|
A. Facts of the Case
1. An unlisted State Government undertaking deals in
transportation of passengers by trams and buses in the city of
Kolkata. The company was incorporated at London in the year
1880. Later, the company was taken over by the State Government
in the year 1976 and the new company was incorporated on 15th
October, 1982. Apart from regular audit by the Office of the Principal
Accountant General (the State), the company is audited by statutory
auditors appointed by the Comptroller and Auditor General of India
(C&AG), New Delhi. During the financial year 2006-07, a new
auditor has been appointed to audit the accounts of the company.
An issue has been raised by the statutory auditors during the
course of their audit. The background of the issue is contained in
the following paragraphs.
2. The company had outstanding dues to another company, XYZ
Ltd. in the form of fuel surcharge on account of high tension
electricity (amounting to Rs. 20,59,22,169) and delayed payment
surcharge (Rs. 25,35,37,643). The querist has stated that the State
Government sanctioned an amount of Rs. 45,94,59,812 in the
financial year 2001-02 in the form of capital grant towards settlement
of the said outstanding dues to XYZ Ltd. by book adjustment
against some receivables from XYZ Ltd. by the State Government.
A copy of Order No. 2907-F.B. dated 5.11.2001 of the State
Government has been supplied by the querist for the perusal of
the Committee. The company running the trams had been unable
to pay to XYZ Ltd. the electricity charges since a long time. The
delayed payment surcharge (Rs. 25.36 crore) was disclosed as a
contingent liability by the company. The company was unable to
pay the debt to XYZ Ltd. as it was beyond its means due to its
capital having been totally eroded due to continuous losses year
after year. The State Government came to a settlement with XYZ
Ltd. with regard to the dues for the energy bills of the company,
which is wholly owned by the State Government. In the said settlement, the Director of the Electricity Board, State Government,
adjusted the unpaid electricity consumption bills of the company
along with other local/public bodies against the sum which XYZ
Ltd. owed to the State Government by way of electricity duty.
Thus, the adjustment of the company’s accumulated debt and
delayed payment surcharge to XYZ Ltd. was by book entry. There
was contra-debiting the debt of the company to the head, ‘3055
Road Transport-00-800-other expenses-Non-plan-005-grant to the
company for adjustment of energy bill of XYZ Ltd. (TR) 31-grant-
IN-Plan-02-Other grant’. As per the querist, the communication
dated 5.11.2001 of the State Government in this connection bears
out the facts stated. Thus, as per the querist, it is clear from the
nature of the grant by the State Government that the entire grant
was for the purpose of stemming the erosion of the capital of the
company, which is owned by the State Government (emphasis
supplied by the querist). According to the querist, it is an SOS act
of the State Government to improve the liquidity position of its own
undertaking and keep it going in the larger public interest. The
adjustment with XYZ Ltd. was only a mode as the State Government
had to receive its dues from XYZ Ltd.
3. According to the querist, the accounting narration of the State
Government, as indicated above, clearly shows that the intention
of the State Government was to save the sub-stratum of the
company, its own undertaking, which was on a high funds crisis.
The Government came forward to help its own undertaking and
thus, ensure its survival. The State Government found this
necessary in the interest of maintaining the mass conveyance of
public transport system in the city in which the wholly owned
company of the State Government has been playing a major role
for a century and a quarter. The grant is an imperative step for
strengthening its capital base.
4. The querist has stated that the Deputy Secretary to the State
Government vide letter no. 2578-WT/TR/P/7T-7/2005 dated 08th
June, 2005 had clarified that the grant is provided to its wholly
owned company to assist in overcoming the shortage of capital
and thus, it is a capital contribution. As per the querist, the letter in
this connection bears out the facts stated above.
5. The querist has further stated that in the assessment procedure
of Assessment Year 2002-03, the fact was raised by the A.C.I.T.
and he declined to accept it as a capital grant. The company
contended the views of the assessing officer and approached the
higher authority. The C.I.T. (A) and then I.T.A.T. (Kol.) rejected
the views of A.C.I.T. and upheld the company’s view supported by
the documents received from its 100% owner, the State
Government.
6. A similar situation arose in the financial year 2005-06, when
the State Government vide its order no. 103-WT(F)/TR/N/7T-9/
2003 dated 6th July, 2005, sanctioned a grant of Rs. 2 crore for
adjustment against electricity dues to XYZ Ltd. upto March 2005.
