Expert Advisory Committee

1.35 Query:

Qualifications in auditor’s report.

1. The audit report of a company, among other things, contained the following paragraph:

“V (a) The depreciation provided by the company under the provisions of the Electricity (Supply) Act, 1948, falls short of depreciation calculated in terms of Section 205(2) (b) of the Companies Act, 1956. This has resulted in short provision of Rs. 3,329.90 lakhs for the year and over statement of reserves by Rs. 18,366.96 lakhs (refer Note No. 19)

(b) The sale of power from TSII to Electricity Boards from 0.00 Hours to 6.00 Hours on 1.4.91 has been provisionally accounted at 55 paise per KW Hr. based on previous agreement terms.

(c) The transmission charges for export of power from newly commissioned Salem-Udumalpet lines have been accounted on parameters applicable to transmission lines of stage-I.

(d) Power exported to EBs from Unit IV of Thermal Station II during test and trial run has been billed at provisional rate of Rs. 1.16/KWHr and abated to capital cost.

(e) On account of change in accounting policy, the profit before tax has decreased by Rs. 848.18 lakhs on account of

Rs. in lakhs

i) Change in basis of valuation of

stock of natural oil (Refer Note 21(b)) 4.82

ii) Provision for accrued earned leave

encashment of certain categories of

continuing employees on estimated

basis (Refer Note 21 (d)) 800.00

iii) Treating a Urea reactor deployed as

replacement during the year as a

spare instead of a capital item and

extending such treatment to another

reactor so deployed in an earlier year

(Refer Note 21 (e)) 46.82

iv) Extension of accrual basis of

accounting for recovery of

electricity variation charges from

employees (Refer Note 21 (c)) (-)3.46

(f) Subject to our remarks under Para V (a) to (e) the accounts give a true and fair view

i) In the case of Balance Sheet of the state of affairs as at 31^st March, 1991, and

ii) In the case of Profit and Loss Account of the profit for the year ended on that date.”

2. In the above report, in Para (V) (e), the following statement is made.

“………, the profit before tax has decreased by Rs. 848.18 lakhs on account of …..”.

In the view of the company, this is only a statement of fact as distinct from the statement “Profit is understated” which would represent a qualification. However, while reporting the true and fair view in para (V) (f), the auditors have also qualified this statement of fact as “subject to our remarks under para (V) (a) to (e) the accounts give true and fair view……..”. By this reporting an otherwise ordinary statement of fact has become a qualification, requiring the company to reply in the addendum to the directors’ report.

3. According to the querist, during the course of audit, the auditors had not objected to the transactions referred to in para (V) (e). In fact, the auditors were in total agreement with the point of view of the company. Moreover, the transactions in question are in agreement with the accepted accounting concepts and represented improved policy changes. Therefore, this statement of fact under para (V) (e) should have been left out from the purview of the qualificatory remarks in para (V) (f) for reporting true and fair view.

4. The querist has sought the opinion of the Expert Advisory Committee with respect to the following issues:

(a) Although the audit report is the sole prerogative of the auditor, can the company suggest to the auditor leaving para (V) (e) from the purview of para (V) (f), since there was no objection raised by the auditors on the transactions referred to in (V) (e)?

(b) In case the suggestion of the company is not accepted by the auditor, whether this statement under (V) (e) read with para (V) (f) is to be construed as a qualification requiring a reply to be furnished by the company or that no reply need be furnished to this para despite inclusion of para (V) (e) also within the purview of the ‘subject to’ statement in para (V) (f).

(c) Whether the Institute could issue guidelines to the auditors not to include such a statement of facts which does not represent a qualification under the ‘subject to’ statement, as in para (V) (f) of the auditors’ report.

Opinion January 20, 1993

1. The opinion of the Committee expressed herein is confined to the matters relating to the manner of making qualification in audit report. The Committee has not considered the propriety or other wise of the changes made in the accounting policies by the company and that of the accounting treatments of matters forming part of the qualifications. However, the Committee presumes that the changes and effects thereof have been accounted for and disclosed in accordance with Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India, in this regard.

2. The Committee notes para 3.12 of the ‘Statement on Qualifications in Auditor’s Report’, issued by the Institute of Chartered Accountants of India, which reads as follows:

“3.12 It is customary for qualifications to be made by the use of expressions such as, ‘subject to’ or ‘except that’. The expressions ‘read with the notes thereon’ or ‘together with the notes thereon’ are of an explanatory nature and do not constitute qualifications. It is therefore important when seeking to qualify a report, that the auditors shall use such recognised terminology which clearly implies a qualification. It is not a correct practice to merely make a factual statement in the auditors’ report without taking exception thereto. In a case where the treatment of underwriting commission was not in accordance with the accepted accounting practice, the auditors reported as under:

“Underwriting commission on shares taken up by the corporation underwriting arrangements has been taken to Profit and Loss Account. This is contrary to accepted accounting practice.

We report that the Balance Sheet shows a true and fair view …….”

This method of reporting is not proper. The report should have been worded as follows:

“Underwriting commission on shares amounting to Rs…….taken up by the Cor poration under underwriting arrangements has been taken to Profit and Loss Account. This is contrary to accepted accounting practice and has resulted in the profit being overstated by Rs….

Subject to the above, we report that the Balance Sheet shows a true and fair view…”

The use of the words ‘subject to’ is essential to bring out the qualification.”

3. The Committee is of the view that the auditor should make a qualification in his report, when he is in disagreement with any accounting treatment and the matter involved is material enough to have a bearing on true and fair view of financial statements, or constitutes any contravention of law having bearing on accounts. Thus, in case of a change in accounting policy, the auditor should make a qualification in his report only when he does not concur with the propriety of such change and/or the effect of such change on profits has not been disclosed in accordance with the requirements of Accounting Standard (AS) 5, issued by the Institute of Chartered Accountants of India and Clause 3 (xv) of Part II of the Schedule VI to the Companies Act, 1956. In case he agrees with such change and the effects thereof have been disclosed as suggested above, he should not make a qualification.

4. On the basis of the above, the Committee is of the following opinion in respect of the issues raised in para 4 of the query:

(a) Kindly refer to para 3 above.

(b) Yes. The directors should reply on the said qualification in their reports.

_____________________________