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AUDIT OF LEDGERS
Unit Structure
1.0 Objective
1.1 Steps Involved in the Audit of Ledgers
1.2 Audit of Bought Ledger
1.3 Audit of Sales Ledger
1.4 General Ledger
1.5 Practical Illustrations
1.6 Audit of Main Journal
1.7 Balance Sheet Audit
1.8 Summing Up
1.9 Questions for Exercise

1.0 OBJECTIVES

After studying the unit the students will be able:

 To Provide Classified Financial Information
 To Provide Check On Arithmetical Accuracy
 To Help Ascertain Profit Or Loss
 To Help Study The Financial Position

1.1 STEPS INVOLVED IN THE AUDIT OF LEDGERS

The audit of ledgers normally involves the following steps:

(i) Internal check - Test the quality of internal check-regarding

timely and correct entries in the ledger.

(ii) Opening balances - Trace the opening balances from previous

year's audited balance sheet. In case, the entity is getting its
accounts audited for the first time since inception or it was audited
in previous year by some other auditor, follow the procedures given
in SA 510 "Initial Engagements - Opening Balances "issued by
ICAI.

(iii) Postings - Check postings from cash book and other books of
prime entry (i.e., purchases book, sales book, journal, purchase
returns book, sales return book, bills receivable book, bill payable
book).
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(iv) Control accounts - Total up the balances in the subsidiary
ledgers. Tally the totals with those in the control accounts.

(v) Verification of personal account balances - Verify

personal account balances with statements of account received
from the parties or by arranging direct confirmation. The procedure
of direct confirmation should be applied in the manner stated in SA
505 External Confirmations issued by ICAI.

(vi) Verification of Real accounts - The real account balances

should be verified by

 physical verification (as in the case of cash and

investments),
 checking the working papers of physical verification exercise
conducted by the management (as in the case of fixed
assets and inventories),
 inspection of documents (as in the case of intangible assets
such as patents and trade marks), and
 direct confirmation (as in the case of stocks lying with third
parties).

(vii) Scrutiny of individual accounts - Scrutinize individual

accounts. Examine the composition of balances. Examine age
analysis of various items outstanding.

(viii) Totals - Check totals of ledger accounts, schedules of

balances, groupings etc.

(ix) Tracing into the final accounts - Trace the balances in

individual accounts on to the schedules, from thereon into the
groupings-and from the groupings into the final accounts.

( x ) Analytical Review - Examine the reasonability of balances by

applying analytical procedures e.g. comparison with opening
balances, debtors turnover ratio, creditors turnover ratio, current
ratio, fixed assets turnover ratio, working capital turnover ratio etc.

1.2 AUDIT OF BOUGHT LEDGER

Following is the procedure to the audit the Bought Ledger

(Creditor's Ledger)

Audit of bought ledger should be taken up only after vouching of

Purchase Journal, Purchase Returns Journal, Cash Book and
Journal and verification of Bank Reconciliation Statement have
been completed and all the queries arising from these have been
satisfactorily resolved. The steps in audit of bought ledger are
generally the following:
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( a ) Opening balances - Check the opening balances of all
suppliers accounts from the last year's audited schedule.

( b ) Postings - Check the postings from the books of prime entry

(i.e., purchase journal, purchase returns journal, cash book, bills
payable book, main journal).

(c) Totals - Check the totals of individual accounts of suppliers.

( d ) Agreement with control account - The total of balances of the

individual suppliers' accounts agree this total with the control
account of sundry creditors in the general ledger.

(e) Debit balances-

♦ Pay special attention to debit balances in suppliers' accounts.

Enquire into the reasons for such debit balances. These may be
advances against which supplies are yet to be received or they may
represent advances not adjusted against billing. Another possibility
could be that the payment to the supplier has been posted to his
debit but the entry for purchases (i.e., by debiting purchases and
crediting his account) has been omitted.

♦ Scrutinize advances against which deliveries are pending for long

time. See that these are genuine advances and not merely financial
accommodation of a favoured party. Whether the advance is a
genuine one or merely for financial accommodation should be
judged keeping in mind factors such as :
• the value of purchases;
• the proportion of value of purchases given as advance;
• the normal lead time for delivery;
• the normal trade practices; and
• whether the party is a sister concern.

These debit balances should not be netted off from credit balances
but shown separately on Assets side of the Balance Sheet.

( f ) Composition o f balances - Scrutinize the composition of

balances by matching each credit (for supplies) with the
corresponding debit entry (for payment of bills). The unmatched
items should be enquired. If not, there may be cases where the
opening balances or earlier credits are unpaid but the later ones
are paid. This may reveal any of the following possibilities:—
( i ) Remittances to creditors misappropriated.
(ii) Disputes regarding previous balances.
(iii) Liability regarding the amount no longer exists.
(iv) Fictitious liability created to suppress profits.
(v) Payment entry omitted from the books.
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(g) Direct confirmation - The auditor should apply direct
confirmation procedures for creditors balances (at least a sample of
them) in the manner stipulated in SA 505.

(h) Tracing into the final accounts - Trace the balances from
the ledger accounts into the schedule of creditors and from
thereon to the groupings and then on to the final account

1.3 AUDIT OF SALES LEDGER

Following is the procedure for conducting the Audit of Sales

Ledger (Customer's Ledger)

The audit of the sales ledger (customer's ledger) should be

taken up only after the books of prime entry i.e., sales day book,
sales return book, main journal and cash book have been vouched,
Bank Reconciliation Statement has been examined and queries
arising out of vouching and examination of BRS have been
satisfactorily resolved. The following steps will be generally
required in the audit of sales ledger:

( a ) Opening balances - Check the opening balances with the

audited balance sheet of last year.

( b ) Postings - Check the postings from sales day book, sales

return journal, credit notes register, debit notes register, main
journal and bills receivable book.

(c) Totals - Check totals i.e., castings of accounts of individual

customers.

( d ) Agreement with control accounts - Check the total of

balances of individual customers account. Tally this total with the
control account in the general ledger.

