1. A director of a limited company undertakes foreign trips in connection with the company’s business. At the time of the trip he draws from the company US $400 per day for the duration of the trip. On returning back, he gives a declaration stating that he has spent the entire amount of advance taken without giving any details of the expenditure incurred and supportings thereof. The company, accordingly, books the entire advance taken by him as expenditure for the business on the basis of the declaration given.

B . Query

2. In view of the facts stated above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the declaration given by the director in respect of the expenditure incurred (without any details or supporting) is a sufficient document for booking the amount as a business expenditure.

(b) Whether the declaration in (a) above is a sufficient document for audit purposes.

(c) In the absence of any details and the supportings, whether the auditor can take a stand under section 227(1A) sub-clause (e) of the Companies Act, 1956, that personal expenses have been charged to revenue.

(d) If the director is able to support part of the expenditure and not the whole, whether the balance of the unsupported expenditure not refunded will be taxable in the hands of the recipient.

(e) In that event, whether the balance of unsupported expenditure, if approved by the Board of Directors, will be treated as the directors’ remuneration for the purpose of the Companies Act, 1956.

(f) Whether the Board of Directors can approve such unsupported expenditure.

C. Points considered by the Committee

3. The Committee notes that the querist has, inter alia, sought the opinion on legal aspects related to taxation and company law in paragraphs 2(d), (e) and (f). In this context, the Committee notes Rule 2 of the Advisory Service Rules, which provides that the Committee will deal with queries relating to accounting and/or auditing principles and allied matters and as a general rule will not answer queries which involve only legal interpretation of various enactments. Since taxation of unsupported expenditure incurred on foreign trips by the director of the company and treating such expenditure as remuneration under the Companies Act, 1956, involve interpretation of law only, the Committee does not offer any opinion on these issues. The Committee’s opinion, therefore, is restricted to the accounting/auditing issues raised in the query.

4. The Committee notes that paragraph 15 of the Auditing and Assurance Standard (AAS) 1, ‘Basic Principles Governing an Audit’, issued by the Institute of Chartered Accountants of India, provides as follows:

"15. The auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial information."

5. The Committee further notes that the Auditing and Assurance Standard (AAS) 5, ‘Audit Evidence’, issued by the Institute of Chartered Accountants of India, explains the expression ‘sufficient appropriate audit evidence’. Paragraph 2 of the Standard states that "Sufficiency refers to the quantum of audit evidence obtained; appropriateness relates to its relevance and reliability".

6. The Committee also notes that paragraph 7 of AAS 5 provides as follows:

"7. The reliability of audit evidence depends on its source - internal or external, and on its nature - visual, documentary or oral. While the reliability of audit evidence is dependent on the circumstances under which it is obtained, the following generalisations may be useful in assessing the reliability of audit evidence:

 · External evidence (e.g. confirmation received from a third party) is usually more reliable than internal evidence.

· Internal evidence is more reliable when related internal control is satisfactory.

· Evidence in the form of documents and written representations is usually more reliable than oral representations.

· Evidence obtained by the auditor himself is more reliable than that obtained through the entity."

7. It would be observed from the above that an auditor has to obtain sufficient appropriate audit evidence in all cases for formulating his opinion on the information under audit. Where, owing to the circumstances, it is not possible for the auditor to do so, it would be appropriate for him to disclaim any opinion on the information under audit.

8. The Committee further notes that paragraph 2.28 of the ‘Statement on Qualifications in Auditor’s Report’, issued by the Institute of Chartered Accountants of India, dealing with clause (e) of section 227(1A) of the Companies Act, 1956, provides as below:

"2.28 The practice of meeting certain types of personal expenses of employees is normal and is recognised both by the Income-tax Authorities and the Company Law Board. Illustrative of such expenses are the provision of rent-free quarters, conveyance for personal use, medical expenses, expenses on leave travel, maternity benefits, canteen facilities, etc. The charging to revenue of such personal expenses, either on the basis of the company’s contractual obligations, or in accordance with accepted business practice, is perfectly normal and legitimate and does not call for any special comment by the auditor. Where, however, personal expenses not covered by contractual obligations or by accepted business practice are incurred by the company and charged to revenue account, it would be the duty of the auditor to report thereon."

9. In the context of the facts of the case, the Committee observes that payment for foreign trip can be made by the company to the director in the form of an ‘allowance’ or a ‘reimbursement’. An ‘allowance’ is a fixed sum of money allowed on the basis of certain entitlement criteria, e.g., designation, period of service, salary drawn, etc., which is payable to the employee irrespective of the actual expenditure. No evidence supporting the expenditure is required for payment of an ‘allowance’ to an employee. On the other hand, a ‘reimbursement’ is the payment against actual expenditure. In order to claim reimbursement, an employee is generally required to furnish evidence of having incurred the expenditure. The Committee notes from the facts of the case that in the given case, the director has not been given the advance against his ‘allowance’ for the foreign trip. The advance has been given to the director to meet the expenditure to be incurred by him which should be accounted for and adjusted against reimbursement of actual expenditure. However, the Committee notes that the querist has stated in paragraph 1 above that on returning from a foreign tour, the director gives a declaration stating that he has spent the entire amount of advance taken without giving any details. The Committee is of the view that the auditor should ascertain other relevant facts such as whether the advance paid to the director is pursuant to the policy of the management of the company which is based on the approximate estimation of the expenditure normally incurred by a person of the status of a director on visiting a foreign country and that the same policy is applicable to persons of similar status in the company. If the auditor feels that the amount of advance taken is reasonable approximation of the expenditure incurred keeping in view the above factors, then even a declaration of the director pursuant to the policy of the management to obtain declaration in such cases, that the amount in question has been expended by him for official purposes may be considered adequate in the absence of grounds for suspicion. However, if the auditor is not satisfied, he may call for the necessary details of the expenditure incurred and ask for evidence in the form of documents such as counterfoils of air-tickets, hotel bills, etc.

D. Opinion

10. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 2:

(a) Whether the declaration given by the director in respect of the expenditure incurred (without any details or supportings) is a sufficient document for booking the amount as a business expenditure or not would depend upon the factors discussed in paragraph 9 above.

(b) It is a matter of professional judgement of the auditor as explained in paragraph 9 above.

(c) If the auditor is not satisfied on the basis of the procedures performed as explained in paragraph 9 above that the expenditure incurred by the director is justified, he may state in his report that the expenditure, to the extent it is not reasonable, represents the personal expenses that have been charged to revenue for the purpose of section 227 (1A) sub-clause (e) of the Companies Act, 1956.

(d), (e) and (f) The Committee does not offer any opinion on these issues as stated in paragraph 3 above.

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1Opinion finalised by the Committee on 28.10.2003.