Duties of an Auditor on Issue of Shares and Reissue of Forfeited Shares

1. Duties of an Auditor on Issue of Shares

When a company issues shares, the auditor must examine whether the issue has been made in accordance with the provisions of the Companies Act and the Memorandum and Articles of Association. The main duties are:

(a) Examination of legal authority The auditor should verify that the company is legally authorized to issue shares as per its Memorandum of Association and that the issue does not exceed the authorized capital. Any issue beyond the authorized capital must be supported by a special resolution and approval of the concerned authority.

(b) Compliance with the Companies Act The auditor must check that the provisions of the Companies Act relating to the issue of shares — such as issue at par or premium, private placement, right issue, bonus issue, and public issue — have been duly followed. In case of a public issue, the prospectus must be filed with the Registrar of Companies (OCR) and the Securities Board of Nepal (SEBON).

(c) Verification of application money The auditor should verify the application money received along with the applications. The amount must not be less than the minimum prescribed (usually 5% of the nominal value). The bank statements, bank reconciliation statements, and the cash book should be checked to confirm that the money has actually been received.

(d) Checking of allotment and calls The auditor must examine the allotment procedure to ensure that shares are not over-allotted or under-allotted and that the allotment is made on a fair and reasonable basis. The calls made on shares (allotment money, first call, second call, etc.) should be checked against the board resolution and the articles of association. The auditor should also verify that proper notice was given to shareholders before making calls.

(e) Treatment of over-subscription Where the issue is over-subscribed, the auditor should verify that the excess application money is either refunded or adjusted against allotment or calls as per the terms of the prospectus. The refund should be made within the prescribed time limit.

(f) Verification of share capital accounts The auditor should verify the Share Capital Account, Share Premium Account, and Calls-in-Arrears Account. The total amount credited to Share Capital should equal the nominal value of shares issued. Any premium received must be credited to the Securities Premium Account and not treated as revenue.

(g) Checking of underwriting commission and brokerage If shares are issued through underwriters or brokers, the auditor should verify that the commission or brokerage paid does not exceed the limit prescribed by the Companies Act and that it is properly authorized by the articles.

(h) Examination of calls-in-arrears and calls-in-advance The auditor should verify the amount of calls-in-arrears and calls-in-advance. Calls-in-arrears should be shown as a deduction from the called-up capital, and calls-in-advance should be shown separately under current liabilities.

(h) Proper disclosure The auditor must ensure that the share capital is properly classified into authorized, issued, subscribed, called-up, and paid-up capital and is disclosed correctly in the financial statements as per the legal requirements.

2. Duties of an Auditor on Reissue of Forfeited Shares

When shares are forfeited for non-payment of calls and later reissued, the auditor has the following duties:

(a) Verification of forfeiture The auditor should verify that the forfeiture was made in accordance with the articles of association and that proper notice was given to the defaulting shareholder before forfeiture. The board resolution authorizing forfeiture should be examined.

(b) Checking of forfeited shares account The auditor should verify the Forfeited Shares Account (also called Share Forfeiture Account). The amount already received on forfeited shares, less any expenses or discount on reissue, should be credited to this account. The auditor must ensure that the amount credited does not exceed the amount actually received on those shares.

(c) Examination of reissue procedure The auditor should check that the reissue of forfeited shares is properly authorized by the board of directors and is made in accordance with the articles. The reissue may be at par, at premium, or at discount, but the discount on reissue cannot exceed the amount already received on the forfeited shares.

(d) Verification of reissue price The auditor should verify the amount received on reissue. If the shares are reissued at a discount, the discount should be adjusted against the Forfeited Shares Account. If reissued at a premium, the premium should be credited to the Securities Premium Account.

(e) Treatment of balance in forfeited shares account After reissue, any balance remaining in the Forfeited Shares Account should be transferred to the Capital Reserve Account. The auditor should verify this transfer and ensure that it is correctly recorded.

(f) Checking of share capital account The auditor should verify that the Share Capital Account is credited with the nominal value of the reissued shares. The total share capital should not exceed the authorized capital.

(g) Proper accounting treatment The auditor must ensure that the accounting entries for forfeiture and reissue are correctly passed. For example:

• On forfeiture: Share Capital A/c is debited, Calls-in-Arrears A/c is credited, and Forfeited Shares A/c is credited.
• On reissue: Bank A/c is debited, Discount on Reissue A/c is debited (if any), and Share Capital A/c is credited.
• On transfer: Forfeited Shares A/c is debited and Capital Reserve A/c is credited.

