Category: Management Notes

Management Notes

Relationship between Cost Accounting and Management Accounting

indiafreenotesby indiafreenotes2

Cost Accounting is the branch of accounting concerned with recording, classifying, analysing, summarising and allocating costs of products, processes or services. It determines the cost of production, helps in cost control and reduction, and provides data for valuation of inventory, pricing decisions, and profitability analysis. It uses techniques like standard costing, marginal costing, budgetary control and variance analysis. Its primary users are internal management, though it also aids external reporting. Cost accounting bridges financial and management accounting by supplying detailed cost information for planning, control and decision-making. It is both historical and forward-looking, and is essential for efficient resource utilisation and competitive pricing. It forms the basis of management accounting.

Characteristics of Cost Accounting:

1. Cost Determination

Cost Accounting is primarily concerned with the determination of cost of products, services, jobs, processes, and activities. It systematically collects and classifies expenses relating to materials, labour, and overheads. These costs are allocated and apportioned to determine the total and unit cost of production. Cost Sheets and other cost statements are prepared to ascertain the cost of individual products or services. Accurate cost determination helps management understand the actual cost incurred in production and operations. It also provides a basis for pricing decisions, profitability analysis, cost comparison, and cost control. Thus, cost determination is a fundamental characteristic of cost accounting.

2. Cost Classification

A significant characteristic of Cost Accounting is the classification of costs according to their nature and purpose. Costs may be classified as fixed, variable, semi variable, direct, indirect, product, period, controllable, and uncontrollable costs. Proper classification helps management understand how different costs behave under changing business conditions. It also facilitates the calculation of product costs and supports important decisions such as pricing and production planning. Classification makes cost information systematic and meaningful. Therefore, the proper identification and classification of costs enables an organisation to achieve effective cost analysis, cost control, budgeting, and managerial decision making.

3. Cost Control

Cost Accounting plays an important role in controlling costs incurred by an organisation. It compares actual costs with budgeted costs, standard costs, or predetermined costs to identify deviations. Management can investigate the reasons for significant variations and take appropriate corrective measures. Cost control focuses on preventing unnecessary expenditure, reducing wastage, and improving the efficiency of resource utilisation. Techniques such as Standard Costing and Variance Analysis are useful for this purpose. Effective cost control helps an organisation maintain costs within planned limits while maintaining required quality. Thus, cost accounting contributes significantly to operational efficiency and profitability improvement.

4. Cost Reduction

Another important characteristic of Cost Accounting is its emphasis on cost reduction. Cost reduction involves achieving a permanent decrease in the cost of production or operations without unnecessarily reducing the quality, efficiency, or usefulness of the product or service. Cost accountants analyse material consumption, labour efficiency, production methods, overheads, and wastage to identify opportunities for savings. They may suggest improvements in processes, better utilisation of resources, or elimination of unnecessary activities. Cost reduction helps an organisation improve its profit margin and competitiveness. Therefore, cost accounting continuously assists management in finding practical ways to reduce costs and improve efficiency.

5. Detailed Analysis

Cost Accounting has a detailed and analytical nature because it provides information about individual products, jobs, processes, departments, and activities. It analyses the different components of cost, including direct material, direct labour, and overheads. Cost accountants also analyse cost behaviour, cost variances, efficiency, and profitability. Techniques such as Marginal Costing, Standard Costing, Process Costing, and Job Costing provide detailed information for analysis. Such information helps management identify inefficient activities, control expenditure, and improve production performance. Therefore, detailed cost analysis enables management to understand the reasons behind costs and take appropriate corrective and improvement measures.

6. Budgetary Control

Budgetary Control is closely associated with Cost Accounting because it helps management plan and control costs. Budgets are prepared for materials, labour, production, overheads, and other operating expenses. Actual costs are then compared with budgeted figures to identify deviations. Cost accountants analyse these deviations and provide explanations to management. This process helps prevent unnecessary expenditure and ensures that resources are used according to planned objectives. Budgetary control also promotes coordination between different departments and improves financial discipline. Therefore, Cost Accounting uses budgeting information to support planning, cost control, performance evaluation, and efficient utilisation of organisational resources.

7. Cost Reporting

Cost Accounting provides regular cost reports to management for monitoring business operations. These reports may contain information about production costs, material consumption, labour costs, overheads, unit costs, variances, and profitability. Reports can be prepared for different departments, products, processes, jobs, or activities according to management requirements. The information helps managers identify areas where costs are increasing and take timely corrective action. Cost reports also support planning, budgeting, pricing, and performance evaluation. Therefore, systematic cost reporting ensures that management receives relevant, accurate, and timely cost information for effective control and operational decision making.

8. Helps in Pricing Decisions

Cost Accounting provides an important basis for pricing decisions by determining the cost of producing goods or providing services. Management can analyse total cost, unit cost, fixed cost, variable cost, and profit margin before deciding an appropriate selling price. In competitive markets, cost information helps determine whether a proposed price is sufficient to cover relevant costs and provide a reasonable return. Techniques such as Marginal Costing and Cost Volume Profit Analysis can also assist in special pricing decisions. Therefore, Cost Accounting provides reliable cost information that helps management establish suitable prices while maintaining profitability and market competitiveness.

Management Accounting

Management Accounting is the branch of accounting that provides timely financial and non-financial information to internal management for planning, controlling, and decision-making. It is not governed by rigid rules or standard formats. It uses techniques like budgeting, standard costing, marginal costing, ratio analysis, and CVP analysis. It draws data from historical records and future estimates. Its primary users are managers at all levels. Objectives include policy formulation, performance evaluation, cost control, resource optimisation, and profit maximisation. Management accounting is forward-looking, flexible, and tailored to managerial needs. It helps in strategic planning, operational control, and sound decision-making. Thus, it is an essential tool for effective management and overall organisational long-term success.

Characteristics of Management Accounting:

1. Management Oriented

Management Accounting is primarily management oriented because it provides information according to the requirements of internal management. It assists managers in performing important functions such as planning, decision making, coordination, and control. The information may relate to costs, sales, profits, budgets, production, and operational performance. Reports are prepared according to the needs of top, middle, and lower level management. Unlike financial accounting, management accounting mainly serves internal users rather than external stakeholders. Its purpose is to help managers take appropriate actions and achieve organisational objectives. Thus, its management oriented nature makes it an important decision support tool.

2. Future Oriented

Management Accounting is largely future oriented because it helps management prepare plans for future business activities. Although it uses past and present financial information, this information is analysed to predict future conditions and support managerial decisions. Management accountants prepare budgets, forecasts, estimates, and projections relating to sales, production, costs, profits, and cash flows. Such information helps managers identify future opportunities and possible risks. Techniques such as Budgetary Control, Standard Costing, and Cash Flow Forecasting support future planning. Therefore, the future oriented nature of management accounting helps reduce uncertainty and enables management to achieve its future organisational objectives.

3. Analytical Nature

Management Accounting has an analytical nature because it involves the detailed analysis and interpretation of financial and non financial information. Management accountants examine costs, revenues, profits, budgets, variances, ratios, and operational performance to provide useful conclusions. Techniques such as Ratio Analysis, Variance Analysis, Marginal Costing, and Break Even Analysis are used for this purpose. The objective is not simply to present accounting figures but to explain their meaning and implications to management. Such analysis helps identify problems, opportunities, inefficiencies, and areas for improvement. Therefore, its analytical nature makes accounting information more useful for managerial planning and decision making.

4. Decision Making Tool

Management Accounting serves as an important decision making tool for managers. It provides relevant information needed to choose the most appropriate alternative from different available options. Managers may need to make decisions regarding pricing, production, product mix, investment, expansion, outsourcing, and cost reduction. Management accountants analyse relevant costs, revenues, and expected benefits associated with different alternatives. Techniques such as Marginal Costing, Relevant Cost Analysis, and Cost Volume Profit Analysis support managerial decisions. Management accounting does not make decisions itself; instead, it provides information and analysis that enable managers to make rational, informed, and profitable decisions.

