Verification and Valuation of Assets and Liabilities Bcom Notes
Verification and Valuation of Assets and Liabilities Bcom Notes:- In this post, I am giving you the notes of Bcom 3rd Year auditing, which is going to be very useful in your examination and you should share this post to all friends and all your groups so that your friends also read this post. Could. Verification Valuation Assets Liabilities
Verification and Valuation of Assets and Liabilities
Meaning and Definitions of Verification
Literary meaning of verification is proving the truth’ or ‘confirmation’. Verification is a process normally carried out at the end of the year, to confirm the ownership, valuation and existence of items at the balance sheet date. With the help of verification, the auditor ensures that the assets are free from any charge or lien. Some important definitions of verification are as follows:
According to Spicer and Pegler, “Verification of assets implies an enquiry into the value, ownership and title, existence and possession, and the presence of any charge on the assets.”
According to Lancaster, “The verification of assets is a process by which the auditor substantiates the accuracy of the right hand side of the balance sheet, and must be considered as having three distinct objects:
(i) verification of the existence of assets.
(ii) the valuation of assets, and
(iii) authority for their acquisition.”
Verification Valuation Assets Liabilities
Verification of assets includes the following points:
(a) that the assets were in existence on the date of the balance sheet;
(b) that the assets had been acquired for the purpose of the business and under a proper authority;
(c) that the right of ownership of the assets vested in or belonged to the undertaking:
(d) that they were free from any lien or charge not disclosed in the balance sheet;
(e) that they had been correctly valued having regard to their physical condition; and
(f) that their values are correctly disclosed in the balance sheet.
If the auditor fails to verify the assets as shown in the balance sheet, he will be held liable for damages as it was decided the case of London Oil Storage Company Ltd. Vs. Sear Halsuk & Co. (1904). The learned judge observed, “It is the duty of the auditor to verify the existence of assets stated in the balance sheet and he will be liable for any damage suffered by the client if he fails in his duty.”
The auditor also make verification of liabilities shown in the balance sheet. He verifies the following facts regarding liabilities:
(i) The liabilities are clearly disclosed in the balance sheet.
(ii) All the liabilities are real and related to the concern.
(iii) All the liabilities upto the date of balance sheet are included.
(iv) Liabilities are fully authorised and properly valued in accordance with generally accepted accounting principles.
Verification Valuation Assets Liabilities
Objects of Verification
The following are important objects of verification:
(1) Correct valuation of the assets and liabilities
(2) Certification of the arithmetical accuracy of the accounts books
(3) Whether the Balance Sheet exhibits a true and fair financial position of the concern
(4) Finding out Existence of the Assets
(5) Finding out the Ownership and Title of the Assets
(6) Detection of Fraud and Irregularities
Duty af an Auditor in Relation to Verification
Or
General Rules of Verification
Duty of an auditor in relation to verification can be divided into two parts:
(i) In relation to the verification of assets,
(ii) In relation to the verification of liabilities.
In Relation to the Verification of Assets
The auditor should give his attention to the following while verifying assets:
(1) Existence of Assets: The auditor should see that all the assets shown in the balance sheet must exist in the concern.
(2) Proper Valuation: He should see that valuation of asset has been made properly.
(3) Charge: He should see whether or not the assets are free from any charge or lien. If there is any charge on the assets, auditor should mention it in his report.
(4) Ownership of the concern: The auditor should see that the assets were under the ownership of the concern.
(5) Proper arrangement of writing off the fictitious assets: If there are some fictitious assets in the concern, the auditor should see that there must exist proper arrangement for writing of these assets.
(6) Depreciation: The auditor should see that depreciation applied at each asset is adequate and proper.
(7) Distinction between revenue and capital expenditure: The auditor should see that proper distinction is made between capital and revenue expenditures. Expenses o repairs and renewal of assets must have been debited t expenditure account.
(8) Properly disclosed: He should see that all the assets have been included in the balance sheet and disclosed properly. Increase or decrease in property, if any, has been shown in the balance sheet.
