Propriety Audit: Concept and Requirements

After reading this article you will learn about Propriety Audit:- 1. Concept of Propriety Audit 2. Propriety Requirements and Propriety Elements of Reporting in the Indian Company Law.

Concept of Propriety Audit:

Propriety audit may be defined as ‘Audit concerning the decisions of the executives, with an emphasis on public interest, financial discipline, basically to get audit satisfaction that such decisions are within the frame-work of sanction, authority, rule, procedure and law made by a competent body, and to advise the executives either in preventing or reducing losses and increasing productivity or improving performance by timely reporting’.

No precise or specific rules can be laid down for regulating the course of audit against propriety. Propriety audit extends beyond the formality of the expenditure to its wisdom, faithfulness and economy. It should not only ensure that an expenditure incurred is duly sanctioned by an appropriate authority but should also investigate the justifications and the necessity for it.

The auditors, while conducting the propriety audit, should in any case ensure observance of the following Canons of Financial Propriety:

(a) The expenditure should not, prima facie, be more than the occasion demands. Every public officer is expected to exercise the same vigilance in respect of expenditure incurred from public moneys as a person of ordinary prudence would exercise in respect of expenditure of his own money.

(b) No authority should exercise its power of sanctioning expenditure to pass an order which will be directly or indirectly to his own advantage.

(c) Public money should not be utilised for the benefit of a particular person or section of the community unless:

i. The amount of expenditure involved is insignificant or

ii. A claim from the amount could be enforced in a court of law or

iii. The expenditure is in pursuance of a recognized policy or custom.

(d) The amount of allowances (e.g. travelling allowances) granted to meet the expendi­ture of a particular type, should be so regulated that these are not on the whole sources of profit to the recipients.

Besides the scrutiny of individual transactions with a view to detect eases of improper expenditure, an auditor, while performing the task of propriety audit, should examine how far the transactions sanctioned are adequate in discharging the financial responsibilities with regard to the various schemes undertaken.

To assess the adequacy or otherwise of the effect of financial responsibilities, propriety, audit should examine on the following broad lines:

1. Whether the technical estimates or detailed programme and cost schedules are being framed and that the same are adhered to; if not, whether there are adequate reasons for excess, delays, etc., or whether these are occasioned by inefficient handling, wastes, etc. or due to incorrect preparation of original estimates.

2. Whether there have been any serious avoidable delays in the progress of the schemes resulting in increase in the total cost of the scheme.

3. Whether there has been any wasteful expenditure including that resulting from lack of co-ordination.

4. Whether there have been any losses of recurring nature.

5. Whether the performance and cost compare with the results obtained in respect of similar schemes in other fields or in other public projects.

6. How far the physical targets have been achieved within the estimated or sanctioned time.

7. How far the ultimate objectives of the expenditure have been fulfilled.

Propriety audit has its following limitations:

1. In decision-making process:

Since the auditor, in terms of propriety audit, examines and scrutinizes every decision of the executive, the executive often does not take quick and bold decisions. It affects dynamism, progress and causes delay.

2. In compliance with Regulations:

The executives become inclined to function strictly according to rules and regulations. This does not ensure achievement of targets or objectives.

3. Timeliness:

The audit and its report, if delayed, will not be of much use. It will be a futile report on an unprofitable contract after incurring losses.

Presently the forms of organisation which are having the benefits of propriety audit are:

i. Government companies, such as the State and Central Government undertakings. The Comptroller and Auditor General of India has a right to conduct efficiency-cum- economy oriented propriety audit, in addition to the statutory audit under his guidelines and instructions.

ii. Public limited companies. A chartered accountant in practice within the meaning of the Chartered Accountants Act, 1949 has also some right to conduct such propriety audit in a limited sense according to the provisions contained in Section 227 of the Companies Act, 1956.

iii. Companies where cost accounting record rules have been made applicable compulsorily and where the Central Government specifically issues orders for the conduct of Cost Audit under Section 233B of the Companies Act, 1956. A Cost Accountant in practice within the meaning of Cost and Works Accountants Act, 1959 has a right to conduct such audit and submits his report covering the points which are propriety based.