5. Selective Nature

Management Accounting has a selective nature because management does not require every piece of accounting information for decision making. Management accountants select information that is relevant, significant, timely, and useful for a particular managerial purpose. They collect information from financial and operational records and present only the data required by management. The information provided may differ according to the requirements of top, middle, and lower level management. This approach saves managerial time and helps managers focus on important matters. Therefore, the selective nature of management accounting ensures that the right information is provided to the right person at the right time.

6. Flexible Nature

Management Accounting has a flexible nature because there is generally no rigid format for preparing internal management reports. Reports can be designed according to the nature of business, managerial requirements, and specific circumstances. Management accountants may use different techniques such as Budgetary Control, Standard Costing, Marginal Costing, Ratio Analysis, and Variance Analysis, depending on the purpose. The frequency and format of reports can also be changed according to management needs. This flexibility allows management accounting to adapt to changing business conditions. Therefore, its flexible nature makes it suitable for different organisations and various managerial situations.

7. Continuous Nature

Management Accounting is a continuous process because management requires regular and updated information for effective planning, control, and decision making. Management accountants continuously collect, classify, analyse, and interpret financial and operational information. Reports may be prepared daily, weekly, monthly, quarterly, or whenever required by management. Continuous comparison of actual performance with budgets and standards helps identify deviations at an early stage. Management can then take corrective action without unnecessary delay. Since business conditions and managerial requirements change continuously, management accounting also needs to provide updated information. Thus, its continuous nature supports effective managerial control and timely decisions.

8. Interdisciplinary Nature

Management Accounting is interdisciplinary because it uses knowledge and techniques from several different fields. Besides accounting, it makes use of economics, statistics, mathematics, finance, operations management, and business management. For example, statistical techniques may be used for forecasting, economic principles may support pricing decisions, and financial techniques may assist investment decisions. Management accountants combine information from different disciplines to provide comprehensive analysis to management. This approach enables managers to understand business problems from different perspectives and make better decisions. Therefore, the interdisciplinary nature of management accounting makes it a broad and practical tool for managerial effectiveness.

Relationship between Cost Accounting and Management Accounting:

1. Common Objective

Cost Accounting and Management Accounting are closely related because both aim to provide useful information for improving business efficiency and profitability. Cost accounting mainly determines and controls the costs of products, services, processes, and activities. Management accounting uses this cost information along with financial and non financial information for planning, decision making, and control. Both systems help management use organisational resources efficiently and reduce unnecessary expenditure. Cost information provides a strong foundation for managerial analysis. Therefore, although their scope and functions differ, both contribute towards achieving the organisation’s overall objectives and improved performance.

2. Cost Accounting as a Basis

Cost Accounting provides an important information base for Management Accounting. Cost accountants collect, classify, analyse, and report detailed information about materials, labour, overheads, production costs, and unit costs. Management accountants use this information to prepare budgets, analyse profitability, evaluate performance, and make managerial decisions. For example, cost information can support decisions regarding pricing, product mix, make or buy decisions, and cost reduction. Thus, management accounting depends considerably on accurate cost information. Cost accounting therefore acts as a foundation for several management accounting techniques and provides detailed information required for effective managerial planning and control.

3. Common Use of Cost Information

Both Cost Accounting and Management Accounting make extensive use of cost information. Cost accounting determines the cost of products, services, jobs, processes, and activities, while management accounting interprets this information according to managerial requirements. Information regarding fixed costs, variable costs, direct costs, indirect costs, and marginal costs helps management understand cost behaviour and profitability. Such information supports budgeting, pricing, production planning, and cost control. Therefore, cost information acts as an important link between the two systems. Accurate and timely cost information enables management to make better decisions and improve the organisation’s financial and operational performance.

4. Cost Control and Reduction

Cost Control and Cost Reduction are important areas common to both Cost Accounting and Management Accounting. Cost accounting identifies and analyses costs and compares actual costs with standard or budgeted costs. Management accounting uses these findings to help managers take corrective actions and improve operational efficiency. Techniques such as Standard Costing, Variance Analysis, and Budgetary Control are useful in controlling costs. Both systems aim to prevent wastage, eliminate unnecessary expenditure, and improve the utilisation of resources. Therefore, Cost Accounting provides detailed cost information, while Management Accounting uses that information for broader cost control, planning, and managerial action.

5. Support for Decision Making

Cost Accounting and Management Accounting are both useful for managerial decision making, although management accounting has a broader role. Cost accounting provides detailed information about the costs associated with different products, services, processes, and alternatives. Management accounting uses this information to evaluate decisions concerning pricing, production, product selection, expansion, outsourcing, and resource allocation. Techniques such as Marginal Costing and Relevant Cost Analysis help managers compare alternatives. Thus, cost accounting supplies the necessary cost data, while management accounting interprets and applies it to specific managerial situations. Both therefore contribute to rational and informed decision making.

6. Performance Evaluation

Both Cost Accounting and Management Accounting contribute to performance evaluation. Cost accounting provides information about the performance of products, processes, departments, and production activities by analysing costs and efficiencies. Management accounting uses this information along with budgets, financial results, and operational indicators to evaluate the performance of different responsibility centres. Variance Analysis helps identify differences between actual and predetermined performance. The causes of significant deviations can then be investigated and corrective actions can be taken. Therefore, cost accounting provides detailed performance information, while management accounting uses it for broader performance measurement, control, accountability, and improvement.

7. Budgeting and Planning

Budgeting and Planning establish another important relationship between Cost Accounting and Management Accounting. Cost accounting provides historical and estimated information regarding material, labour, production, and overhead costs. This information is used by management accountants while preparing various budgets. Management accounting then coordinates these budgets and uses them for planning, control, and performance evaluation. Actual results are compared with budgeted figures to identify variances and take corrective action. Therefore, cost accounting supplies detailed cost data required for budget preparation, while management accounting uses that information to develop comprehensive plans and ensure effective resource allocation and operational control.

8. Complementary Functions

Cost Accounting and Management Accounting perform complementary functions within an organisation. Cost accounting concentrates mainly on cost determination, classification, analysis, control, and reduction. Management accounting has a wider scope and uses cost information along with financial and non financial information for planning, decision making, coordination, and control. Cost accounting therefore provides detailed information, while management accounting interprets and applies that information to broader managerial problems. Neither system completely replaces the other. Together, they provide management with a comprehensive information base for improving efficiency, controlling costs, evaluating performance, and achieving the organisation’s overall objectives and profitability.

Key Differences between Cost Accounting and Management Accounting

Basis Cost Accounting Management Accounting
Main Objective Determines and controls product costs Supports managerial planning and decisions
Primary Focus Focuses mainly on cost determination Focuses on overall business management
Scope Mainly concerned with cost information Covers financial and non financial information
Primary Users Cost managers and production managers Managers at all organisational levels
Nature Mainly cost oriented and analytical Broad, analytical, and decision oriented
Main Function Cost ascertainment and cost control Planning, control, and decision making
Information Used Mainly uses detailed cost data Uses cost and financial information
Decision Support Provides limited decision making information Provides comprehensive decision making information
Techniques Standard costing and cost classification Budgeting, ratio analysis, and marginal costing
Time Perspective Mainly focuses on current and past costs Focuses on past, present, and future
Reporting Provides detailed cost reports Provides various managerial reports
Legal Requirement Generally not universally mandatory Generally not legally mandatory
Coverage Covers production and operational costs Covers the entire organisation
Main Output Cost sheets and cost reports Management reports and analytical statements
Overall Purpose Improves cost efficiency and control Improves overall managerial effectiveness
Management Notes

Role and Functions of Management Accountant

indiafreenotesby indiafreenotes1

Management Accounting refers to the process of identifying, measuring, analyzing, interpreting, and communicating financial and non-financial information to managers for informed decision-making within an organization. Unlike financial accounting, which focuses on external reporting and statutory compliance, management accounting is forward-looking and tailored to internal users such as executives and department heads. It encompasses tools like budgeting, cost analysis, variance analysis, and performance evaluation to support planning, control, and strategic decision-making. By translating raw financial data into actionable insights, management accounting helps organizations optimize resource allocation, improve efficiency, and achieve both short-term operational goals and long-term strategic objectives across industries worldwide.