A copy of the said order has been supplied by the querist for the
perusal of the Committee. As per the querist, it is the government’s
policy to adjust the dues against government fuel surcharge dues
from XYZ Ltd. by book adjustments. As experienced from previous
years and as a prudent matter, the company treated the same as
capital receipt and showed under capital reserve as evidenced
from the balance sheet. The statutory auditors sought explanation
to the transaction and after scrutinising all the papers, they admitted
that the transaction was rightly treated in the accounts. The matter
was also taken up by the Resident Audit Officer, C.A.G., vide their
query no. AQ/1/CTC/Annual A/cs/2005-06 dated 03.11.2006 relating
to audit query of financial year 2005-06. The company replied the
matter as stated above and the statutory auditors also agreed with
the management’s reply. After being satisfied with the reply, the
Principal Accountant General (Audit), the State, served his report
with “no comments” for the financial year 2005-06.
7. During the audit for the financial year 2006-07, the statutory
auditors for that year again raised the question over the transaction
and the company narrated the matter as above though the
transaction did not pertain to the year under audit. It was purely a
previous year’s transaction, which occurred and transacted in the
same year itself. The company also submitted to the auditors all
the papers relating to the financial year 2001-02 and 2005-06 as
evidence and tried to explain that the matter is well settled. However,
they suggested the company to ignore all the facts that happened
earlier and make changes in the current year’s accounts, to which the company denied. The auditors accordingly qualified the
accounts vide qualification no. 4.6(ii)(a), which reads as below:
“(a) The sanction of payment in the previous year by the
State Government of Rs. 200 lakh as a subsidy to clear off
“outstanding electricity charges upto March 2005” has been
treated as capital grant awarded by the State Government “to
rescue out the company from capital erosion” instead of treating
the same as revenue subsidy in terms of Accounting Standard
(AS) 12, ‘Accounting for Government Grants’ like other revenue
subsidies received and accounted for. This has resulted in
overstating the carrying amount of loss and capital reserve by
Rs. 200 lakh. Further, the nomenclature, “capital grant awarded
by the State Government (Promoter) to rescue out the
company from capital erosion” in the capital reserve as
disclosed by the company is not as per documents available.
However, we have been informed by the management that
the C&AG and the previous auditor of the company have
supported the accounting treatment as well as disclosure made
by the company.”
8. The situation being peculiar and unforeseen by the company,
the querist desires to know whether an auditor can ignore the
views of previous auditors appointed by the C&AG and cleared by
the C&AG itself. If so, in the view of the querist, the sanctity of the
auditors’ report upon which one relies is questionable. As per the
querist, the matter was not overlooked by anybody but discussed
at length by every authority. Further, if it is appropriate for the
auditor to raise the issue again, then infinite number of financial
statements of previous years can be reconstructed and there would
not be any final structure of financial statements in any year though
it is created by adopting proper accounting norms and duly audited
by appropriate authority.
B. Query
9. The querist has been advised to seek the opinion of the
Expert Advisory Committee of the Institute of Chartered Accountants
of India on the following issues:
(i) The subject matter of auditors’ qualification no. 4.6(ii)(a),
relates to the financial year 2005-06. Whether the statutory auditors can re-open and recommend changes
of the duly audited accounts of prior years in the current
year, on the plea that they are not in agreement with
the treatment of past year transactions, even if past
statutory auditors appointed by the C&AG, Principal
Accountant General (of the State) and the Income-tax
Department [C.I.T. (A) and Tribunal] have approved the
treatment in the accounts in that year.
(ii) Whether the current year’s auditors can recommend
changes in past years’ audited financial statements or
qualify the statements only because they dispute the
accounting treatment of an item of opening balance
which was duly audited and certified by a fellow member
of the Institute.
C. Points considered by the Committee
10. The Committee, while answering the query has considered
only the issues raised in paragraph 9 above and has not touched
upon any other issue(s) arising from the Facts of the Case, such
as, the propriety of accounting for the grant received from the
State Government in the context of which the current auditors
have qualified the financial statements vide their qualification no.
4.6(ii)(a), etc.
11. The Committee notes the following paragraphs of Standard
on Auditing (SA) 510 (AAS 22), ‘Initial Engagements – Opening
Balances’, issued by the Institute of Chartered Accountants of
India (ICAI):
“1. The purpose of this Standard on Auditing (SA) is to
establish standards regarding audit of opening balances in
case of initial engagements, i.e., when the financial statements
are audited for the first time or when the financial statements
for the preceding period were audited by another auditor. This
Standard would also be considered by the auditor so that he
may become aware of contingencies and commitments existing
at the beginning of the current period.”
