only provide reliable financial information to investors globally but also lower compliance costs since the need for restatement of accounts would be obviated for Indian companies seeking to tap international financial markets.

The Ministry of Corporate Affairs would, through the reform of accounting standards, continue to strengthen the corporate financial systems, at par in the best international practices, in the interest of all stakeholders to meet the requirements of India's changing economy.

The Indian arm of the global consultancy firm Ernst & Young, however, denied any wrong doing saying it had adhered to all the guidelines.

Amid the controversy after selection of Lanco Globeleq consortium as the successful bidder for the 4,000 Mw power project in Madhya Pradesh, the Central Vigilance Commission (CVC) had asked the power ministry to get into the act. The project was later awarded to Anil Ambani group's Reliance Power.

Acting on a direction from ministry in november last year, the PFC's vigilance wing had probed the issue pertaining to "professional conduct of E&Y and alleged omissions and commissions" of various committees involved in evaluation of the bids for the project.

Pointing to "major lapse" on part of E&Y and the bid evaluation committee, the Chief Vigilance Officer of PFC said in his report: "

It is suggested that PFC/ministry of power may initiate a process for debarring M/s E&Y from bidding for projects under the purview of ministry of power."

When contacted, PFC Chairman V K Garg and director Shyam Wadhera, who was also the chairman of the Board of Sasan Power Ltd declined to comment on the vigilance report.

A spokesperson for E&Y told PTI in an emailed statement "E&Y is not aware of the said report. We maintain that E&Y has adhered to all the guidelines with regard to the selection process."