Role of Management Accountant:

1. Planning and Forecasting

The management accountant plays an important role in organisational planning and forecasting. They analyse past financial information, current business conditions, and expected future trends to help management prepare realistic plans. They assist in preparing budgets, sales forecasts, production plans, cash flow estimates, and financial projections. By providing relevant accounting information, they help managers set objectives and determine the resources required to achieve them. Management accountants also compare actual results with planned results and identify deviations. Their forecasts help management anticipate future opportunities and challenges. Thus, planning and forecasting enable an organisation to use its resources effectively and achieve its long term goals.

2. Decision Making

Management accountants provide useful financial information to managers for making important business decisions. They analyse costs, revenues, profits, investments, and alternative courses of action. Their reports help management decide matters such as pricing, product selection, make or buy decisions, expansion, discontinuing a product, and resource allocation. They also apply techniques such as marginal costing, cost benefit analysis, and relevant cost analysis. By presenting accurate and timely information, management accountants reduce uncertainty and help managers choose the most suitable alternative. Therefore, the management accountant acts as an important source of financial advice and supports management in making rational and profitable business decisions.

3. Cost Control

Cost control is an important responsibility of the management accountant. They collect and analyse information relating to material, labour, production, administration, and other business costs. They compare actual costs with predetermined standards and budgets to identify unnecessary expenditure and cost variations. When significant differences are found, the management accountant investigates their causes and suggests corrective measures. They may also recommend methods for reducing wastage, improving efficiency, and controlling operating expenses. Effective cost control helps an organisation increase profitability without unnecessarily affecting the quality of products or services. Thus, management accountants help management maintain costs within planned and acceptable limits.

4. Budget Preparation

The management accountant plays a key role in preparing and coordinating organisational budgets. They collect information from different departments and help prepare budgets for sales, production, purchases, labour, expenses, cash, and capital expenditure. They ensure that individual budgets are properly coordinated with the overall objectives of the organisation. After budgets are prepared, management accountants monitor actual performance against budgeted figures and report significant variances to management. They also help identify the reasons for deviations and suggest corrective actions. Budgeting enables management to plan income and expenditure, allocate resources efficiently, and maintain financial discipline. Therefore, the management accountant is central to the budgeting process.

5. Performance Evaluation

Management accountants help management evaluate the performance of departments, divisions, products, and individual responsibility centres. They prepare performance reports by comparing actual results with budgets, standards, and previous periods. They calculate and analyse various financial measures such as profitability, cost efficiency, sales performance, and return on investment. They also identify favourable and unfavourable variances and investigate their causes. This information helps managers recognise areas of good performance and areas requiring improvement. Management accountants may also suggest corrective actions to improve efficiency. Therefore, their role in performance evaluation helps management measure organisational effectiveness and ensure that employees and departments work towards common objectives.

6. Financial Analysis and Interpretation

A management accountant analyses financial and accounting information and presents it in a form that management can easily understand and use. They examine financial statements, cost reports, budgets, ratios, cash flows, and other relevant information. Through techniques such as ratio analysis, trend analysis, comparative analysis, and break even analysis, they identify important financial trends and business conditions. They interpret the results and explain their implications to managers. This helps management understand profitability, liquidity, efficiency, and financial stability. Thus, financial analysis and interpretation enable managers to make informed decisions and take appropriate actions for improving the organisation’s financial performance.

7. Internal Control

The management accountant assists in establishing and maintaining an effective system of internal control within the organisation. They help develop procedures for safeguarding assets, preventing errors, controlling costs, and ensuring the accuracy of accounting records. They review financial and operational information to identify weaknesses, irregularities, and inefficiencies. Management accountants may also coordinate with internal auditors and other departments to improve control procedures. Effective internal control reduces the risk of fraud, misuse of resources, and financial errors. It also promotes accountability among employees. Therefore, the management accountant contributes significantly to protecting organisational resources and maintaining reliable financial information.

8. Providing Information to Management

One of the most important roles of a management accountant is to provide timely, relevant, and accurate information to management. They prepare various reports relating to costs, budgets, profits, sales, cash flows, performance, and financial conditions. The information is presented according to the needs of different levels of management. Management accountants also explain financial results and highlight important issues requiring managerial attention. Such information helps managers in planning, controlling operations, evaluating performance, and making decisions. Since managerial decisions depend greatly on the quality of available information, the management accountant acts as an important link between accounting information and effective management.

Functions of Management Accountant:

1. Planning

Planning is a primary function of the management accountant. They assist in formulating short-term and long-term plans by translating organizational objectives into financial terms. They prepare forecasts, budgets, and feasibility studies, analyzing historical data, market trends, and resource availability to estimate future revenues, costs, and cash flows. This helps management set realistic targets and choose among alternatives. They also update plans as conditions change, ensuring flexibility. By linking strategy with numbers, they provide a roadmap for action. This function ensures resources are allocated efficiently and activities are coordinated toward common goals, reducing uncertainty and supporting sustainable growth.

2. Controlling

Controlling involves monitoring actual performance against predetermined standards, budgets, and plans. Management accountants collect actual data, compare it with targets, and calculate variances. They analyze favorable and unfavorable deviations to identify causes such as inefficiency, price changes, or inaccurate estimates. They report findings to managers and recommend corrective actions. This function also includes designing internal controls to safeguard assets and ensure compliance. Through continuous monitoring, management accountants help keep operations on track, prevent waste, and maintain financial discipline. Effective controlling ensures that organizational activities remain aligned with strategic objectives and that corrective measures are taken promptly.

3. Decision-Making

Management accountants support decision-making by providing relevant, timely, and accurate information. They perform techniques such as cost-volume-profit analysis, incremental analysis, capital budgeting, and sensitivity analysis. They evaluate alternatives for pricing, outsourcing, investment, product mix, and discontinuation. They quantify financial impacts and consider qualitative factors like risk and strategic fit. By presenting clear recommendations, they help managers choose the most beneficial course of action. This function is forward-looking and involves scenario modeling. It reduces uncertainty and improves the quality of managerial judgments. Ultimately, it helps maximize profitability, liquidity, and long-term value.

4. Reporting

Reporting is a core function of the management accountant. They prepare internal reports such as performance reports, variance analyses, cost sheets, budgets, forecasts, and dashboards. These reports are tailored to managers’ needs and emphasize relevance, timeliness, and clarity rather than regulatory formats. They present financial and non-financial information in an understandable manner. Regular reporting keeps management informed about progress, problems, and opportunities. It supports coordination among departments and enables timely intervention. Management accountants also ensure reports are accurate, reliable, and comparable. Effective reporting facilitates transparency, accountability, and informed decision-making throughout the organization.

5. Interpreting Financial Information

Management accountants interpret financial data and translate it into meaningful insights for non-financial managers. They explain ratios, trends, variances, and relationships in simple language. They highlight key issues, risks, and opportunities hidden in the numbers. This function bridges the gap between accounting records and managerial action. They also advise on the financial implications of operational decisions. By providing context and analysis, they help managers understand performance and take corrective steps. Interpretation goes beyond presenting figures; it involves drawing conclusions and recommending actions. It enhances financial literacy across the organization and supports effective planning, control, and decision-making.

6. Cost Accounting and Control

Management accountants determine and control costs of products, services, activities, and processes. They use methods like job costing, process costing, standard costing, and activity-based costing. They analyze cost behavior, cost drivers, and cost variances. This function helps in pricing, profitability analysis, and efficiency improvement. They identify waste, non-value-added activities, and opportunities for cost reduction without sacrificing quality. They also prepare cost estimates for new products and contracts. Continuous cost control protects margins and enhances competitiveness. By providing accurate cost information, they support operational and strategic decisions.