(e) Credit balances - Pay special attention to credit balances. It

may be such that money has been received in advance from a
customer or that the sales entry (debiting customer and creditors:
sales) must have been omitted.

(f) Composition o f balances - Match each debit for sales to

customer with corresponding collection on the credit side. Many
customers (particularly big companies) send the remittance advices
showing the invoices against which payments have been made.
Refer to these while matching the payments against the respective
invoices. Unmatched items should be followed up with
management for explanations. Observe the patterns and enquire
about any change in it. For example, a customer who was making
payments in full in one stroke is now making part payments. This
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may reflect that the customer is having financial difficulties or that
teeming and lading is being practiced.

( g ) Long outstanding balances - This has been listed as a

fraud risk factor by SA 240. This could mean any of the following
possibilities :

♦ Bad debts requiring write-offs.

♦ Fictitious sales booked in previous year to bolster profits.
♦ Misappropriation of collections.
♦ Omission of postings for collections.
♦ In case of closely-held companies or firms, the money has been
paid to proprietor, partner or director who has deposited it in his
personal account.

( h ) Foreign currency debtor balances - See that these are stated

in the balance sheet by converting the foreign currency receivable
into rupees by applying the closing rate (i.e., exchange rate on
balance sheet date). The differences arising i.e. exchange
differences should be adjusted in Profit and Loss Account as per
AS-11.

(i) Subsequent Collections - Verify the genuineness of the debtor

balances by checking whether they have been collected in the
following period.

(j) Direct confirmations - Obtain direct confirmations of debtor

balances by sending out confirmation requests in the manner
stipulated in AAS-30 External confirmations.

(k) Tracing into the final accounts - Trace the debtors balances
into the schedules of balances from thereon into groupings, from
there into final accounts.

( l ) Credit card receivables - In case company accepts payment

by credit cards, check reconciliation of receivables as per books
with credit card company's statements.

1.4 GENERAL LEDGER

The General Ledger contains individual accounts of assets,

liabilities, income and expenses. Let us study (a) Why scrutiny of
general ledger is done (b) What is done before such scrutiny (c)
how scrutiny of general ledger is done.

 Why Scrutiny is Done

The objective of the scrutiny of general ledger is to obtain
audit evidence in the following matters.
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Actual Expenses: The assets and liabilities shown in the general
ledger actually exist at the year end. The transactions giving rise to
income and expenses recorded in the general ledger actually
occurred.

a) Complete Record: The general ledger records all the assets

legally owned by the concern at the year – end; all the liabilities
legally payable by the concern at the year – end; all the income
earned by the concern during the year; and all the expenses
incurred by the concern during the year.

b) Value: The closing balances of assets and liabilities are

properly valued. The transactions giving rise to income and
expenses have been recorded at the proper amounts.

c) Disclosure: The closing balances of assets and liabilities are

properly classified and disclosed in the balance sheet. The
amounts of income and expenses are properly disclosed in the
profit and loss account.

 What is done before scrutiny

Before making a scrutiny of General Ledger, auditor should

ensure that the following audit procedures have been duly
completed:

a) Study of Internal Control: Auditor should have studied and

evaluated the accounting system and internal audit

b) Vouching of Transaction: Then, based on the results of the

above study, the auditor should have vouched the transactions
which occurred during the year.

 How Scrutiny is done

Audit of general ledger involves the following:

1. Checking opening Balances.
2. Checking posting from Registers, Books and Journals.
3. Checking Castings and Totals of the ledger Accounts.
4. Scrutiny of Ledger Accounts.
5. Checking Summary and Groupings.

These steps are explained in detail below.

1. Checking opening Balances

Opening Balances of the General Ledger should be verified

with reference to the audited accounts, the General Ledger and the
schedule of balance for the previous year.
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a) In vouching, auditor checks the entry in the original books such
as Cash Book, Sales register, Bills Receivable Register, Purchase
Register, Bills Payable Register, Debit Note/ Credit Note Register,
Journal etc. The next step is to check the postings from these
books into the General Ledger. Auditor should check that the
correct amount is posted in the correct account on the correct side
of the account.

b) Posting may be checked on sample basis. Auditor may check

either all the postings for say 3 months or check posting into
selected accounts for the whole year.

c) The following aspects should be checked –

i. All entries are posted as per the dates i.e. in chronological
order.
ii. No entry is inserted in between two entries afterwards.
iii. No entry is altered.
iv. Against each entry, there is reference of the folio of the original
book or register.

2. Checking Casting
Auditor should check the totals of the ledger accounts. If an
account runs into many pages, he should check that the total of one
page is correctly carried forward to the next page.

3. Scrutiny of Ledger Accounts

General Ledger contains accounts of Income, Expenses,
Assets or Liabilities. The scrutiny of Income and Expenses
Accounts is described below.

A. Sales Account
I. In-depth Checking: Sales Account being the main source
of income is scrutinized in depth. The monthly summary is
checked from the Sales Register Debit / Credit Note Register.
Posting from cash / bank / journal are individual and not
summary postings. These are checked on sample basis.

II. Cross – Checking: Sales amount is cross – checked with

figures of sales in the Sales Tax Returns, Excise Registers,
Returns with Government authorities like import and Export
authorities etc.

III. Cut – off Transactions: The cut off transactions are

checked in detail to ascertain whether (a) all goods dispatched
have been billed and (b) bills are raised only against goods
dispatched.
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IV. Transactions after balance Sheet date: The transactions
after the balance sheet date e.g. goods retuned etc. are
checked to find out if they affect the sales account of the year
under audit.