“3. For initial audit engagements, the auditor should
obtain sufficient appropriate audit evidence that:
(a) the closing balances of the preceding period have
been correctly brought forward to the current period;
(b) the opening balances do not contain misstatements
that materially affect the financial statements for
the current period; and
(c) appropriate accounting policies are consistently
applied.”
“6. The auditor will need to consider whether the accounting
policies followed in the preceding period, as per which the
opening balances have been arrived at, were appropriate and
that those policies are consistently applied in the financial
statements for the current period and where such accounting
policies are inappropriate, the same have been changed in
the current period and adequately disclosed.
7. When the financial statements for the preceding period
were audited by another auditor, the current auditor may be
able to obtain sufficient appropriate audit evidence regarding
opening balances by perusing the copies of the audited
financial statements. Ordinarily, the current auditor can place
reliance on the closing balances contained in the financial
statements for the preceding period, except when during the
performance of audit procedures for the current period the
possibility of misstatements in opening balances is indicated.”
“12. If the opening balances contain misstatements which
materially affect the financial statements for the current
period and the effect of the same is not properly accounted
for and adequately disclosed, the auditor should express
a qualified opinion or an adverse opinion, as appropriate.”
12. From the above, the Committee notes that even though the
opening balances reflect the effect of the preceding periods, these
form an integral part of the financial statements for the current
period. If the opening balances are not correct, the financial
statements for the period will not portray a true and fair view.
Accordingly, it is the duty of every auditor to ensure that the
opening balances have been arrived at using appropriate accounting
policies. For this, the auditor will need to consider the appropriateness of the accounting policies followed in the preceding
period by examining the records underlying the opening balances.
If based upon above procedures, the auditor concludes that the
accounting policies are inappropriate, the auditor needs to consider
whether the same have been changed in the current period and
adequately disclosed in accordance with the requirements of
Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period,
Prior Period Items and Changes in Accounting Policies’ and other
pronouncements of the ICAI. In other words, the auditor needs to
consider whether the same have been rectified through rectification
entries in the current year. In case the effect of the incorrect
opening balances is not properly accounted for and adequately
disclosed in the accounts for the current year, the auditor should
express a qualified or an adverse opinion, as appropriate. The
Committee also notes paragraph 3.5 of the Preface to the
Statements of Accounting Standards issued by the Institute of
Chartered Accountants of India (ICAI) which states that the
responsibility for the preparation of financial statements and for
adequate disclosure is that of the management of the enterprise.
The auditor’s responsibility is to form his opinion and report on
such financial statements. Thus, the Committee is of the view that
the auditor cannot on his own re-open the duly audited accounts
of prior years in the current year and recommend changes therein.
He can only express his opinion on the accounts for the year
under audit. Accordingly, in case of incorrect opening balances,
the rectification of the same will have to be carried out in the
current year’s accounts through appropriate entries.
13. From the above, the Committee is of the view that under the
given circumstances of the company under consideration, the
auditor on his own cannot reopen the duly audited accounts of the
prior years and recommend changes therein. However, since the
opening balances are an integral part of the financial statements
for the current period, if in the opinion of the auditor, the opening
balances are not based on appropriate accounting policies and
the effect thereof is not properly accounted for (i.e., rectified) and
adequately disclosed in the accounts for the current year, the
auditor should qualify his audit report on the accounts of the current
year or give an adverse report, as deemed appropriate by him.
D. Opinion
14. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 9 above:
(i) The auditors cannot on their own reopen the duly audited
and adopted accounts of prior years and recommend
changes therein in the current year on the plea that
they are not in agreement with the treatment of past
year transactions. The auditors can only express their
opinion on the accounts for the year under audit.
(ii) The auditors cannot recommend changes in the past
year’s audited financial statements. However, since the
opening balances are an integral part of the financial
statements for the current period, if in the opinion of the
auditor, the opening balances are not based on
appropriate accounting policies and the effect thereof is
not properly accounted for (i.e., rectified) and adequately
disclosed in the accounts for the current year, the auditor
should qualify his audit report on the accounts of the
current year or give an adverse report, as deemed
appropriate by him.
|