7. Budgeting

Budgeting is the process of preparing financial plans for a specific period. Management accountants coordinate budget preparation across departments, set targets, and consolidate estimates into master budgets. They ensure budgets align with strategic goals and resource constraints. They also monitor budget execution, analyze variances, and recommend revisions. Budgets serve as tools for planning, coordination, control, and performance evaluation. Management accountants educate managers on budgetary procedures and promote participation. They help balance aspirations with realities. Effective budgeting improves resource allocation, accountability, and financial discipline. It also provides a benchmark for measuring actual performance.

8. Performance Evaluation

Management accountants design and operate performance measurement systems. They use financial and non-financial indicators such as profit, ROI, productivity, quality, and customer satisfaction. They compare actual results with budgets, standards, and benchmarks. They prepare divisional, departmental, and managerial performance reports. This function identifies strengths, weaknesses, and areas for improvement. It supports accountability, motivation, and reward systems. They also use balanced scorecards and key performance indicators. By evaluating performance objectively, they help management link operations to strategy. It encourages continuous improvement and efficient use of resources.

Management Notes

Financial Trend Analysis

indiafreenotesby indiafreenotes4

Trend analysis is a technique employed by technical analyst in the financial industry to predict the future movements of a given asset. They employ historical data to determine the direction of the trend. The goal of this procedure is to identify attractive investment opportunities that are currently showing an upward trend; and of course, to identify downtrends too, so investors can get out before losing money.

Perhaps one of the disadvantages of trend analysis is that past behavior is not always consistent in the future, in other words, whatever the price of a given security did in the past is not necessary an indication of what it will do in the future because there are a lot of other significant elements that come into play when it comes to determining the value a financial security.

Trend analysis involves the collection of information from multiple time periods and plotting the information on a horizontal line for further review. The intent of this analysis is to spot actionable patterns in the presented information. In business, trend analysis is typically used in two ways, which are as follows:

  • Revenue and cost analysis: Revenue and cost information from a company’s income statement can be arranged on a trend line for multiple reporting periods and examined for trends and inconsistencies. For example, a sudden spike in expense in one period followed by a sharp decline in the next period can indicate that an expense was booked twice in the first month. Thus, trend analysis is quite useful for examining preliminary financial statements for inaccuracies, to see if adjustments should be made before the statements are released for general use.
  • Investment analysis. An investor can create a trend line of historical share prices and use this information to predict future changes in the price of a stock. The trend line can be associated with other information for which a cause-and-effect relationship may exist, to see if the causal relationship can be used as a predictor of future stock prices. Trend analysis can also be used for the entire stock market, to detect signs of an impending change from a bull to a bear market, or the reverse. The logic behind this analysis is that moving with a trend is more likely to generate profits for an investor.

When used internally (the revenue and cost analysis function), trend analysis is one of the most useful management tools available. The following are examples of this type of usage:

  • Examine revenue patterns to see if sales are declining for certain products, customers, or sales regions.
  • Examine expense report claims for evidence of fraudulent claims.
  • Examine expense line items to see if there are any unusual expenditures in a reporting period that require additional investigation.
  • Extend revenue and expense line items into the future for budgeting purposes, to estimate future results.

When trend analysis is being used to predict the future, keep in mind that the factors formerly impacting a data point may no longer be doing so to the same extent. This means that an extrapolation of a historical time series will not necessarily yield a valid prediction of the future. Thus, a considerable amount of additional research should accompany trend analysis when using it to make predictions.

Advantages of Trend Analysis:

(a) Possibility of making Inter-firm Comparison:

Trend analysis helps the analyst to make a proper comparison between the two or more firms over a period of time. It can also be compared with industry average. That is, it helps to understand the strength or weakness of a particular firm in comparison with other related firm in the industry.

(b) Usefulness:

Trend analysis (in terms of percentage) is found to be more effective in comparison with the absolutes figures/data on the basis of which the management can take the decisions.

(c) Useful for Comparative Analysis:

Trend analyses is very useful for comparative analysis of date in order to measure the financial performances of firm over a period of time and which helps the management to take decisions for the future i.e. it helps to predict the future.

(d) Measuring Liquidity and Solvency:

Trend analysis helps the analyst/and the management to understand the short-term liquidity position as well as the long-term solvency position of a firm over the years with the help of related financial Trend ratios.

(e) Measuring Profitability Position:

Trend analysis also helps to measure the profitability positions of an enterprise or a firm over the years with the help of some related financial trend ratios (e.g. Operating Ratio, Net Profit Ratio, Gross Profit Ratio etc.).

Disadvantages of Trend Analysis:

(a) Selection of Base Year:

It is not so easy to select the base year. Usually, a normal year is taken as the base year. But it is very difficult to select such a base year for the propose of ascertaining the trend. Otherwise, comparison or trend analyses will be of no value.

(b) Consistency:

It is also very difficult to follow a consistent accounting principle and policy particularly when the trends of business accounting are constantly changing.

(c) Useless in Inflationary Situations:

Analysis of trend percentage is useless at the time of price-level change (i.e. in inflation). Trends of data which are taken for comparison will present a misleading result.

Types of trend

Uptrend

It is the trend when financial markets and assets move in upward directions, resulting in an increase in the price. It is usually the time of boom in the economy, where overall sentiments are favorable.

Downtrend

In the downtrend or the bear market, the economy, financial markets, and assets prices move in the downward direction. It is the time when companies shrink operations and overall investor sentiment is not favorable.

Sideways / Horizontal Trend

In this, the assets prices or the broader economy-level are not moving in any direction, rather are moving sideways. This means, moving up for some time and then down on the same level.  It is a risky movement as investors are unsure of what will happen to their investment.

Management Notes

Audit of Cooperative Societies

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The co-operative societies Act,1912, a central act, contain fundamental law regarding the formation and working of co-operative societies in India and is applicable in many states with or without amendments.

Co-operative society is a business organization with a special mode of doing business , by pulling together all the means of production co-operatively, eliminating the middlemen and exploitation from outside force.

Any ten persons who are competent to enter into contract may make an application to the Registrar of Co-operative Societies as per section 6 of the Co-operative Societies Act, 1912. By-laws may be framed by each society and should be registered with Co-operative Societies. Effectiveness of change in by-laws of societies is applicable only when changes are approved by Registrar of Societies. There are two types of society’s, limited liabilities and un-limited liabilities societies. Any member is not liable to pay more than the nominal value of share held by them and no member can own more than 20% of shares of societies.

Government is encouraging co-operative societies to help society. Co-operative societies are operative in various sections like consumer, industrial, service, marketing, etc.

Under accounting system of Co-operative societies, the terms receipt and payment are used for two-fold aspect of double entry system.

Members are elected at the annual general meeting of the society. Day-to-day work of cooperative society is managed by the managing committee.

Audit of Co-operative Society

Let us now discuss the provisions for Audit as Per Section 17 of the Co-operative Society Act, 1912 −

The Registrar shall audit or cause to be audited by some person authorized by him by general or special order in writing on his behalf, the accounts of every registered society once at least every year.

The Audit under sub-section (1) shall include an examination of overdue debts, if any, and a valuation of the assets and liabilities of the society.

The Registrar, the Collector or any person authorized by general or special order in writing on his behalf by the Registrar, shall at all-time have access to all the books, accounts, papers and securities of a society, and every officer of the society shall furnish such information concerning the transactions and working of the society as the person making such inspection may require.

Audit as per Section 17 of the Co-operative Societies Act , 1912.

  • The registrar shall audit or cause to be audited by some person authorized by him, the accounts of every registered society at least once a year.
  • The audit under shall include an examination of overdue debts , if any, and a valuation of assts and liabilities of the society.
  • The registrar, the collector or any person authorized shall at all the times have access to all the books , accounts, papers and securities of a society, and every officer of the society shall furnish such information in regard to the transactions and working of the society as the person making such inspection may require.