In Relation to the Verification of Liabilities
Duty of an auditor in relation to verification of liabilities are & follows:
(1) Reality of liabilities: The auditor should see whether all the liabilities shown in the balance sheet is real or not.
(2) Amount of liabilities: He should see whether a liabilities have been included at correct value and they really become due at the date of balance sheet.
(3) Clearly explained: The auditor should see that ever liability must have been explained clearly in the balance sheet there is no other liability which has been left to write in the balance sheet.
(4) Belongs to the concern: He should see whether all the liabilities belongs to the concern and of the employees.
(5) Contingent liabilities: The auditor should see that contingent liabilities have not been included in the real liabilities.
(6) Adjusted amount of liabilities: If there is any increase or decrease in the liabilities, it must have been shown in the balance sheet.
Verification Valuation Assets Liabilities
Valuation of Assets and Liabilities
Estimation of the value of the assets keeping in mind their value on the date of the balance sheet is termed as valuation. Valuation forms an important part of every audit, because the accuracy of Balance Sheet depends much upon how correctly the estimation of the value of various assets and liabilities has been made. Both over-valuation and under-valuation of assets and liabilities would exhibit wrong picture of the financial position of a concern. The auditor has to see that the assets and liabilities appearing in the balance-sheet have been exhibiting their proper value, i.e., neither they have been over-valued nor under-valued.
Verification Valuation Assets Liabilities
Objects and Importance of Valuation
Valuation of assets has a great importance in business. In its absence, the balance sheet is not able to present true and accurate financial position of the business. Wrong valuation of assets affects not only the balance sheet but also the profit and loss account of the business. Under-valuation of assets will result in accumulation of secret reserve which will be misused by the owners. On the other hand, if assets are over-valued, profits will unnecessarily increase. As a result dividends will distribute from the capital and one day the capital will vanish completely. Not only this, the customers will also be cheated in the absence of proper valuation. It is thus, clear that valuation plays an important role in business life.
Generally, valuation of assets is done to serve the following purposes:
(1) Knowledge of correct financial position: With the help of the valuation of assets and liabilities, correct financial position of a concern can be found out.
(2) Knowledge of value of assets at the date of balance sheet: The main object of valuation is to know the real value of assets at the date of balance sheet.
(3) Knowledge of difference in the value of assets: Valuation helps to know the difference of the value of assets between the date on which the asset was acquired and the date on which the balance sheet was drawn. So, the reasons for this difference can be debated over.
(4) Knowledge of goodwill: Valuation of assets and liabilities help to know the goodwill of the concern.
(5) Investment of capital: Valuation also helps to know how the capital of the concern stands invested.
(6) Satisfaction of auditor: Valuation helps the auditor to describe his report properly and accurately.
(7) Knowledge of secret reserve: Correct valuation helps to know whether there exists secret reserve in the concern or not.
Verification Valuation Assets Liabilities
Valuation and Auditor
Or
An Auditor is not a Valuer
Valuation does not only relates to the determination of the values of the assets as appearing in the balance sheet but is also critical examination of these values on the basis of normally accepted accounting, standards. Thus, the valuation of asset should be done by a responsible officer of the concern and the dutyd the auditor is to see whether they have been properly valued or not But a more important question is that how can he find out at what value should these assets appear in the balance sheet. For this purpose, he should obtain the certificates of professional an approved valuers and other competent persons. He can always rel upon these certificates and should also mention that fact in his aud report. He cannot work as a valuer because he does not possess the technical knowledge to find out the value of the assets.
However, he is not a valuer but he is deeply concerned with valuation of assets because ultimately he is to certify that the bas of valuation of assets is correct, and the assets shown in the balance sheet are properly valued in accordance with the generally accept conventions and accounting principles. If he is satisfied with the method of valuation he is free from his liability. If he is not, he mentions it in his report. In this regard, Lancaster’s words are significant:
“But the limitations of an auditor when concerned with ass values should not be overlooked. He is not a valuer and cannot expected to act as such. All that he can to is to verify the original cost price and to ascertain that as far as possible the current values are fair and reasonable and are in accordance with accepted commercial possible to value assets at cost less depreciation and the certificate of an official of the business is relied upon, it is very desirable that mention should be made of this fact in the auditor’s report on the balance sheet.”