(h) Disclosure in financial statements The auditor should ensure that the forfeited shares and their reissue are properly disclosed in the financial statements. The Capital Reserve arising from forfeiture should be shown separately under reserves and surplus.

(i) Compliance with legal provisions The auditor must check that all legal provisions relating to forfeiture and reissue — such as the maximum discount allowed, the time limit for reissue, and the treatment of the balance — are duly complied with.

Conclusion

In both cases — issue of shares and reissue of forfeited shares — the auditor acts as a watchdog of the shareholders' interest. The auditor must verify not only the arithmetical accuracy of the entries but also the legal validity of the transactions. Any irregularity in the issue or reissue of shares must be promptly reported to the management and, if necessary, to the shareholders. Thus, the auditor plays a vital role in ensuring transparency, legality, and fairness in the company's share capital transactions.

(a) Purchase book over-cast by Rs 20,000 Purchases are overstated by Rs 20,000, so cost of goods sold is too high and gross and net profit are understated by Rs 20,000.

(b) Freight on machinery Rs 2,00,000 posted as Rs 20,000 to Freight A/c The amount is a capital expenditure and should have been debited to Machinery for Rs 2,00,000. Instead only Rs 20,000 was charged to Freight (an expense), so expenses are overstated and net profit is understated by Rs 20,000 (depreciation ignored). The bank/cash credit of Rs 2,00,000 was correct, so the shortfall of Rs 1,80,000 on the debit side went to Suspense.

(c) Credit purchase from Rita Rs 60,000 posted to Gita's account Only a personal account was wrong; purchases are correctly recorded, so there is no effect on profit.

(d) Sales return from Mathura Rs 50,000 posted to the Return Outward Book Wrongly, Mathura was debited and Return Outward was credited; correctly, Return Inward should be debited and Mathura credited. Return Outward is overstated, which lowers net purchases, and Return Inward is not recorded, which leaves sales too high. Gross profit and net profit are therefore overstated by Rs 1,00,000 (50,000 + 50,000).

(e) Machinery purchased for Rs 20,000 debited to Purchases A/c A capital item has been treated as an expense, so purchases are overstated and net profit is understated by Rs 20,000 (depreciation ignored).

i. Compensation of Rs. 10,000 to a worker injured in a factory accident

Opinion: Revenue expenditure.

Reason: The compensation is a payment made to meet a loss arising in the ordinary course of business operations. It does not create any asset or add to the earning capacity of the business; it is an operating/administrative expense of the current period. Hence it is charged to the profit and loss account as revenue expenditure. (If the amount were abnormally large, it could be treated as a deferred revenue expenditure and written off over a few years.)

ii. Rs. 30,000 theft from shop on Saturday night

Opinion: Revenue expenditure (loss by theft).

Reason: Theft of cash/goods is an abnormal loss of the current period. It brings no benefit to the business and creates no asset, so it cannot be capitalised. It is written off to the profit and loss account in the year in which it occurs. Since the amount is small and its benefit period is nil, it is not carried forward as a deferred revenue expenditure.

iii. Allowance of Rs. 20,000 paid to an employee for purchasing raw material

Opinion: Revenue expenditure.

Reason: The allowance is incurred in connection with the purchase of raw material, which is a circulating/current asset consumed in production within the accounting period. The benefit is exhausted in the same period, so the allowance is part of the cost of raw material and is charged to the profit and loss account (trading account) as revenue expenditure. It is not a capital expenditure because no fixed asset or permanent earning capacity is created.

iv. Motorcycle showroom purchased 2 laptops at Rs. 150,000

Opinion: Capital expenditure.

Reason: Laptops are fixed assets (office equipment) used in the business for administration and sales operations. They have a useful life of more than one accounting period and add to the earning capacity of the showroom. Therefore the Rs. 150,000 is capitalised and shown in the balance sheet, with depreciation charged over the useful life. (If the laptops were held for resale, they would be treated as purchases/revenue, but here they are for use in the showroom.)

v. Machine valued Rs. 2 million purchased in two installments — Rs. 1 million now and Rs. 1 million after six months with 20% interest

Opinion: The machine cost is capital expenditure; the interest is revenue expenditure.