V. Analytical Review: The sales account should be

analytically reviewed; if the products and prices are standard
and constant during the year, sales should be equal to
Quantity Sold x Standard Price.

a. Sales for the current year should be compared with the sales of
the previous year. Any abnormal difference should be
investigated.
b. Sales Quantity should be reconciled. Thus, Sales Quantity
= Opening Stock + Production – Closing Stock.
c. Input – output ratio should be checked.
d. Various Turnover Ratios should be computed and compared
Viz. (a) Sales to Net Capital employed. (d) Sales to Fixed
Assets Employed. (c) Stock Turnover Ratio. (d) Debtors
Turnover Ratio etc. Further, the profitability ratios viz. (a) Gross
Profit to sales and (b) Net profits to sales should be
computed and investigated.

VI. Book Entries: Auditor has to enquire (u/s 143) whether

transactions of sales etc. are not mere book entries. Thus, if
large sales are made to a concern towards the year end and
these goods are returned immediately in the beginning of the
next year, these may be fictitious sales to inflate profits.

VII. Sales to Group Concerns: Auditor has to ascertain whether

total sales to a group concern during the year exceed Rs.
50,000. if so, he has to report whether the rates charged are
reasonable compared to the market rates for similar items.

VIII. Checking Trial Balance and Grouping: Auditor should check

the balance of Sales Account into the Trial Balance and the
Grouping. He should see that –

a. No account in the nature of miscellaneous income e.g. Scrap

sales is grouped under sales.
b. The debit balance in the Sales Return Account, if any, in the
ledger is deducted form the gross sales amount.

IX. Schedule III: Auditor should see that the sales are classified as
required by schedule III of the Companies Act. The value and
quantities of major items are to be disclosed separately.
Earnings in foreign currency from export of goods on F.O.B.
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basis should also be disclosed by way of a note to the final
accounts.

B. Other Income Account:

1. Sample Checking: Other Income accounts e.g. Scrap Sales,
Rent Received, Dividends Received etc. being the incidental and
not the main sources of income are scrutinized on sample basis.

2. Cross – Checking: Income amount is cross – checked with

details available from other memorandum registers such as Scrap
Sales Register, Property Register (for rent), Investment Register
(for dividends, interest etc.) etc.

3. Cut – Off transactions: The Cut – off transactions are checked

in detail to ascertain whether (a) income revised in advance and (b)
income accrued are adjusted.

4. Transaction after Balance Sheet Date: The transactions after

the balance sheet date e.g. sale of shares cum – dividend etc. are
checked to find out if they affect the income account of the year
under audit.

5. Analytical Review: The income account should be analytically

reviewed i.e.
 If the items of scrap and prices are standard and constant
during the year scrap sales should be equal to Quantity sold X
standard price.
 Scrap Sales for the current year should be compared with
the scrap sales of the previous year. Any abnormal
difference should be investigated.
 Scrap Sales Quantity should be reconciled. Thus scrap sales
quantity=Opening stock + Generation of Scrap – closing Stock.
 Input – Output ratio should be checked from the Production
and cost records, to ascertain whether scrap generated is
normal or not.

6. Book Entries: Auditor has to enquire (u/s 227 of the

companies act) whether transactions are not mere book entries.

7. Checking Trial Balance and Grouping: Auditor should check

the balance of the income account into the trial balance and the
grouping. He should ensure that any major item in the nature of
miscellaneous income is shown separately.
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C. Income Accrued / Received in Advance:

1. Accrual Accounting: ‘Accrual” is the fundamental basis of

accounting. A Limited Company must maintain its accounts on
accrual basis. Under this basis, (a) income which has accrued is
booked even if not actually received and (b) amount which is
received in advance is not treated as income. This gives rise to (a)
Income Accrued and (b) Income Received in Advance.

2. Accounting standard: Auditor should follow the guidelines

contained in Accounting Standard 9 – Revenue Recognition –
issued by the Institute of Chartered Accountants of India (ICAI) for
this purpose.

3. Scrutiny of Income A/cs: Auditor should scrutinize all Income

Account (especially accounts like Service Charges Recovered,
Interest, Rent, Royalties and Dividends) to ascertain the amounts
accrued or received in advance.

4. General Rule: As a general rule, income should be booked

when it has accrued as per the terms of agreement between the
parties.

5. Service Charges: Income from service charges accrues when

the service is performed and complete. Thus income from job work
(i.e. processing of material supplied by others) accrues when the
job or processing is completed. If a job is complete at the year end,
but not yet billed, auditor should ensure that the income from that
job is shown as accrued and receivable in the books. On the other
hand, if any amount is received but the job is not complete as at
year end, it should be shown as income received in advance.

6. Interest Earned: Interest accrues on time basis at the rate

agreed. Thus, if a loan agreement states that interest on a loan of
Rs. 1,00,000 is payable @20% per year, interest for a year would
be Rs. 20,000. If only Rs. 15,000 are received till the year end,
interest of Rs. 5,000 has accrued and must be booked. On the
other hand, if interest received is Rs. 25,000, Rs. 5,000 is received
in advance and pertain to the next year. Auditor should scrutinize
the interest account to ascertain the amount of interest accrued or
Interest Received in Advance.

7. Rent: Rent also accrues on time basis at the rate agreed. Thus,
if a rent agreement states that rent of Rs. 1,000 is payable per
month, rent for a year would be Rs. 12,000. If only Rs. 10,000 is
received till the year end, rent of Rs. 2,000 has accrued and must e
booked. If on the other hand, Rs. 15,000 is received during the
year, Rs. 3,000 should be shown as Rent Receivable in advance.
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8. Royalty: Royalty means the charges for use of know – how,
patents, trade marks and copyrights. Royalties accrue as per the
terms of the concerned agreement.

9. Dividends: Dividends on share accrue when the dividend is

declared by the shareholders. Auditor should enquire from the
client whether any such dividend has been declared on the shares
held as investment till the year end.

10. Prior Period Income: Prior Period Income means income

credited to the current year’s profit and loss account, though
relating to earlier years, due to the omission to treat such income
as income accrued during the concerned year. Such items should
be disclosed separately in the profit and loss account.

D. Purchase Account:

1. In – depth checking: Purchase Account being the main item of

expenditure is scrutinized in depth. The monthly summary is
checked from the purchase Register and the debit / credit note
register. Posting from cash/ bank/ journal are individual and not
summary postings. These are checked on sample basis.