De Paula quote his views in this regard that:
“It must be borne in mind that the actual valuation are made by the proprietors or officials of the concern who have a practical knowledge of such assets, and that an auditor’s duty is confined to testing the valuations as far as he can, and in this way satisfying himself that the position shown appears to be correct, he cannot, however, in any way guarantee the accuracy of the valuation.”
On the basis of the above statements it can be said that although auditor is not a valuer, but if he make any negligence regarding valuation of assets he will be held guilty. Therefore he should take utmost care regarding valuation and should kept in mind the following points:
(1) Checking of propriety of valuation: The auditor should check the propriety of valuation done by the management. He has to see that valuation is correct and appropriate and according to the principles of accounting.
(2) Advice from Experts: If necessary, the auditor should inquire into the basis of valuation from technical experts. He should also get certificate from experts in this regard.
(3) Follow-up of Articles and accounting principles: The auditor should also see whether all the rules and articles of the company and all the conventions and accounting principles have been followed.
(4) Certificate from responsible officials: In case of any doubt, the auditor should seek a certificate from responsible officials and should mention it in his report.
(5) Study of judgements regarding valuation: If any judgement regarding valuation has been given by a court, it should be followed.
(6) Mentioning suspicion in his report: In case he is not satisfied with the mode of valuation or if he feels that the values have not been determined on the basis of generally accepted conventions, he must include this fact in his audit report.
Valuation of Stock-in-Trade
Valuation of the stock-in-trade is one of the most important duties of an auditor in order to arrive at the correct profit and loss of the concern under audit. If the quantity and the value of the stock is not properly recorded, the financial statements will not present the true and correct position of the concern. If stock in trade is overvalued, it may increase the profits of the concern and if it is undervalued, secret reserve be created and it may also lead to fall in share value due to disclosure of low profits. Verification and valuation of stock in trade, should, therefore, be given utmost care and attention.
Stock-in-trade is a floating asset, therefore it should be valued “at cost price or market price whichever is less.” It is based on the accounting rule that no attention should be given to anticipated profits but a provision for anticipated losses must be made. In valuation of stock, cost price and market price play a significant role. These are explained in detail as follows:
Verification Valuation Assets Liabilities
Valuation of Stock and Auditor
Although auditor is not a valuer and it is not his work to make valuation of stock yet he cannot escape from his liability regarding proper and correct valuation of stock therefore he should apply tests to see that the stock-in-trade has been valued appropriately and correctly. If he fails in his duty, he will be held responsible. Some of the duties of the auditor in this connection are given below:
(i) He should get the certificate from the management regarding existence, authority and valuation of stock.
(ii) As to the cost figures, the auditor must satisfy himself that they have been calculated on some acceptable method and are applied consistently. If the method of valuation of the stock has been changed as compared to the previous year, it will be advisable for the auditor to mention this fact in his report.
(iii) The auditor should examine that stock sheets are duly signed by the competent authority and ensure that calculations, additions and castings are correct.
(iv) The auditor should see that the goods with the consignee of the goods sent on approval are not valued at selling price.
(v) If there is any fluctuation of gross profits, he should find out the reasons.
(vi) He should check the purchases and sales books to ensure that the goods purchased and sold have been properly recorded.
(vii) He should also see that proper provision is made for depreciation of the damaged and out of fashion stock etc.
(viii) He should see that the stock-in-trade in the balance sheet of a company is shown according to Schedule VI, Part I of the Companies Act.
(ix) If the auditor has any suspicion regarding valuation of stock, he should mention it in his report.
Verification Valuation Assets Liabilities
Valuation of Goodwill
Goodwill is the value of reputation of the firm. It enables the firm to earn more profit than the normal rate of profit. Goodwill has? no physical existence as much. It does not diminish in value with use. It has the potentiality of self-growth. The value of goodwill varies with the earning capacity of business.