Reason: The price of the machine (Rs. 2 million) is incurred to acquire a fixed asset that will be used for several years and will generate future economic benefits; hence it is capitalised. The interest of 20% on the deferred installment (Rs. 1,000,000 × 20% × 6/12 = Rs. 100,000) is a financing cost incurred for the period, not for acquiring the asset, so it is charged to the profit and loss account as revenue expenditure. It is not a deferred revenue expenditure because its benefit does not extend beyond the current period.

(a) Advice to the Board of Directors

i. Writing off the whole Rs 200,000 preliminary expenses in the first year

Advice: The decision is correct and prudent — it may be approved.

Reasons:

• Preliminary expenses (expenses of forming the company, issue of shares/debentures, legal charges, etc.) are fictitious assets. The expenditure has already been incurred and there is no asset that can be realised in cash, so it has no realisable value.
• Under the Companies Act, 2063 and generally accepted accounting principles, such expenses should be written off as early as possible, and certainly out of profits, so that the balance sheet does not show assets which do not exist.
• Since the company has sufficient profit in the first year itself, writing off the entire amount in that year is the most conservative and honest treatment. It also prevents the danger of dividend being paid out of capital in later years.

Conditions the auditor should attach:

1. The amount must be supported by proper vouchers and actually incurred for the company's formation/issue work.
2. The write-off must be approved by the Board (and disclosed in the notes to accounts).
3. The policy must be applied consistently in future years.
4. After the write-off, the company's capital must remain intact and it must still be able to meet its liabilities — i.e., the write-off should not be made merely to reduce profit and evade tax or to create secret reserves.

ii. Distributing the Rs 100,000 gain on sale of an old machine as dividend

Advice: The decision should NOT be accepted. The gain should be transferred to Capital Reserve.

Reasons:

• Profit on sale of a fixed asset is a capital profit, not a revenue profit. The machine was held for use in the business and not for resale, so the gain does not arise from the normal operating activity of the company.
• Distributing a capital profit as dividend amounts to distribution out of capital, which reduces the capital base of the company and weakens its financial position.
• Under the Companies Act, 2063, dividend can be declared only out of profits of the company. A capital profit may be distributed only if all of the following conditions are satisfied:
  1. The Articles of Association permit such distribution;
  2. The profit is realised in cash;
  3. The book value of the remaining assets is not impaired;
  4. The capital of the company remains intact after the distribution.
• Since these conditions are normally not satisfied, the auditor should advise the Board to transfer the gain to Capital Reserve and use it for capital purposes such as writing off fictitious assets or issuing bonus shares.

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(b) Reserve or Provision

Key test applied: A provision is a charge against profit for a known liability or anticipated loss/diminution in asset value; a reserve is an appropriation of profit retained to strengthen the financial position.

1. Meaning of Government Auditing (2 marks)

Government auditing is the independent examination and verification of the accounts, records, and financial transactions of government offices, departments, and public-sector organisations, carried out by a constitutional or statutory authority (in Nepal, the Office of the Auditor General – OAG) to ascertain whether public funds have been collected, spent, and accounted for in accordance with the law, budget, and prescribed rules, and whether they reflect a true and fair view of the financial position.

It is also called public auditing or state auditing, and its legal basis in Nepal is Article 241 of the Constitution along with the Audit Act, 2075.

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2. Objectives of Government Auditing (5 marks)

1. To verify legality and regularity — to ensure that all revenue collected and all expenditure incurred are as per the existing laws, rules, and appropriations approved by the legislature.
2. To examine the accuracy of accounts — to check whether the books of account, financial statements, and other records present a true and fair view of the government's financial position and results.
3. To ensure accountability of public funds — to hold the executive accountable to the legislature (Parliament) and ultimately to the taxpayers for the use of public money.
4. To detect and prevent fraud, misappropriation, and irregularities — to uncover embezzlement, misuse, and wasteful spending, and to discourage their recurrence.
5. To evaluate economy, efficiency, and effectiveness (value for money) — to assess whether public resources have been used economically and whether programmes have achieved their intended objectives.
6. To support the budget and financial administration — to provide reliable information and suggestions that help in improving budgeting, financial control, and accounting systems.
7. To report to the legislature and recommend corrective action — to submit audit reports to the President/Parliament (and to the Public Accounts Committee) so that necessary legal and administrative reforms can be made.

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3. Difference between Government Auditing and Commercial Auditing (8 marks)

Conclusion: Government auditing is a constitutional, wide-scoped, non-profit-oriented audit aimed at legislative control over public money, whereas commercial auditing is a statutory but narrower, profit-oriented audit aimed at expressing an opinion on the fairness of private business accounts.