2. Cross – Checking: Total Purchase amount is cross – checked

with figures of purchases in the sales tax returns, excise
registers, returns with government authorities like import and
export authorities etc.

3. Cut – off transactions: The cut – off transactions are checked

in detail to ascertain whether (a) all goods received have been
billed and (b) bills are booked only against gods received.

4. Transactions after balance sheet date: The transactions after

the balance sheet date e.g. debit notes received, goods
returned etc. are checked to find out if they affect the purchase
account of the year under audit.

5. Analytical Review: The purchase account should be

analytically reviewed i.e.
 If the raw material and prices are standard and constant during
the year purchases should be equal to Quantity x rates.
 Purchases for the current year should be compared with the
purchases of the previous year. Any abnormal difference should
be investigated.
 Purchases Quantity should be reconciled. Thus, purchase
quantity = Opening Stock + Consumption – closing stock.
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 Input – output ratio should be checked, to ascertain
whether purchases, consumption, production and stocks are
consistent with each other.
 Purchase Ratios should be computed and compared viz.
purchase to sales, purchases to Creditors etc.

6. Book Entries: Auditor has to enquire (u/s 227 of the

companies act) whether transactions of purchases etc. are not
mere book entries. Thus, if large purchases are made from a
concern towards year end and these goods are returned
immediately in the beginning of the next year, these may be
fictitious purchases to suppress profits.

7. Purchases from Group Concerns: Auditor has to ascertain

whether total purchases from a group concern during the year
exceed Rs. 50,000. If so, he has to report whether the rates
charged are reasonable compared to the market rates for
similar items.

8. Checking Trial Balance and Grouping: Auditor should check

the balance of the purchase account into the Trial Balance and
the Grouping. He should see that –

a. No account in the nature of miscellaneous purchase e.g. gift

articles purchased is grouped under purchases.
b. The Purchases Returns Account, if any, in the ledger is
deducted from the gross purchases amount.

E. Other Expense Accounts

1. Sample Checking: Other Expenses account e.g. Manufacturing

Expenses, Administrative and Office Expenses, Sales and
Distribution Expenses etc. should be scrutinized on sample basis.

2. Cross Checking: Expenses accounts should be cross –

checked with details available from other memorandum registers
such as Excise Registers, Sales Tax Returns, Provident Fund
Returns, Insurance Registers etc.

3. Cut – off Transactions: The cut off transactions are checked in

detail to ascertain whether (a) all outstanding expenses and (b) all
pre paid expense are adjusted.

4. Transactions after balance Sheet Date: Transaction after the

balance sheet date e.g. payment of expenses etc. are checked to
find out if they affect the expenses account of the year under audit.
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5. Analytical Review: The expenses account should be
analytically reviewed i.e.:

 If the items of stores and prices are standard and constant

during the year stores expenses should be equal to
Quantity X Rates.
 Major Expense for the current year should be compared with
their corresponding figures of the previous year. Any abnormal
difference should be investigated.
 Packing Material Quantity should be reconciled. Thus
packing materials consumed = opening stock + purchases
– closing stock.
 Major Expense Ratio should be computed e.g. (a)
Manufacturing Expenses to Sales or (b) Selling andDistribution
Expenses to sales. Any abnormalities should be investigated.

6. Book entries: Auditor has to enquire (u/s 143 of the

Companies Act) whether transactions are not mere book
entries.

7. Checking Trial balance and Grouping: Auditor should check

the balance of the Expenses account into the trial balance and
the grouping. He should see that any major item in the nature of
miscellaneous expenses (i.e. exceeding 1% of the turnover) is
shown separately.

F. Outstanding / Pre – paid expenses

1. Accrual Accounting: “Accrual” is the fundamental basis of

accounting. A Limited Company must maintain its accounts on
accrual basis. Under this basis,

a. Expenses which have accrued are booked, even if not actually

paid, and

b. Amounts which are paid in advance are treated as per paid

expenses. This gives rise to (a) Outstanding expenses and (b) Pre
– paid expenses.

2. Scrutiny of Expenses A/c: Auditor should scrutinize all

expense accounts (especially accounts like service charges paid,
interest, rent, salaries, royalties etc.) to ascertain the amounts
outstanding or prepaid.

3. General Rule: As a general rule, expenses should be booked

when they have accrued as per the terms of agreement between
the parties.
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4. Service Charges: Services charges accrue when the service is
performed and complete. Thus, charges for job work (i.e.
processing by outsiders of materials supplied by the concern)
accrue when the job or processing is complete. If a job is complete
at the year end, but not yet billed, auditor should ensure that the
service charges are shown as accrued and payable in the books.
On the other hand, if any amount is paid but the job is not complete
as at year end, it should be shown as pre paid expenses.

5. Interest Due: Interest accrues on time basis at the rate agreed.

Thus, if a loan agreement states that interest on a loan of Rs.
1,00,000 is payable @ 20% per year, interest for an year would be
Rs. 20,000. if only Rs. 15,000 are paid till the year end, interest of
Rs. 5,000 has accrued and must be booked as outstanding
expenses. On the other hand, if interest paid is Rs. 25,000. Rs.
5,000 are paid in advance and pertain to the next year. Auditor
should scrutinize the interest account to ascertain the amount of
Interest Outstanding or Interest Pre-paid.

6. Rent: Rent also accrues on time basis at the rate agreed. Thus,
if a rent agreement states that rent of Rs. 1,000 is payable per
month, rent for a year would be Rs. 12,000. If only Rs. 10,000 is
paid till the year end, rent of Rs. 2,000 has accrued and must be
booked as outstanding expenditure. If on the other hand, Rs.
15,000 is paid during the year, Rs. 3,000 should be shown as Pre –
paid expenses.

7. Royalty: Royalty means the charges for use of know – how,

patents, trade marks and copyrights. Royalties accrue as per the
terms of the concerned agreement.