REGISTRAR means a person appointed to perform the duties of registrar of co-operative societies under this act.

The following points are required to be kept in mind in connection with the audit of co-operative society:

  • Qualification of auditor: Apart from the chartered Accountant within the meaning of the Chartered Accountancy Act, 1949, some of the state co-operative Acts have permitted persons holding a government diploma in co-operative accounts or in co-operation and accountancy and also a person who has served as an auditor in the co-operative department of government to act as an auditor.
  • Appointment of the auditor: An auditor of co-operative society is appointed by the registrar of co-operative societies and the auditor so appointed conducts the audit in behalf of registrar and also submits his audit report to him as well as to the society.
  • Books, Accounts and other records of co: operative societies-under section 43(h) of the Act . a state government can frame rules prescribing the books and accounts to be kept by a co-operative society.

Special features of co-operative Audit

The general process of auditing involved in audit work such as checking of posting , ascertainment of arithmetical accuracy ,vouching , verification of assets and liabilities and final scrutiny of balance sheet are well known by everyone. But in case of co-operative society audit certain special features are there to be borne in mind while doing audit of it. These features are as follows:

  • Examination of overdue debts: Auditor shall report these overdue debts as for period from 6 months to 5 years and more than 5 years. Furthermore, analysis is done by the auditor in viewpoint of recovery of these debts and these are classified as good debt or bad debts. Now auditor is also liable to checkout whether provision regarding bad debts is provided or not and if provided then that is appropriate or not for current situation of bad debts of the society.
  • Overdue interest: Overdue interest should be excluded from interest outstanding and accrued due while calculating profit. In practice an overdue interest reserve is created and the credit of overdue interest credited to interest account is reduced.
  • Certification of bad debts: As per the law, bad debts can be written off only when they are being certified by the auditor as bad where the law requires it and if not then managing committee of society must authorize the write-off.
  • Valuation of assets and liabilities: They will have to ascertain the existence, ownership and valuation of assets. Fixed assets should be valued at cost less adequate provision for depreciation. The incidental expenses incurred in acquisition and the installation expenses of assets should be properly capitalized. The current assets be valued at cost or market price , whichever is lower. Regarding liabilities, the auditor should see that all the known liabilities are brought into the account, the contingent liabilities are stated by way of a note.
  • Adherence to co-operative principles: The auditor will have to ascertain that how far the objective for which the co-operative organization is set up , have been achieved in the course of its working. The assessment is not necessary in terms of profits, but in terms of extension of benefits to its members who have formed it. While auditing the expense, the auditor should see that they are economically incurred and no wastage of funds. The principle of propriety audit should be followed for this purpose.
  • Observations of the provisions of the act and rules: The financial implications of the infringements which are pointed out by the co-operative societies Act and rules and bye-laws, should be assessed by the auditor and they should be reported properly.
  • Verification of member’s register and examination of their pass books: Examination of the entries in member’s pass books regarding the loan given and its repayment and confirmation of loan balances in person is very much important in co-operative societies to assure that the entries in books of accounts are free from manipulation.
  • Special report to registrar: During the course of audit if the auditor notices that there is some serious irregularity then he has report this irregularity to the registrar by drawing his specific attention to the point. The registrar on receipt of such special report may take necessary action against the society.
  • Audit classification of the society: After the judgement of an overall society, the auditor has to award a class to the society. This specific class is awarded by the auditor as accordance to the criteria given by the registrar. It is to be noted that if management is not satisfied by the class given by the auditor then they may appeal to the registrar.
  • Discussion of draft audit report with managing committee: On conclusion of the audit , they should ask to the secretary of the society to convene managing committee meeting to discuss the audit draft report. The audit report should never be finalized without the discussion with the managing committee.

Form of Audit Report

The form of audit report to be submitted by the auditor, as prescribed in various states , contains a number of matters which the auditor has to state or comment upon. In addition to the report the auditor has to attach schedules to the report regarding the following Information:

  • All transactions which appears to be contrary to the provisions of the Act , the rules and bye-laws of the society.
  • All sums which ought to have been, but have not been brought into account by the society.
  • Any material, or property belonging to society which appears to the auditor to be bad or doubtful of recovery.
  • Any material, or property belonging to society which appears to the auditor to be bad or doubtful of recovery.
  • Any material irregularity or impropriety in expenditure or in the realization or monies due to society.
  • Any other matters specified by the registrar in this behalf.
Management Notes

Audit of Insurance Companies

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The Insurance auditors shall examine policy and liability procedures, risk valuation, tax documents, and various other financial records of insurance. It is to ensure that proper insurance rates and premiums are implemented and regulators laws are being followed by insurance companies. Claims and commissions are also the core areas to verify during the course of insurance audits. In addition to these responsibilities, insurance auditors might be expected to maintain quality control between insurance companies and policyholders.

An Indian insurance company is formed and registered under the Companies Act, 2013 and the aggregate holdings of equity shares by a foreign company, either by itself or through its subsidiary companies or its nominees, do not exceed twenty-six per cent of the paid-up equity capital of such Indian insurance company. The sole objects of the Indian Insurance Company shall be to carry on life insurance business or general insurance business or re-insurance business. The said definition is according to section 2 of Insurance Act 1938.

The Insurance Audit & Role of Insurance Auditors

As per Section 12 of the Insurance Act, 1938, the financial statements of every insurer are required to be audited annually by an auditor. According to IRDA Act, 1999, every insurer, in respect of insurance business transacted by him and in respect of his shareholders ‘funds, should prepare, a Balance Sheet, a Profit and Loss Account, a separate Account of Receipts and Payments and a Revenue Account in accordance with the regulations made by the IRDA at the end of each financial year.

The central and branch auditors of an insurance company are appointed at the annual general meeting of the company and the approval of the C & AG required before the appointment is made. With the latest amendment to the Insurance Act, 1938 and the Companies Act, 2013, Authority (IRDAI) has issued the revised guidelines that Insurers shall comply with the provisions relating to appointment of Auditors as contained in the Companies Act, 2013. Additionally, insurers shall also comply with the provisions contained in such guidelines. Further the recommendation of the Audit Committee, the Board shall appoint the statutory auditors, subject to the shareholders’ approval at the general meeting of an Indian insurance company. The branch auditors is appointed to conduct the audit of the divisions have the same rights and obligations under the statute as those of the, statutory auditors to whom they are expected to submit their report. However the branch auditors at division level certified the Trial balance of the division duly incorporated the financial statements of the branches under divisions.

An insurer cannot remove its statutory auditor without the prior approval of the Authority. An audit firm cannot accept the audits of more than three insurers (Life/Nonlife/Health /Reinsurer) at a time. The appointment can be cancelled if found that the appointment of auditors by insurers is not in line with the guidelines.

Four Important Audit Points in Insurance Company Profit & Loss Account

  1. Verification of Premium

The premium collections are credited to a separate bank account and no withdrawals are normally permitted from that account for meeting the general expenditure. As per the policy of the insurance company, the collections are transferred to the Regional Office or Head Office. No Risk shall be assumed by the insurer without receipt of premium according to section 64VB of the Insurance Act, 1938. Verification of premium is of utmost importance to an auditor because Insurance premium is collected upon issuing policies. It is the consideration for bearing the risk by the insurance company. The auditor should apply the following procedures: –

  • Before commencing verification of premium income, the auditor should look into the internal controls and compliance which are laid down for collection and recording of the premiums.
  • Cover notes should be serially numbered
  • The auditor should check whether Premium Registers have been maintained chronologically, giving full particulars including GST charged as per acceptance advice on a day -to-day basis.
  • The auditor should verify whether the figures of premium mentioned in the register tally with those in General Ledger.
  • The auditor should verify whether instalments falling due on or before the balance sheet date, whether received or not, have been accounted for as premium income as for the year under audit.