Vouching — Concept, Importance and Objectives

1. Concept of Vouching (3 marks)

Vouching is the act of examining documentary evidence (vouchers, invoices, receipts, bank statements, minutes, contracts, etc.) in order to ascertain the accuracy and authenticity of the entries made in the books of accounts. It is the process of proving that a transaction recorded in the books is genuine, correctly recorded and properly authorised.

According to R.B. Bose, "Vouching means testing the truth of entries appearing in the books of accounts."

According to Taylor and Perry, "Vouching is the technique followed by an auditor to verify the accuracy of the transactions as recorded in the books of accounts."

A voucher is the written documentary evidence in support of a transaction — cash memo, invoice, debit/credit note, pay-in-slip, cheque counterfoil, salary sheet, minute book, etc. Vouching therefore means checking each entry in the books against its supporting voucher, and also checking that the voucher itself is valid, genuine and authorised.

Example: If the cash book shows "Purchases Rs 50,000", the auditor vouches it by examining the purchase invoice, the goods received note, the purchase order and the entry in the purchase book, and by seeing that the amount, date and party name agree.

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2. Importance of Vouching — "Vouching is the backbone of auditing" (6 marks)

Vouching is called the backbone (or backbone of auditing) because the entire edifice of audit rests upon it. Just as the backbone supports the human body, vouching supports the whole audit work. Its importance may be explained as follows:

(a) Foundation of audit work: Vouching is the first and most important step of audit. Verification of assets, liabilities, capital and income all depend on the reliability of the entries vouched. If vouching is weak, the whole audit is weak.

(b) Basis of audit opinion: The auditor expresses an opinion on the truth and fairness of the financial statements. This opinion is possible only when each transaction has been vouched and found genuine.

(c) Detection of errors and frauds: Vouching helps detect errors of principle, errors of omission, errors of commission, misappropriation of cash, teeming and lading, fictitious purchases, inflated expenses, etc.

(d) Prevention of fraud: Since every entry must be supported by a voucher, dishonest employees hesitate to misappropriate funds. Thus vouching acts as a moral check.

(e) Reliability of books of accounts: Books become dependable only when each entry is supported by documentary evidence. Vouching establishes this reliability.

(f) Compliance with legal requirements: Companies Act, Income Tax Act and other laws require proper books and supporting documents. Vouching ensures compliance.

(g) Basis of audit report: A report based on vouched entries is dependable and defensible before shareholders, tax authorities and courts.

(h) Safeguard of assets: Vouching of purchases, sales, cash and bank transactions indirectly safeguards the assets of the organisation.

(i) Helps in valuation and verification: Correct vouching supplies the data needed for correct valuation of stock, depreciation, outstanding expenses and prepaid items.

(j) Economy and efficiency of audit: A systematic vouching programme reduces time, cost and duplication of work.

(k) Moral check on staff: It creates a sense of responsibility among the accounting staff.

(l) Basis of evidence: Vouchers constitute the documentary evidence on which the auditor's certificate stands.

Thus, without vouching, audit is like a body without a backbone — it cannot stand.

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3. Objectives of Vouching (6 marks)

The objectives of vouching may be grouped under two heads:

A. Primary (Main) Objectives

(i) To verify the genuineness of transactions: To ensure that the transactions recorded actually took place and are not fictitious.

(ii) To verify the accuracy of entries: To see that the amount, date, name of party and account head have been correctly recorded in the proper books.

(iii) To verify the authenticity of vouchers: To examine whether the vouchers are genuine, original, complete and properly dated and numbered.

(iv) To ensure proper authorisation: To check that each transaction has been sanctioned by the competent authority.

(v) To ensure arithmetical accuracy: To verify totals, sub-totals, carry forwards and postings to the ledger.

(vi) To ensure correct posting and classification: To see that entries are posted to the correct accounts and under the correct head — capital and revenue items are not mixed.

B. Secondary (Secondary/Subsidiary) Objectives

(i) Detection of errors: To detect errors of omission, commission, principle, duplication and compensating errors.

(ii) Detection of frauds: To detect misappropriation of cash, misappropriation of goods, teeming and lading, fictitious assets and window dressing.

(iii) Prevention of frauds and errors: To create a moral check so that frauds are not committed in future.

(iv) Verification of assets and liabilities: To provide a reliable base for verifying the existence, ownership and valuation of assets and liabilities.