According to Lancaster, “Goodwill is an intangible asset and has no monetary value outside the business itself. Moreover, as a rule, it is capable of realisation only if the whole business is sold.”
In principle, its valuation is a simple and easy task, but in practice it is not so simple. In the words of Spicer and Peglar:
“Goodwill is an asset which is difficult to value precisely and it is impossible to be dogmatic as to the basis upon which the valuation should be computed, even among accountants there is no settled opinion, there are, however, in most trades, recognised methods of valuing goodwill.”
Valuation of goodwill is not made every year but it is done only on special occasions and for special purposes only i.e. At the time of purchasing a business, enterance of a new partner, death or retirement of a partner etc.
Verification Valuation Assets Liabilities
Methods for the Valuation of Goodwill
(1) Average Profit Method: In this method, average profit of a few previous years is calculated and multiplied by the fixed number of years. For example, profit for the previous five years of a company is Rs. 25,000, Rs. 20,000, Rs. 35,000, Rs. 30,000 and Rs. 40,000 respectively. Value of goodwill has to be calculated on the two years purchase of average profits, then goodwill will be calculated as follows:
Average Profit= 25,000+20,000+ 35,000 + 30,000 + 40,000 / 5
= 1,50,000 / 5 = Rs. 30,000
= Rs. 30,000
Value of Goodwill 30,000×2= Rs. 60,000
(2) Super Profit Method: Super profit is the excess profit earned by an old firm in comparison with a new firm. The super profit calculated in this manner is multiplied by the fixed number of years to obtain the amount of goodwill. The formula for its calculation is
Normal Profit = Capital x Rate of Profit / 100
Super Profit = Actual Profit – Normal Profit
Goodwill = Super Profit x Fixed number of years.
Example:
Average invested capital = Rs. 12,00,000
Actual profit earned by the concern = Rs. 1,50,000
Normal rate of return = 10%
Valuation of goodwill is done on three years purchases.
Solution: Normal Profit= 12,00,000×10% = Rs. 1,20,000
Super profit = Actual Profit – Normal Profit
= 1,50,000 – 1,20,000 = Rs. 30,000
Goodwill = Super Profit x 3 = 30,000×3= Rs. 90,000
(3) Capitalisation Method: Under this method, first of all, super profit is calculated and it is capitalised with the normal rate of return. This capitalised amount of super profit is considered as value of goodwill.
Example:
Average invested capital Rs. 10,00,000
Actual profit earned by a concern = Rs. 1,20,000
Normal rate of return = 10%
Calculate the value of goodwill with capitalisation method.
Solution: Normal Profit= 10,00,000 x 10% = Rs. 1,00,000
Super Profit 1,20,000-1,00,000 = Rs. 20,000
Goodwill = Super Profit / Normal Rate of Profit = 20,000 / 10% = Rs. 2,00,000
(4) Annuity Method: (i) Under this method, first of all super profit is calculated,
(ii) Present value of annuity is found out for a certain period at a certain rate,
(iii) Amount of goodwill is found out by multiplying the super profit with the annuity.
Example: Profits of Arnav Ltd. for previous four years is Rs. 15,000, Rs. 25,000, Rs. 30,000 and Rs. 40,000 respectively. Average capital employed in the business is Rs. 2,00,000. Normal rate of return is 10%. Calculate the value of goodwill on the basis of annuity method. Present value of annuity of Rs 1 at 10% for four years is Rs. 2.50.
Solution:
Average Profit = 15,000+25,000+30,000+ 40,000 / 4
= Rs. 27,500
Normal Profit= 2,00,000 x 10% = Rs. 20,000
Super Profit 27,500-20,000 = Rs. 7,500
Goodwill = Super Profit x Value of Annuity
= 7,500 x 2.50 = Rs. 18,750
Verification Valuation Assets Liabilities
Duties of an Auditor Regarding Valuation of Goodwill
Goodwill is an assets which neither depreciate nor become obsolete therefore it must be shown in the balance sheet at their cost price.