  1. Verification of Claims

The auditor should obtain from the divisions/branches, the information for each class of business. The auditor should determine the total number of documents to be checked giving due importance to claim provisions of higher value. The claims under policies comprise the claims paid for losses incurred, and those estimated or anticipated claims pending settlements under the policies. Settlement cost of claims includes surveyor fee, legal expenses, etc. The Claim Account is debited with all the payments including repair charges, fire fighting expenses, police report fees, survey fees, amount decreed by the Courts, travel expenses, photograph charges, etc. The auditor should-

  • Check whether provision has been made for all unsettled claims.
  • Check whether provision has been made for only such claims for which the company is legally liable.
  • Check whether provision made is normally not in excess of the amount insured.
  • Check in case of co-insurance arrangements, the company has made provisions only in respect of its own share of anticipated liability.
  • Check claimed paid should be duly sanctioned by the authority concerned

  1. Verification of Commission

The remuneration of an agent is paid by way of commission which is calculated by applying a percentage to the premium collected by him. Commission is payable to the agents for the business procured and is debited to Commission on Direct Business Account. An insurance business is solicited by insurance agents. The auditor should verify-

  • Voucher disbursement entries with reference to the disbursement vouchers with copies of commission bills and commission statements.
  • Check whether the vouchers are authorized by the officers- in –charge as per rules and income tax is deducted at source, as applicable.
  • Test check correctness of amounts of commission allowed.
  • To check whether commission outgo for the period under audit been duly accounted or not.

  1. Verification of Operating Expenses

All the administrative expenses in an insurance company are broadly classified under 13 heads as mentioned in Schedule IV. The auditor should check-

  • Expenses in excess of Rs.5 Lakhs or 1% of net premium, whichever is higher, should be shown separately.
  • Expenses not directly relating to insurance business should be shown separately for example, expenses relating to investment department, bank charges etc.
Management Notes

Audit of Educational Institutions

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Maintenance of Accounts of Educational Institutions

A large number of educational institutions are registered under the India Society Registration Act, 1860. The purpose behind the formation of educational institutions is to spread education and not just earn profits. The following table lists out the sources for collection of amount and also the different types of expenses incurred by the educational institutions:

Main Source of Collection

  • Admission fees, tuition fees, examination fees, fines, etc.
  • Securities from students.
  • Donations from public
  • Grants from Government for building, prizes, maintenance, etc.

Types of Expenses / Payments

  • Salary, allowances and provident fund contribution for teaching and non-teaching staff.
  • Examination expenses
  • Stationery & printing expenses
  • Distribution of scholarships and stipends
  • Purchase and repair of furniture & fixture
  • Prizes
  • Expenses on sports and games
  • Festival and function expenses
  • Library books
  • Newspaper and magazines
  • Medical expenses
  • Audit fees and audit expenses
  • Electricity expenses
  • Telephone expenses
  • Laboratory running & maintenance
  • Laboratory equipment
  • Building Repair & maintenance

Preliminary Audit of Educational Institutions

Following points need to be considered by an Auditor while conducting audit of educational institutions:

  • It is to be confirmed whether the letter of his appointment (the Auditor’s) is in order.
  • The Auditor should obtain a list of books, documents, register and other records as maintained by the educational institutions.
  • He should examine the audit report of last year and should note down the observation and qualification, if any.
  • He should note down the important provisions regarding to accounts and audit from the Trust Deed, Charter of Regulations.
  • He should examine the Minutes of Meetings of the Board of Trustee or the Governing Body for important decisions regarding the sale or purchase of fixed assets, investments or delegation of finance power.
  • In case of colleges and university, the Grants Commission provides Grants to them subject to certain conditions. The Auditor should study all the conditions concerning grants.
  • The Auditor should examine the Code of State regarding grant-in-aid.
  • He should be aware of all the provisions and rules of related laws concerning books of account and audit.

Internal Control System

The Auditor should independently check the internal control system regarding authorization procedures, record maintenance, safeguarding of assets, rotation and division of staff duty, etc. Following are some of the important aspects that need to be considered by an Auditor to keep a check on the internal control system −

  • Whether internal control and internal check system is working, if yes, how effectively.
  • Is there is any system to physically verify the fixed assets, stores and consumables at regular interval.
  • An Auditor should verify the control system concerning proper authorization, obtaining quotations, proper maintenance of accounts and record regarding purchase of fixed assets, purchase of material, investment, etc.
  • Whether bank reconciliation statement is prepared at regular intervals and what kind of action is taken for uncleared cheque which were pending since long.
  • Whether waiver of fees is properly sanctioned by appropriate authorities.
  • The person who is collecting fees and the cashier should not be the same person.
  • Class wise fees receivable and the actual fees received reconcile or not.
  • Whether collected fees is deposited in bank on a daily basis.
  • Fees collection register should be maintained on a daily basis.
  • Whether approved list of supplier of sports material, stationery, lab items are readily available.
  • Whether control system for payment is adequate or not.
  • The system of letting out conference hall and class rooms, etc. for seminars and conventions.
  • Whether fees structure is properly authorized along with change in fee structure if any.

Audit of Assets and Liabilities

The following points need to be considered while conducting an audit of Assets and Liabilities −

  • Verification of Assets register should be done considering grants on purchase of assets, if any received from State Government/ University Grant Commission (UGC).
  • Verification of depreciation is very important; it should be according to useful life of assets or as per the Companies Act, whichever is applicable.
  • If educational institution is running under Indian Public Trust Act, it is must for an Auditor to check, where investments have been made, because as per the Indian Public Trust Act, investment can be made in specific securities only.
  • If donation is received in the form of investment, an Auditor has to check all related correspondence with the donor.
  • All the applicable requirements of law should be fulfilled for the purchase of investments and fixed assets.
  • An Auditor should read and note down the state code and provisions relating to the conditions and procedures of Grants. He should also verify the requirements of State/UGC which are to be fulfilled by educational institutions for receiving Grants and also for continuations of Grants.

Audit of Income of Educational Institutions

The following points need to be considered by an Auditor while conducting audit of the Income of Educational Institutions:

  • Fees and charges received on account of admission fees, tuition fees, sports fees, examination fees etc. should be verified based on the approved fees structure.
  • Verification of counterfoil copies of fees receipt with fees received register should be done.
  • Prescribed conditions by the State Government and the University Grants Commission should be verified whether fulfilled or not.
  • Cash book should be verified with counterfoil of receipt book and fees register.
  • Fees receivable and actual fees received should be reconciled.
  • Charges and fees received and receivable should be examined on account of hostel accommodation, mess, housekeeping and clothing, etc.
  • Cash book should be verified with the donation received register.
  • Donation received should be accounted for according to the nature of donation means careful distinction should be there for revenue nature donation and capital nature donations; the same procedure is to be followed for Grants received.
  • The purpose and utilization of grant should be same.
  • Investment register and cash book should be verified for income received on account of interest on investment and dividends, etc.

Audit of Expenses of Educational Institutions

The following points need to be considered by an Auditor while conducting audit of Expenses of Educational Institutions:

  • Electricity expenses, telephone expenses, water charges, stationery and printing, purchase of sports items should be properly verified with quotation, purchase bills, inward register and Bills received from service providers, etc. All purchases should be authorized by appropriate person.
  • In case where hostels purchase food items, provisions, clothing, etc. should be properly verified.
  • Verification of Tax Deducted at Source, Employee State Insurance and Provident Fund should be checked. It is also very important that all deducted amount should be deposited in appropriate Government accounts well within time without any default. These can be verified from relevant bank challans.
  • Payment made on account of salary should be verified from terms of appointment and increment policy. Auditor should verify the computation of salary and check whether all required deductions are made out of it or not like advance salary, loan installment, absence from duty, ESI (Employee State Insurance), PF (Provident Fund), etc. The Net Salary Payable amount will be verified from cash book and bank pass book for salary paid.
  • Terms and conditions, cash book, voucher and receipts should be the basis for the verification of scholarship paid.
  • Appropriate provision should be made on account of outstanding payments.
Management Notes

Professional Ethics of an Auditor

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Professional ethics refers to the professionally accepted standards of personal and business behavior, values, and guiding principles.