(v) Ensuring compliance with law: To see that the provisions of the Companies Act, Income Tax Act and memorandum and articles are followed.

(vi) Supporting the audit report: To collect sufficient, reliable evidence so that the auditor can give a true and fair report.

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Conclusion

Vouching is not merely a mechanical comparison of entries with vouchers; it is the soul and backbone of auditing. It gives the auditor the evidence base, detects and prevents frauds and errors, and makes the final audit report dependable. Hence the statement "Vouching is the backbone of auditing" is fully justified.

Verification of Liabilities

Verification of liabilities means examining and confirming that all liabilities appearing in the balance sheet are genuine, correctly valued, properly classified, and completely recorded — and that no liability has been omitted or overstated. The following procedures are adopted for each item:

a. Preference Share Capital

1. Examine the Memorandum and Articles of Association to verify the authorized amount, rate of dividend, and terms of redemption of preference shares.
2. Check the Minutes Book of the Board and shareholders' meetings for the resolution authorizing the issue.
3. Verify the issue proceeds with the cash book, bank statement, and bank reconciliation statement.
4. Inspect the Register of Members (or share application and allotment book) to confirm the amount actually received and the number of shares issued.
5. Test the arithmetical accuracy of the amount shown under this head, and see that it agrees with the general ledger and the balance sheet.
6. Ensure proper presentation — i.e., the amount is shown separately from equity share capital, and any calls in arrears or calls in advance are adjusted correctly.
7. In case of redeemable preference shares, verify that redemption was made out of divisible profits or fresh issue, as required by law.

b. Loans

1. Examine the loan agreement, debenture trust deed, or mortgage deed to verify the amount, rate of interest, terms of repayment, and security offered.
2. Check the Minutes Book for the resolution authorizing the loan.
3. Verify the receipt of loan amount with the cash book and bank statement.
4. Inspect the loan ledger account and confirm the balance outstanding at the year end.
5. Check interest paid/payable and see that it is correctly calculated and charged to the profit and loss account.
6. Obtain a certificate or direct confirmation from the lender regarding the balance outstanding.
7. Verify that secured loans are properly disclosed and that the security offered is noted in the balance sheet.
8. Ensure that loans are properly classified into secured/unsecured, short-term/long-term.

c. Trade Creditors

1. Check the purchase book, purchase returns book, and ledger to verify the amounts due to suppliers.
2. Examine the statement of account received from creditors and reconcile with the firm's records; differences should be investigated.
3. Obtain a schedule of creditors and verify it with the total of the creditors' ledger (control account).
4. Send confirmation letters to major creditors to confirm balances directly.
5. Verify that all purchases are recorded by checking goods received notes against invoices — to detect unrecorded liabilities.
6. Check payments made after the balance sheet date to ensure liabilities of the current year are not omitted.
7. Ensure proper classification — creditors for goods should be separated from creditors for expenses.

d. Contingent Liabilities

1. Examine the Minutes Book, legal files, and correspondence to identify pending law suits, disputed claims, guarantees given, and bills discounted.
2. Obtain a certificate from the management (letter of representation) listing all contingent liabilities.
3. Inspect the solicitor's or legal advisor's report regarding the probable outcome of pending cases.
4. Verify bills discounted and guarantees with the bank and the relevant documents.
5. Ensure that contingent liabilities are not shown as actual liabilities but are disclosed by way of a footnote to the balance sheet, as required by accounting standards.
6. Check that the amount disclosed is reasonable and that the nature of each contingency is properly described.

e. Outstanding Liabilities

1. Prepare a list of all expenses — wages, salaries, rent, interest, audit fees, etc. — and verify that the unpaid portion at the year end is correctly recorded.
2. Examine the relevant expense accounts and check that the outstanding amount is calculated on a proper basis (e.g., time basis, contract basis).
3. Compare with the previous year's figures to see that no item is omitted or understated.
4. Check payments made in the next accounting period to identify expenses relating to the current year but paid later.
5. Verify the arithmetical accuracy of the outstanding amounts and see that they agree with the general ledger.
6. Ensure proper disclosure — outstanding liabilities should be shown separately in the balance sheet and not merged with trade creditors.
7. Obtain a certificate from the management confirming that all liabilities have been provided for.

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Conclusion: Verification of liabilities is essential to ensure that the balance sheet presents a true and fair view of the financial position. The auditor must satisfy himself that all liabilities are genuine, complete, correctly valued, and properly classified and disclosed.