The auditor should see that valuation of goodwill must be done on the basis of rules made by the concern and shown at their appropriate value in the balance sheet. If goodwill has been purchased the auditor should find out the correct value of goodwill after checking the agreement reached with the sellers. If the value of goodwill has increased due to revaluation, the auditor must satisfy himself about its desirability.
The Auditor should see that if at all goodwill will has been. written off, it has been done properly. To strengthen the financial position of the institution, goodwill should be written off in profitable years.
Valuation of Shares
Valuation of shares means the calculation of internal value of shares. There are two principal methods of valuation of shares:
- Intrinsic Value Method: This method is also known as Net Assets Method’ or Balance Sheet Method’. This method takes into account the net assets of the company against each share. Net assets is the difference between the realisable value of assets and the liabilities to outsiders. Non-trading assets, if any, should also be included at their market values. The available net assets less the paid-up value of preference shares represents net assets available for equity shareholders. This, divided by the number of equity shares, gives the intrinsic value of each equity share. Under this method, fictitious assets are not included in the assets. In short, value of a share may be expressed by the following formula:
Value Per Share = Net Assets of the Company / Number of Equity Shares
- Yield Method: Yield method takes into account the yield or earnings of the organisation. Generally the investors are interested in the earnings of the company and, therefore, shares are valued on the basis of earnings of the company. The principle in this case is to compare the yield of company in question with normal yield applicable to the industry. If the company gives a higher return than normal yield, the value of its shares will be proportionately higher. If the company gives less than normal yield, the value of its share will be lower. In short, the formula for calculating the value of the share is as under:
Value of a Share= Rate of Earnings / Normal Rate of Return x Paid up Value of Share
Verification Valuation Assets Liabilities
Meaning and Definition of Contingent Liability
A future uncertain liability which is dependent on the happening of some other event is known as a contingent liability. In other words, liabilities which have not arisen up to the date of the balance sheet, but may arise out of the contingent contracts (the performance of which depends upon the happening of a certain event which may or may not happen). Such liabilities are called contingent liabilities.
In short, Contingent liability is a liability which may or may not arise. A contingent liability is different from an actual liability.
Five Examples of Contingent Liabilities
Or
Types of Contingent Liabilities
- Liabilities on Bills Receivable Discounted and not Matured
- Liability for Calls on Partly Paid Shares
- Liability under a Guarantee
- Liability for Cases against the Company not Acknowledged as debts
- Liability for Penalties under Forward Contracts
- Liability in respect of Arrears of Dividend on Cumulative Preference Shares
Verification Valuation Assets Liabilities
Auditor’s Duties Regarding Contingent Liabilities
(1) The auditor should inspect the various contracts entered into by the company and assess the likelihood of contingent liability arising there from. His duty is to ensure that all such likely liabilities have been accounted for and shown in the Balance Sheet.
(2) Examine the Directors Minute Book, correspondence made with the legal advisers and the information obtained from the officials of the business. Ensure that proper provision has been made for all such liabilities. Some liabilities may have no provision made in the books but merely a note made at the foot of the Balance Sheet, e.g., bills receivable which have been discounted and which have not matured at the date of the Balance Sheet, arrears of fixed accumulated dividends, etc. In case for liabilities in respect of which provision has to be made in the Balance Sheet, e.g., liability which may arise in connection with a suit, etc., the auditor should examine such cases and ascertain the amount to be specifically reserved for the purpose.
(3) He should also obtain a certificate from the management to the effect that all contingent liabilities, which are apprehended to materialise at a future date, have been duly disclosed. If such liabilities have not been shown in the foot notes of the Balance Sheet, the auditor can make a note to this fact in his audit-report. It is an important point to note that the Contingent liabilities do not form part of the balance Sheet and, therefore, if he fails to verify them properly he will not be held responsible.
Verification Valuation Assets Liabilities
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