Until recently, test checks were applied only for confirming balances in a few nominal accounts; those of stocks and stores, amount of sale and other similar records relevant to trading transactions, which were voluminous but of similar nature. Now a days on account of increase in the size of business units, but more so due to mechanization of accounting, the test checks are being applied widely for the verification of income and expense accounts as well as assets and liabilities. This has crystallised into a form of audit known as Balance Sheet audit.
A Balance Sheet audit consists of the verification of all includible Balance Sheet items, together with the examination of expense and income accounts which are so closely related to these items that it cannot be properly verified without such analysis and test. Records, vouchers, books and accounts are examined; capital and revenue accounts are analysed. The concept of Balance Sheet audit has been developed along with the development of formal internal control system. In outline form, a Balance Sheet audit will include the following:
1. An examination of partnership agreement, the memorandum and articles of association, minutes of the board of directors, and the system of accounting in force, (depending upon the type of entity).
2. The establishment of ownership of all assets included in the Balance Sheet.
3. Proof that all owned assets are included.
4. The inclusion of the asset in the Balance Sheet is in accordance with the accepted principles of accounting.
5. Proof that all liabilities are included and at proved amounts.
6. The examination of adjusting and closing entries or any other entries necessary to the preparation of the Balance Sheet.
7. Evidence that the distinction has been made in recording transactions between capital and revenue; and that capital and revenue have been created on the basis of accepted accounting principles.
8. Proof that the share capital issues have been made in compliance with the requirements of law and they are correctly recorded in the financial books.
9. An analysis of the charges and credit to the revenue accounts and the inclusion of the resultant balance in the Balance Sheet.
Given below are some of the overall tests which may be applied for verification of balance in the Profit and Loss Account.
- Check direct expense such as customs duty, excise duty with the value of purchases and quantity of goods for sales; verify adjustment of regular expenses e.g. rent, managerial salaries, insurance charges, postage, stationery, etc.
- Compare the total of each expense account comprised in the Trading and Profit Loss Account with the corresponding amount in the same account for the previous year and if there is any material variation in any one of them, find out the reason therefor.
- Determine whether increases or decreases in wages, material consumed and variable expenses appear to be proportionate to the increase or decrease in the turnover.
- Investigate the causes of any material change in the rate of gross profit.
- Enquire into extraordinary expenses, e.g., donations paid to charities or item of a non-recurring nature, like expenses of foreign tours, those on an advertisement campaign and others which have resulted in changes of material amount on the revenue of the period.
- Ascertain whether there have been any changes in the basis of accounting which have resulted in significant increase or decrease in the amount of expenses included in the Trading and Profit and Loss Account e.g. due to non-provisions of closing stock of stationery or advertisement material,
non-provisions of bonus or gratuity payment to staff, etc.
- Compare schedules of outstanding expenses and provision with those for the previous period and ascertain causes of any material changes therein; check in detail the provisions for depreciation and taxation.
Income Account :
- Verify different types of income in respect of which separate Demand Registers are maintained, reference to them and confirm that amounts outstanding have been properly adjusted.
- Examine the system of invoicing goods to ensure that goods cannot be issued without the sale price thereof being received or the amount being debited to the customer’s account.
- Reconcile the quantity of raw material consumed with quantities of finished products manufactured and compare the rate of wastage with that in the earlier period.
- Compare the total of each income account comprised in the Trading and Profit and Loss Account with the corresponding amount in the same account in the previous year and, if there is any material variation, find out reasons therefor.
- The creditors’ ledger trial balance should be extracted the client and agreed with the Control Account, if any, before the balances for confirmation are selected.
- The outstanding liability in respect of goods received, within the last week of the close of the year, should be verified comparing entries in the Goods Inward Register with those in the Purchase Journal. In verifying this, due attention should be paid to the cut-off arrangement made the
- A certificate should be obtained from the client that all the liabilities which had accrued upto the date of the Balance Sheet have been taken into account.
- The trial balance of the debtors’ ledger should be extracted the client and agreed with the Control Account, if any, before the balances for confirmation are selected.
- The amount of sales made during the week before the close of the year should be verified on comparing the entries in the Goods Outward Register with those in the Sales Journal. Here also, due attention should be paid to the cut-off arrangement.
- A certificate should be obtained from the client that all the book debts are good and recoverable and that a provision has been made against those considered bad or doubtful.