It encompasses the personal, organizational, and corporate standards of behavior expected of professionals.

Professionals and those working in acknowledged professions, exercise specialist knowledge, and skill.

How the use of this knowledge should be governed when providing a service to the public can be considered a moral issue and is termed professional ethics.

Professionals are capable of making judgments, applying their skills, and reaching informed decisions in situations that the general public cannot because they have not received the relevant training.

Codes of professional ethics are often established by professional organizations to help guide members in performing their job functions according to sound and consistent ethical principles.

Objectives of Professional Ethics

Professional accountants play an important role in building up the economic well­being of their community and country with their attitude, behavior, and unique services.

They have common objectives, whether they work in capacities of external auditors, internal auditors, financial experts, tax experts, and management accountants.

Their common objectives are to perform their duties and responsibilities and to attain the highest levels of performance by the ethical requirements generally to meet the public interest and maintain the reputation of the accounting profession.

Personal self-interest must not prevail over these duties. The IFAC and ICAEW Codes of Ethics help accountants to meet these obligations by setting out ethical guidance to be followed.

To achieve these objectives, they have to establish creditability, professionalism, quality of service, and confidence.

Acting in the public interest involves having regard to the legitimate interests of clients, government, financial institutions, employees, investors, the business and financial community, and others who rely upon the objectivity and integrity of the accounting profession to support the dignity and orderly functioning of commerce.

In summary, then, the key reason accountants need to have an ethical code is that people rely on them and their expertise. It is important to note that this reliance extends beyond clients to the general community.

Accountants deal with a range of issues on behalf of clients. They often have access to confidential and sensitive information.

Auditors claim to give an independent view. It is, therefore, critical that accountants are independent.

Compliance with a shared set of ethical guidelines gives protection to accountants as well, as they cannot be accused of behaving differently from other accountants.

Codes of Professional Ethics

Here we will describe the two well-known codes of professional ethics;

  • IFAC code of ethics for professional accountants,
  • AICPA code of professional conduct.

IFAC Code of Ethics for Professional Accountants

A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest.

In acting in the public interest, a professional accountant should observe and comply with the ethical requirements of this Code.

A professional accountant is required to comply with the following fundamental principles:

  1. Integrity

A professional accountant should be straightforward and honest in all professional and business relationships.

  1. Objectivity

A professional accountant should not allow bias, conflict of interest or undue influence of others to override professional or business judgments.

  1. Professional Competence and Due Care

A professional accountant has a continuing duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation, and techniques.

Professional accountants should act diligently and by applicable technical and professional standards when providing professional services.

  1. Confidentiality

A professional accountant should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose.

Confidential information acquired as a result of professional and business relationships should not be used for the personal advantage of the professional accountant or third parties.

  1. Professional Behavior

A professional accountant should comply with relevant laws and regulations and should avoid any action that discredits the profession.

Management Notes

Company Auditor: Qualification, Qualities and Duties

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Cost accounting is the accounting method for ensuring cost-effectiveness by accumulating, organising, recording, calculating, analysing and assessing the overall expenses incurred on a product, process or project, etc. It is mostly used in industrial units or factories where the goods are manufactured.

Unlike financial accounting, cost accounting is a broader perspective to review and control the performance of the industries by the management. To know more about the different types of expenses incurred in operating a business, one must be aware of the cost classification.

Qualification of an Auditor

According to law, no specific qualification is recommended for the auditor in case of the proprietary concern, but in the case of the companies, the following qualification is must:

  • A chartered accountant, having a certificate of practice from the institute of chartered accountants of India.
  • A person, having an authentication in “Part B” stating that he designated to act as an auditor.

Qualities of a Company Auditor

  1. Sovereignty

He should not aide his intuition to the will of his clients or any other person and should keep himself free from any sympathy allegedly and prepare financial statement of the management in an impartial way.

  1. Honesty

He should always maintain sincerity while operating his duties.

  1. Conversation skills

In the course of managing an audit, the auditor has to collaborate with numerous officers and parties; thus, he should have excellent communication skill.

  1. Maintain confidentiality

The auditor should maintain the privacy of the accounts unless authorized by the client or enforced by the law.

  1. Expertise

The auditor must have an awareness about the client’s business and the current economic direction, etc. Consciousness about the laws like taxation laws, companies act, partnership act.

  1. Sensitivity

The auditor has to deal with different persons while performing his duties; he has to handle his sub-ordinates as well as clients; thus, he should have the tact to handle them in any situations.

  1. Coherent skills

The auditor must have the ability to analyze and illustrate the problems so that he can appropriately handle them when faced.

Responsibilities of an Auditor

  • Examination: Interrogation of the accounting system and internal control is must to safeguard their suitability.
  • Checking of books: The books of accounts should be checked thoroughly to ensure its arithmetical accuracy.
  • Documentation: Investigating documentary pieces of evidence to reinforce the books of accounts.
  • Full incorporation: Analyzing whether all entries have been recorded in the books of accounts or not while preparing the financial statement.
  • Conventionality: Examining that the books of accounts or financial statement should not contain any fraudulent or faulty entry.
  • Authentication of assets and liabilities: Verification of assets and liabilities for checking their existence, valuation, completeness and disclosure in financial statements.
  • Statutory Consent: In case of audit of general insurance companies, bank the auditor, secure compliance of financial statements with the compatible decree.
  • Disclosure: Auditor examines whether the data in the financial statement acknowledged adequately or not.
  • Facts and integrity: Auditor ensure whether financial statement as a whole serves accurate and fair view of profit/loss, assets and liabilities in the appropriate forms.

Duties of an Auditor

Duties of Company Auditor

Duty under Section 227: It is otherwise known as the duty to give report. After completion of audit work, the auditor should give a report expressing his opinion. The report may be long or summarized. It may be in the form of a letter or statement. Whatever the form may be, it must be addressed to shareholders. And its report may be with condition or without condition. An unconditional report is called a clean report and a conditional report is called a qualified report.

The audit report should include the following:

  • Whether the company is maintaining proper books and records or not.
  • Whether financial explanations from company staff are received or not.
  • Whether financial statements are prepared in accordance with the requirements of companies act or not.
  • Whether the balance sheet is giving a true and fair view or not.
  • Whether profit and loss account is giving a true and fair view or not.
  • If there are branches, whether statements from branch auditors under Sec. 228 are properly received or not.

Duties of Company Auditor: The Companies Act, 1956

  • Section 227: Duty to give report.
  • Section 165: Duty to certify statutory report.
  • Section 240: Duty to assist government inspector.
  • Section 58 (A) and 58 (B): Duty with regard to public deposits.
  • Section 62 and 63: Duty to certify prospectus.
  • Section 227 (1A): Duty to conduct an inquiry with regard to matters mention in the section.
Management Notes

Company Auditor Appointment

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The new regime of Companies Act 2013 has changed the requirement for appointment of the auditor in Companies. There has been a paradigm shift in the provisions relating to appointment of Statutory Auditor. This article broadly covers the provisional requirement for appointment of the auditor under Companies Act, 2013. The responsibility of evaluating the validity and reliability of financial statements is to the auditors.

It involves an intelligent scrutiny of the books of account of a Company with reference to documents, vouchers and other relevant records to ensure that the entries made therein giving a clean and clear picture of the business. Hence, the need to appoint Statutory Auditor arises.

Appointment of First Auditor of of Company Auditor under Companies Act, 2013

As per section 139(6) the first auditor of the company other than a government company shall be appointed by the Board within 30 days of Incorporation. In case of Board’s failure, an EGM shall be called within 90 days to appoint the first auditor. The law is silent regarding from when this time limit of 90 days be reckoned, it is better to take a stricter view and interpret that the 90 days limit starts from Incorporation rather than expiry of 30 days.