8. Salaries and Wages: Normally, salaries and wages of the last

month of the accounting year would be outstanding at the year end.
These amounts would be paid in the next month. While making the
provision, provisions should be made for the gross salaries and
wages i.e. including the employer’s contribution to provident fund,
ESIS etc.

9. Commission on Sales: Commission may be payable to sales

staff, or outside agents. The amount of commission would depend
upon the terms of agreement and the amount of sales. The auditors
should verifies the computation of commission and ascertain the
commission outstanding or pre – paid as on the year end. Auditor
should verify that the appointment and terms of a sole selling agent
are approved by the shareholders in a general meeting. Schedule
III requires that commission to sole selling agents and must be
disclosed separately.

10. Commission to Directors: Commission to directors must be in

accordance with the provisions of the companies act.
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11. Opening Balance: Auditor should check that the opening
balance brought forward from the previous year in the outstanding
expenses account is squared off during the current year. The
difference between the provision for outstanding expenses brought
forward and the actual payment in the next year must be properly
adjusted.

12. Prior Period Income: Prior Period expenses are expenses

debited to the current year’s profit and loss account, though relating
to earlier years, due to the omission to treat such expenses as
outstanding expenses during the concerned year. Such items
should be disclosed separately in the profit and loss account.

1.5 PRACTICAL ILLUSTRATIONS

Q.1 Why and how will you as an auditor, make a scrutiny of the
following ledger account? What conclusions will you draw from
such scrutiny?

Ajay’s Ledger
Vineet’s Account (LF No. 21)
Dr. Cr.
Date Particulars F. Amount Date Particulars F. Amount
2001 2001
Apr.01 By balance b/d 400

2002 2002
Mar.2 To Purchase A 1 1,000 Mar.1 By Purchases A 1 5,000
Returns

Mar.7 To Payment A 2 4,000 Mar.5 By Purchases B 3 4,500

Mar.7 To Purchase B 3 900 Mar.26 By Purchases C 6 9,000

Returns

Mar.9 To Payment B 5 3,000 Mar.27 By Purchases C 2 5,000

Mar.31 To bal. c/d 15,000

23,900 23,900

Solution:

1. Name of the ledger : Vineet’s account in the books of Mr. Ajay.

2. Nature of account : Mr. Vineet is the supplier of Mr. Ajay and

hence the nature is of personal account.
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3. Period of the ledger : Mr. Vineet’s account has covered one
financial year from 2001-2002.

4. Reason of scrutiny : The reason of scrutiny of Mr. Vineet’s

account is that the auditor has to obtain audit evidence for the
closing balance in the account is due and payable. He should
also check the balance shown of Rs. 15,000 is correctly valued.
The balance has been correctly valued in balance sheet.

5. Check Casting : The total of the both the sides of the account
i.e. Rs. 23,900 is correct.

6. Check opening balance : the auditor can check opening

balance of Rs. 400 from Creditors schedule from previous year.

7. Check entries : checking of the entries of an account shows :

1. debit : the debit side of the suppliers contains purchase returns

and payment entries.

2. Credit : the credit side of the account contains the opening

balance and purchase transactions.

8. Carry forward : the closing balance of creditor’s account

showing credit balance is normal. Debit balance in a creditors
account means an advance payment. it should be carried
forward in balance sheet.

9. Transfer to balance sheet : auditor should check if the balance

in creditor’s account has been correctly transferred to the
balance sheet under appropriate heading and in schedule.

10. Composition of closing balance : The closing balance

consists of Opening balance of 400 + purchases made on 26th
and 27th March for Rs. 9,000 and Rs. 5,000 respectively + the
difference between the purchase made on 5th March and goods
returned and the payment made i.e. (4,500 – 900 – 3,000) = Rs.
15,000.

If the creditor’s account has a closing balance, confirmation letter

should be sent to the party. If the party does not confirm the
balance, a certificate from the management has to be obtained
for the balance payable. Auditor has to judge whether this
amount is really payable. If the balance remains outstanding for
an unreasonable duration, he shall make further inquiry.

Q.2 Why and how will you, as an auditor, make a scrutiny of

the following ledger account? What conclusions will you draw from
such scrutiny?
 17
Lallan’s Ledger
Mala’s Account (LF No. 21)
Dr. Cr.
Date Particulars F. Amount Date Particulars F. Amount
2002 2002
Jan.1 To bal. b/d A 10,000 Jan.1 By A 1 16,000
Purchase
a/c
Jan.17 To A 1 500 Mar.31 By bal. c/d B 20,000
purchase
(CN for
excess
rate)
Jan.20 To bank A 2 5,000
To discount A 2 500

Mar.25 To bank a/c B 3 20,000

36,000 36,000

Solution :

1. Name of the ledger : Name of the ledger should be mentioned

on top of every account.

2. Nature of account : Nature of account should be observed from

the transactions. From the above ledger transactions we can
observe Mala is a supplier / creditor of Lallan.

3. Period of the ledger : the period covered in above account is

one quarter i.e. 01/01/2002 to 31/03/2002.

4. Reason for scrutiny : account should be scrutinized to obtain

audit evidence that : a) closing balance shown is correct. b) the
balance is properly valued. c) the balance is presented in
appropriate heading in balance sheet and also in corresponding
schedule.

5. Check casting : The totals of both sides (credit and debit) is

should be same. In above case it is Rs. 36,000.

6. Check opening balance : opening balance of the creditor can

be verified from the schedule of creditors as on the previous day
of the opening balance i.e. as on 31st Dec, 2001 in above case.

7. Check entries : auditor should check the debit and credit side of
the account.
 18
1. Debit : Supplier’s account has payments made, credit notes
raised, discount entry and purchase return entries on the debit
side.

2. Credit : Creditor’s / Supplier’s account will have credit opening

balance. Auditor should inquire if supplier’s account is showing
debit balance.

All the purchase entries are on the credit side of the account.

