1.30 Query
Audit of items presented as gifts. 1. A limited company makes presentations of varying nature, ranging from costly jewelry to items of personal utilities like shirts, suit lengths, shoes, spectacles, etc., to its guests and business associates. No written acknowledgment of the receipt of the gifts is furnished by the recipients. The names of the guests are not indicated in the vouchers nor revealed to the auditor of the company. The vouchers are duly passed by the Chief Executive/Managing Director of the company and later, at the time of consideration of annual accounts, the Board of Directors, inter alia, approve the total amount of such presentation expenses as meant for business purposes. The expenditure is exhibited under the head “Charges General” along with other miscellaneous expenses.
2. In the circumstances, the querist has sought the opinion of the Committee on the following issues:
(i) Should the auditor give a disclaimer or qualify his report?
(ii) Would it make a difference if the names of the guests are furnished to him?
(iii) What are the duties of the auditor, in this respect, to the members of the company?
Opinion October 10, 1988
1. The Committee notes that Statement on Standard Auditing Practices: “Basic Principles Governing an Audit” (SAP 1), issued by the Institute of Chartered Accountants of India, states:
“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.” (para 15)
2.The Committee also notes that Statement on Standard Auditing Practices: “Audit Evidence” (SAP 5), issued by the Institute of Chartered Accountants of India, states (para 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 generalizations 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 document 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.”
3. Paragraph 12 of Statement on Standard Auditing Practices: “Audit Evidence” (SAP 5) reads as below:
“Inspection of records and documents provides evidence of varying degrees of reliability depending on their nature and source and the effectiveness of internal controls over their processing. Four major categories of documentary evidence, which provide different degrees of reliability to the auditor are:
- documentary evidence originating from and held by third parties;
- documentary evidence originating from third parties and held by the entity;
- documentary evidence originating from the entity and held by third parties; and
- documentary evidence originating from and held by the entity.”
4. 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.
5. The method by which the auditor seeks to obtain audit evidence would depend primarily upon the nature of the item concerned. In the case cited by the querist, the evidence available for audit purposes comprises the vouchers prepared by the company in respect of the presentations made. This documentary evidence is created by the company itself. As such, the degree of reliability of the evidence is relatively less. It must be recognised, however, that during the course of an audit, situations do arise where the auditor is confronted with this kind of evidence. For example, in the case of cash sales, the cash memos are prepared by the entity itself and it is not necessary that the cash memos are signed by the customer. Even if the cash memos were so signed, it would be a difficult task for the auditor to satisfy himself about the genuineness of the signatures. In situations such as these, the auditor has to rely more on an evaluation of the efficacy of the internal controls established by the entity than on substantive checking. If the auditor finds that the internal controls are well-designed and properly implemented and the circumstances are not such as to arouse his suspicion, he may place reliance on internal controls in forming his opinion in the matter. In the instant case, the aspects which the auditor should examine in this behalf would include ascertaining whether the presentations made were duly authorized; whether they were made for business purposes; and so on. It may also be useful for the auditor to ascertain in industry practices in the matter; past practices of the company; and the extent of presentations made in the context of the overall size of operations of the entity. The auditor should also examine the purchase vouchers in order to satisfy himself whether the items claimed to be gifted were actually purchased. If, on a consideration of all these factors, the auditor is satisfied that the presentations made by the company are reasonable, duly authorised and for business purposes, it may not be necessary for him to take any further steps in the matter. If, on the other hand, the auditor is not satisfied about the above matter, he may qualify his report, stating the reasons for the qualification. A disclaimer of opinion would be appropriate where the auditor is not satisfied about the above matters and the amount of presentations made is so material that in the absence of sufficient appropriate audit evidence in relation thereto, it would be meaningless to express any opinion.
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