In case of Government Companies the first auditor shall be appointed by the Comptroller and Auditor-General of India within sixty days from the date of registration of the company and in case the Comptroller and Auditor-General of India does not appoint such auditor within the said period, the Board of Directors of the company shall appoint such auditor within the next thirty days; and in the case of failure of the Board to appoint such auditor within the next thirty days, it shall inform the members of the company who shall appoint such auditor within the sixty days at an extraordinary general meeting

The first auditor shall hold office till the conclusion of 1st Annual General Meeting.

Appointment of Subsequent Auditor of Company Auditor under Companies Act, 2013

Every company shall, at the first annual general meeting, appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the conclusion of its sixth annual general meeting and thereafter till the conclusion of every sixth meeting.

Tenure of Auditors appointed under Companies Act, 2013

The following class of Companies shall not appoint or reappoint:

(a) An individual as auditor for more than one term of five consecutive years; and

(b) An audit firm as auditor for more than two terms of five consecutive years:

The class of companies shall mean the following classes of companies excluding one person companies and small companies:

(a) All unlisted public companies having paid up share capital of rupees ten crore or more;

(b) All private limited companies having paid up share capital of rupees twenty crore or more;

(c) All companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees fifty crores or more.

Purpose for the appointment of the Auditor

The purpose of the auditors in the company is to protect the interests of the shareholders. The auditor is obligated by law to examine the accounts maintained by the directors and inform them of the true financial position of the company. Auditor gives his independent opinion to the owners or shareholders of the company to protect and keep the company in a safe financial condition.

Appointment Of Auditor Other Than Retiring Auditor By A Special Notice

Where a person other than the retiring auditor is proposed to be appointed as an auditor, or where it is proposed that the retiring auditor shall not be re-appointed, a special notice under Section 115 of the companies Act, 2013 has to be given proposing that such a resolution would be moved at the next annual general meeting.

In case where the retiring auditor has completed a consecutive tenure of five years or, as the case may be – ten years then such special notice can be avoided.

For the purpose of special notice the relevant points are as under:

If the auditor makes a representation in writing to the company and requests for a notification to the members, the company shall

  • State the fact of representation in any notice regarding the resolution
  • The copy of representation should be sent to those members by the company to whom notice of meeting is sent, whether before or after the receipt of representation.
  • If the copy of representation is not so sent, copy thereof should be filed with the Registrar.

(ii) On receipt of the special notice for removing the auditor, the company should send a copy of the same to the retiring auditor.

(iii) Such representation should be of a reasonable length and not too long.

(iv) The special notice should not be received by the company too late for the purpose of circulation to members.

Auditor may require the company to read out the representation in the meeting if it is not so notified to members because it was too late or because of company’s default.

If the Tribunal is satisfied that the rights are being abused by the auditor based on an application either of the company or of any other aggrieved person, then:

  • The copy of the representation may not be sent, and
  • The representation need not be read out at the meeting.
Management Notes

Contingent Liabilities

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Contingent liabilities are liabilities that may be incurred by an entity depending on the outcome of an uncertain future event such as the outcome of a pending lawsuit. These liabilities are not recorded in a company’s accounts and shown in the balance sheet when both probable and reasonably estimable as ‘contingency’ or ‘worst case’ financial outcome. A footnote to the balance sheet may describe the nature and extent of the contingent liabilities. The likelihood of loss is described as probable, reasonably possible, or remote. The ability to estimate a loss is described as known, reasonably estimable, or not reasonably estimable. It may or may not occur.

Before understanding contingent liabilities, one must learn about what is considered as a liability in the accounting and economic context. A liability is any financial event that poses as an obligation to a company, and the company needs to make a monetary settlement regarding it in the future. In other words, it refers to the financial obligations of a company.

These events need to be quantified into monetary terms to be recorded in the books of a company.

Majorly, liabilities are categorised into three subtypes i.e non-current liabilities, current liabilities, and contingent liabilities. A contingent liability is thus a type of financial event that might or might not evolve into an obligation in the future for the company. As per the definition provided by General Accepted Accounting Standards (GAAP), a contingent liability is any potential future expense that depends on a “triggering event” to convert it into an actual loss. A contingent liabilities example is a lawsuit.

As the concept of contingent liability borders on vagueness and considerations regarding which event is recognisable as a potential expense are unclear, there are two yardsticks to follow when dealing with a contingent liability:

  • Whether an event is 50% or more likely to occur in the future.
  • Whether it can be expressed in monetary figures.

If any contingency satisfies these two yardsticks, such an event can be posted in the books. A contingent liability is recorded first as an expense in the Profit & Loss Account and then on the liabilities side in the Balance sheet.

Types of Contingent Liabilities

Contingent liabilities are classified based on the scale of their probability, i.e. likeliness of an event occurring in the future. These types are mentioned below.

  1. Probable contingency

Any financial obligation that has at least 50% chance of occurring in the future is considered a probable contingency, and the loss thus to be realised is considered as a probable contingent liability.

For instance, if a company faces a lawsuit where the plaintiff poses a strong case, then such an event can be considered as a probable contingency. A professional such as a legal counsel will assess the weight of a lawsuit, derive its probability, and if chances of a loss are 50% or higher then express the loss in monetary terms. Following that, it shall be recorded in the books of the company.

Here, it is essential to note why a contingency is recorded in the books even when there is only a 50% chance of a liability arising. It is because, in accountancy, law of conservatism is followed which states the principle that loss is always impending and thus, shall be recorded at a 50% or higher probability of occurrence; whereas profits are unlikely and hence, recording them in the books shall be withheld till profit realisation, or chances are more likely than a loss.

  1. Possible contingency

A possible contingency is when a liability might or might not arise, but chances of its occurrence are less likely than that of a probable contingency, i.e. lower than 50%. Therefore, a possible contingency is usually not recorded in the books, but rather mentioned in the footnotes.

Another reason behind why a possible contingency is not recorded in the books is because it cannot be expressed in monetary terms due to its limited likeliness of occurrence. As mentioned earlier, any contingency that does not satisfy the two yardsticks shall not be recorded in the books of a company.

  1. Remote contingency

As the name suggests, any liability that has minimal chances of occurring and is not possible under normal circumstances is known as a remote contingency. As chances of such contingencies translating to losses for the company are negligible, they are not recorded in the books or mentioned in footnotes.

How to Recognise a Contingent Liability?

Contingent liability has a broad definition, and it is challenging for companies to either rule out or include a contingent liability in their books.

Hence, it is always advisable that companies shall consult professionals who are reasonably adept in the subject matter. This way, companies abide by the rules of GAAP and also possess a substantial argument when being audited.

For instance, if a company faces litigation, it shall consult a lawyer and rely upon his/her discretion regarding inclusion or exclusion of a liability in the books.

Like, if as per precedent and the discretion of a lawyer, a case’s outcome is deemed as ambiguous, then such contingency shall only be mentioned in the footnotes. In this manner, companies shall navigate the vagaries of contingent liabilities.

How Does Contingent Liability Affect Investors?

When a company can recognise in time the possibility of a loss, it then has the opportunity to set up provisions against such losses, thus attempting to attenuate the impact of such future loss. However, that is not the motive behind the recording of a contingency as a liability in the books.

Rather, when a contingent liability is recorded in the books of a company, that information becomes available to the shareholders and auditors as well. Hence, it can be construed that registering a contingent liability is to safeguard shareholders against probable losses.

Even though cases such as lawsuits can be closely followed by shareholders of a company, information regarding warranty, which is also a form of a contingent liability, is not easily accessible by shareholders.

Therefore, to safeguard investors’ interests, probable contingent liabilities (chances of occurrence of at least 50%) of all kinds shall be recorded in a company’s books. It allows individuals to make sound investment decisions.

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