8. Carry forward : The closing balance should be carried forward

to respective schedule and under appropriate head in balance
sheet.

9. Marking of payments : auditor should mark payment against

corresponding invoice and credit / debit notes. This can be done
as follows :

Against an invoice of Rs.16,000(A) advance payment of

Rs.10,000(A) is made + a credit note is raised for Rs.500(A) +
payment is made of Rs.5,000(A) and a discount of Rs.500(A) is
availed. Balance is cleared against the bill.

10. Composition of Closing balance : Closing balance consist of

an advance payment made on 25th March of Rs.20,000 (B).

1. If the advance payment made is returned in cash in the

subsequent year, there is a possibility that it was a loan only
disguised as advance against purchases.

2. If goods are supplied against advance payment, it means the

payment made is genuine.

3. If advance payment is not cleared in subsequent year also, a

letter of confirmation should be sent to the party. If the balance is
not confirmed by the party then a certificate should be obtained
from the management that such balance is recoverable.

11. Check the schedule : Auditor should check the debit balance
in the nature of advance payment to creditor’s is shown
separately as advance on the asset side.

Q.3 Why and how will you, as an auditor, make a scrutiny of

the following ledger account? What conclusions will you draw
from such scrutiny?
 19
Reema’s Ledger
Madhumita’s Account (LF No. 2)
Dr. Cr.
Date Particulars F. Amount Date Particulars F. Amount
2001 2001
Jan.1 To bal. b/d A 6,000 Jan.1 By Bills A 1 4,000
Rec.
May25 To sales B 1 5,000 By Returns A 1 1,000
Sep.08 To bills rec. C 3 2,500 By Bank A 1 950
To interest C 3 500 By Discount A 1 50
To sales C 3 7,000 Jan.5 By Bank B 3 2,350
Dec.12 To bills rec. D 6 8,000 By discount B 3 150
To interest D 6 400 By Bills B 3 2,500
Rec.
Dec.15 To sales E 7 5,000 Sep.8 By Cash C 6 2,000
By Bills C 3 8,000
Rec.
Dec.14 By Cash D 7 8,400
Dec.31 By Bal. c/d E 5,000
34,400 34,400

Solution :

1. Name of the ledger : Above given is Madhumita’s account in

Reema’s Ledger.

2. Nature of account : from the transactions it can be observed

that the account that Madhumita is a debtor of Reema. The
nature of the account is personal.

3. Period of ledger : The above ledger is for an entire calendar

year i.e. from 01/01/2001 to 31/12/2001.

4. Reason for scrutiny : The scrutiny of the account is to be

done to obtain audit evidence that :

a) Closing Balance shown is correct,

b) The balance is properly valued, i.e. the balance is Rs. 5,000 at
the end of the year, no more, no less.
c) The balance is presented in appropriate heading in balance
sheet and also in corresponding schedule.

5. Check casting : The total of both sides i.e. debit and credit
should be same. In above case total of Rs. 34,400 is correct.
 20
6. Check opening balance : The opening balance should be
checked from the schedule of debtors of last year.

7. Check entries : Entries should be in chronological order.

a) debit side : The debit side of a debtors account contains
opening balance, bills receivable honoured, interest received
and Sales entries.
b) Credit Side : Credit side will have sales return entries, bills
receivables and cash received entries.

8. Carry forward : Debtors account is a personal type of account

and appears on the asset side of the balance sheet. It should
be carried forward in appropriate schedule under balance
sheet.

9. Marking of Bills receivables against receipts : in above

case, the opening balance of Rs. 6,000(A) is settled by drawing
a bill of Rs. 4,000(A) + sales return of Rs. 1,000(A) + Cash
receipt of Rs. 950(A) and + a discount of 50(A).
All other transactions should be marked in a similar way for
their respective bills.
10. Closing Balance : After marking of transactions, it can be
observed that the balance at the yearend consists of sales
made on 15th December.

The closing balance of the account is showing debit balance

which is normally seen for debtors account.

The amount of Rs. 5,000 for sales made on 15th December,

should be received in subsequent period. However, if the same
is not received, the debtor shall make inquiry for the same. He
shall also send a letter of confirmation to the party and get the
balance confirmed at the year end. If, there is no confirmation
received from the party, the auditor shall obtain a certificate
from the management that such balance is receivable. From
the frequency of the transactions, the auditor should judge if the
balance is good or bad.

Q.4 Why and how will you, as an auditor, make a scrutiny of

the following ledger account? What conclusions will you draw from
such scrutiny?
 21
Riya’s Ledger
Bills Receivable Account (LF No. 28)
Dr. Cr.
Date Particulars F. Amount Date Particulars F. Amount

2001 2001
Jan.1 To balance A 10,000 Apr.30 By Bank A 1 10,000
b/d
May1 To Ram B 5,000 June2 By Bank B 1 4,900
June6 To Balaram C 10,000 By Discount B 1 100
Aug.18 To Shyam D 7,500 Aug.20 To Bank D 1 7,500
(Collection)
Sep.10 To Balaram E 10,200 Sep.9 By Balaram C 3 10,000
Dec.1 To Sitaram F 5,000 Dec.1 By Atmaram F 3 5,000
Dec.29 To G 7,000 Dec.31 By Balance 17,200
Sangoram c/d
54,700 54,700

Solution :
1. Name of the ledger : The name of the account is bills
receivable account in Riya’s Ledger.

2. Nature of the account : Nature of bills receivable account is

personal.

3. Period of Ledger : Period of ledger is for calendar year

01/01/2001 to 31/12/2001.

4. Reason for scrutiny : Auditor obtains audit evidence by doing

scrutiny of the account. It provides evidence that the closing
balance is correctly valued, opening balance is correctly carried
forward from previous year and closing balance is shown in
balance sheet under assets head.

5. Check casting : the total of debit and credit sides is same, Rs.
54,700.

6. Check opening balance : Auditor should check Opening

balance of Rs. 10,000 is correctly carried forward from previous
year’s balance sheet.

7. Check entries :
a) Debit : The entries are in chronological order. The entries are
of bills drawn of different debtors.
b) Credit : The entries on credit side represent Bills receivable
honoured, and closing balance.
 22
8. Carry forward : Bills receivable is a personal account and
appears on the asset side of the balance sheet.

9. Composition of closing balance : Auditor should mark

payment received against respective bills receivables drawn. In
the above account closing balance consists of Bills drawn on
Mr. Balram Rs.10,200 (E) and Mr. Sangoram Rs. 7000 (G).

Q.5 Why and how will you, as an auditor, make a scrutiny of

the following ledger account? What conclusions will you draw from
such scrutiny?

ABC Ltd.’s Ledger

Loan to Asha Ltd. Account (LF No. 2)
Dr. Cr.
Date Particulars F Amount Date Particulars F Amount
2002 2002
Jan.1 To Bank 2 60,000 June30 By Bank (1st ½ 10 15,000
yrly Installment)

Dec.31 By Balance c/d 45,000

60,000 60,000

Solution :
1. Name of the account : It is a loan account of Asha Ltd in the
books of ABC
.
2. Nature of Ledger : Nature of Loan to Asha Ltd account is
personal.

3. Period of Ledger : The period covered is from 1st Jan, 2002 to

31st December, 2002.

4. Reason of scrutiny : Scrutiny of loan account shows that :

a) Repayments are correctly posted on the debit side (right side)
b) Entries are in chronological order.
c) Against each entry, reference of the folio of original book is
mentioned.

5. Check Casting : The total of the account of Rs. 60,000 is

correct.

6. Check opening balance : Opening balance can be verified

from the balance sheet of previous year 2001.
7. Check entries :
a) Debit Side : Debit side of loan has loan given on 1st January.
Loan amount given should be in power of the lender. Loan has
 23
been granted only after following proper procedures. Loan
granted should be in accordance with respective sections of the
Companies Act, 2013.

b) Credit Side : Loan repayments are on credit side of the

account. The borrow should be competent to make loan
repayments on time. The loan installment is paid only in June
and it has not been paid. The borrower is a company the MOA
should contain the power to borrow money.

8. Composition of closing balance: The closing balance of loan

account has a debit balance which is normal for a borrowers
account.

The closing balance consists of pending loan after payment of

first installment.

Auditor should check if the same is paid in next year, if the loan
is good or doubtful. He should also check if the interest
payments with respect to loan instalments are received on time.

Q.6 Why and how will you, as an auditor, make a scrutiny of

the following ledger account? What conclusions will you draw from
such scrutiny?

Surya Ltd.’s Ledger

Donation & Charity Account (LF No. 77)
Dr. Cr.
Date Particulars F Amount Date Particulars F Amount
2003 2003
Jan.1 To SARS BF6 60,000 Mar.31 By P&L A/c JB8 1,50,000
Relief Fund (transfer)
Mar.10 To BJP BF9 50,000
Fund
Mar.20 To National BF9 40,000
Defense
Fund
1,50,000 1,50,000

Solution :

1. Name of the ledger : The account is a donation account.

2. Nature of the account : Donation / charity account is a nominal

account.

3. Period of the ledger : it has covered period from January 2003

to March 2003.
 24
4. Reason for Scrutiny : The reason for scrutiny is to obtain
evidence that the amount treated as expense is correct and is
correctly disclosed in Profit & Loss Account.

5. Check casting : The total of both sides, Rs. 1,50,000, is

correct.

6. Check opening balance : Nominal accounts do not have

opening or closing balance.

7. Check entries : Auditor should check contributions made are

on debit side of the account and are not directly related to
business of the company or welfare of employees. He should
check donations are within the limit of section 181 of Companies
Act 2013. If the donations exceed the prescribed limit of
donation, he should qualify the report.

Donations made to political party are governed by section 182

of the Companies Act 2013. Donations exceeding prescribed
limit amount to qualifying the report.

Donations of National defence fund is governed by section 183

of the Companies Act, 2013. The section empowers the Board
of Director to make such contributions.
8. Transfer to P&L A/c : The balance of nominal account is to be
transferred to Profit and loss account at the yearend.
9. Closing Balance : Nominal account do not have any closing
balance. The entire amount is to be transferred to P&L Account
and are separately disclosed.

Q.7 Why and how will you, as an auditor, make a scrutiny of

the following ledger account? What conclusions will you draw from
such scrutiny?
Sadhabahar Ltd.’s Ledger
Provision for Tax Account (LF No. 30)
Dr. Cr.
Date Particulars F Amount Date Particulars F Amount
2002 2002
June1 To Advance JF8 1,40,000 Apr.1 By Balance 1,20,000
Tax A/c (A) b/d (A)
[2001-02] [2001-02]
June1 To Liabilities JF8 12,000 June1 By P & L JF8 32,000
for Tax A/c (A) A/c (A)
2003 2003
Mar.31 To Balance 1,60,000 Mar.31 By P & L JF9 1,60,000
c/d [B] A/c (B)
3,12,000 3,12,000
 25
Solution :

1. Name of account : The name of the account is Provision for tax

2. Nature of account : The nature of provision for tax is a provision

account created through an Adjustment entry passed at the
yearend.

3. Period of the ledger : The period of the ledger is FY 2002-03.

4. Reason for scrutiny : The reason for scrutiny is to obtain audit

evidence for the balance of amount is really payable. The
balance is properly valued and is properly valued.

5. Check casting : The total of both sides Rs. 3,12,000 is correct,

6. Check opening balance : the opening balance is Rs.1,20,000 is

for previous year. The assessment order for this year passed by
income tax department is received during the year in June 2002.
Hence, the advance tax paid for that year 1,40,000 is
transferred from the Advance Paid account. The debit of 32,000
in the P&L A/c shows the amount of shortfall in the provision. It
means the tax due as per the assessment order is 1,52,000.
And the advance tax paid of 1,40,000 is credited to the liability
for tax account.

Auditor should check the assessment order for this year. He

shall report the same in his CARO Report.

The provision for current year is made for Rs. 1,60,000. He shall
check the computation of the tax.

7. Composition of closing balance : the closing balance of

1,60,000 is made up of provision for tax payable on income for
current year. It is on the credit side of account which is normal.

8. Transfer of the balance : The final balance of provision account

should be presented in the schedule of Provisions.

1.6 AUDIT OF MAIN JOURNAL

The main journal contains :

(i) Adjusting entries.
(ii) Closing entries.
(iii) Rectification entries.
(iv) Entries which cannot be accommodated in any other subsidiary
book or journal (e.g., credit sale of fixed asset, credit purchase of
fixed asset, share allotment, share capital, creation of capital
redemption reserves, and initial recognition of finance lease)
 26
Points to be kept in mind while auditing the main journal:

(1) Opening entries- Verify opening entries with the audited

balance sheet of the previous year.

(2) Rectification entries - Refer to the original vouchers in respect

of which error was committed to ensure that rectification entries are
genuine and rectification entries have been correctly passed.

The auditor should not assume that every rectification

journal entry is a genuine rectification of an actual error. He should
exercise enough professional skepticism in this matter.

For Example : Cheque received from Mr. Shah is credited to

Mr. Saha's account. Then after 10 days, the "mistake" is
discovered. It is "rectified" by debiting A. Saha and crediting
A. Shah. Only thing is that the data entry man had a "setting"
with A. Shah who told him that he won't be able to send his
cheque within the time allowed for availing cash discount and
further, if somehow he is allowed the cash discount, he would
"share" it with him. Accordingly the above 'mistake' was
committed to give A. Saha the discount which he was not
entitled to.

(3) Supporting Documents - Examine the supporting documents

such as correspondence, contracts, minutes etc.

(4) Adjusting entries - Adjusting entries are passed for—

(a) expenses accrued till the balance sheet date but not paid e.g.,
rent, electricity, etc.

(b) income accrued but not received e.g., interest accrued but not
matured for receipt.

By the time of audit, some of the liabilities provided for may have
already been paid off. The payments may be more than the
provision. But as long as these were estimated on a reasonable
basis, the auditor need not insist on adjusting the difference
between the provision and the payments.

Since adjustment entries are supported by internally

prepared statements, the auditor should obtain independent
evidence for corroborating them.

If the difference between amount provided for and amount

settled is material, the auditor should insist on management
increasing the provision amount.
 27
5) Journal entries not supported by any vouchers like bills,
contracts, etc. - If any journal entries are not supported by
vouchers (except opening entries rectification entries, adjusting
entries and closing entries) the auditor should see whether these
are transactions represented merely by book entries prejudicial to
the interest of the company [section 143 of the Companies Act,
2013].

6) Proper authorization -The auditor should ensure that journal

entries are passed with proper authorization.

7) Non-standard journal entries - Perform tests of non-standard

journal entries to confirm that they are adequately supported and
reflect underlying events and transactions. This may help in
identifying fictitious entries or aggressive recognition practices.
Non-standard journal entries are generally the financial statement
changes or entries made in the books and records (including
computer records) of the entries that are :

♦ Usually initiated by management level personnel; and

♦ Not routine or associated with normal processing of transactions.

1.7 BALANCE SHEET AUDIT

MEANING OF BALANCE SHEET AUDIT

Until recently, test checking was confined to confirming

balances in a few nominal account such as stocks and stores,
amount of sales and other similar records relevant to trading
transaction, which were voluminous but of similar nature. Now-a-
days test checks are being applied widely for verification of income
and expense accounts and assets and liabilities as well. This is due
to two reasons:
(i) Increase in the size of business units, and
(it) Computerization of accounting.

DEFINITION –
A balance sheet audit consists of the verification of all the
balance sheet items along with the examination of expense and
income accounts which are so closely related to those items that it
cannot be properly verified without such analysis and test.

Balance sheet audit will include

(i) Examination of partnership deed, the memorandum and
articles of association, minute books and the system of
accounting in force.
(ii) Verification of ownership or enterprise's control over assets
shown in the balance sheet.
 28
(iii) Proof that all assets owned or controlled by the enterprise are
included.
(iv) Inclusion of assets in the balance sheet is in accordance with
the generally accepted principles of accounting (valuation of
assets).
(v) Proof that all liabilities are included and at actual amounts.
(vi) Examination of closing and adjusting entries and any other
entries relevant to the preparation of balance sheet.
(vii) Distinction between capital expenditure and revenue
expenditure on the basis of accepted accounting principles.
(viii) Proof that share capital issues have been made in compliance
with requirements of law and they are correctly recorded in the
financial books.
(ix) An analysis of the charges and credits to the profit and loss
accounts and the inclusion of the resultant balance in the
balance sheet.

1.8 SUMMING UP

The ledger is a permanent book of record which contains a

number of accounts of different subjects. Its purpose is, therefore to
provide classified financial information about the subjects such as a
person, asset and an expense or income. The fundamental double-
entry principle provides that debit is always equal to credit or vice
versa. Since the ledger account is prepared under the double-entry
system, it helps to prepare a Trial balance that provides a check on
the arithmetical accuracy for recording transactions in the books of
accounts. The ledger is a book of accounts relating to all the
financial transaction of the business. It contains the accounts of all
expenses, losses, incomes and gains. Therefore, it helps to
prepare the profit and loss account of the business so as to
ascertain the profit earned or loss suffered during a specified
period. The ledger also contains the accounts of the financial
transactions relating to capital, all liabilities and assets of the
business. With the help of the balances of these accounts and profit
and loss of the business, a balance sheet may be prepared to show
its financial position at a certain point in time.

1.9 QUESTIONS FOR EXERCISE

1. Discuss Importance and objective of Audit of ledger.

2. How as an auditor scrutiny of bought ledger is done.
3. How as an auditor scrutiny of Sales ledger is done.