In the case of Government Companies the Comptroller and Auditor General of India conducts the propriety audit by effectively covering most of the points either through his Resident Audit parties on a continuous basis or by test checks, and through audit by the statutory auditors specifically under his instructions and guidelines. Such audit, therefore, may reasonably be said to be effective.

In the case of limited companies, the shareholders are generally scattered all over the country. They do not have a real say or control on the conduct of the affairs of the company. The company is in the hands of the Board of Directors. The shareholders need an assurance that their funds are properly managed.

The statutory auditor has a right to enquire such matters designed to curb specific malpractices often committed by the persons at the helm of the affairs, and he is required to report under the Manufacturing And Other Companies (Auditors’) Report Order, 1988. Such provisions contain some of the important propriety elements but do not cover all the elements. In this sense, the audit is not comprehensive enough.

In the interest of the development of healthy corporate sector, it would be better if specific legislation is made to provide suitable guidelines for a propriety audit in this type of companies.

Propriety audit can be extended to any organisation whether sole proprietorship, partnership, club, trust, financial institutions, etc. which desire to get the benefits out of it namely, efficiency, economy, etc. But before accepting or introducing such audit, the organisation itself should ensure that it would not be a costly exercise and for which it should make a cost benefit study.

Propriety Requirements and Propriety Elements of Reporting in the Indian Company Law:

The Companies Act, 1956 has made provisions with regard to the propriety requirements and propriety elements of reporting under Sections 227 and 233B.

Propriety Requirements:

According to Section 227 (1-A) of the Act, the Auditor is required to enquire into:

(a) Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the company and its members.

(b) Whether transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company.

(c) Where the company is not an investment company within the meaning of Section 372 or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than at which they were purchased by the company.

(d) Whether the loans and advances made by the company have been shown as deposits.

(e) Whether personal expenses have been charged to revenue account.

(f) Where it is stated in the books and papers of the company that any shares have been allotted for cash, whether cash has actually been received, in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading.

In all the above cases, the auditor has to enquire statutorily, and on enquiry he is required to report only when there is an unfavorable reply. Obviously, his enquiries should be designed so as to curb specific malpractices generally committed by the persons at the helm of affairs of a company. His audit is, thus, propriety-based.

The auditor is further required to report under the Manufacturing And Other Compa­nies (Auditors’ Report) Order, 1988, issued under the Company Law, which deals with some important propriety elements. He submits his report when there is an unfavorable situation.

Propriety Elements of Reporting:

According to Section 227 (4-A) which provides for propriety elements of reporting, the auditor submits his report describing the position as favourable or otherwise as the case may be in respect of the following matters :

1. “Whether the company is regular in depositing the Provident Fund dues with appropriate authority.” It is a statutory, social and moral obligation imposed on the Company to deposit the provident fund dues regularly with the appropriate authority. Any delay or irregularity in meeting this obligation would certainly amount to injury and injustice towards workmen. Reporting about such irregularities is definitely propriety-based. It would be more proper should the auditor’s report be specific about the extent of irregularity by linking up the duration of delay and the amount of provident fund dues.

2. “Whether prices paid for the purchase of stores, raw materials or components exceeding rupees ten thousand in value for each type from subsidiaries and other parties in which the Directors are interested are reasonable as compared to the prices of such items supplied by other suppliers.”

This is with the object of ensuring that people are cost conscious and that the company funds are not funnelled out by making personal benefits at the cost of the company.

3. “Whether the steps taken by the company for recovery of the principal amount given out as loans or advances in the nature of loans, and the recovery of interest if any thereon, is reasonable and regular.” There may be a practice to benefit some employees at the cost of the organisation. The auditor’s report on such malpractice becomes a propriety-based.

4. “If the company has taken any loan, secured or unsecured from companies or other parties under Sections 301 and 370 (1) (c) of the Act, whether the rate of interest and the terms and conditions of such loans are prima facie prejudicial to the interest of the company.” The auditor has to judge reasonableness objectively by the standards like, urgency, alternative finance available and the rates of interest applicable and the securities lodged and other considerations.

According to Section 233B of the Companies Act, the Cost Auditor’s report, which covers the following points, is propriety based:

(a) Matters which appear to him to be clearly wrong in principle or apparently unjustifiable,

(b) Cases where the company’s funds have been used in a negligent or inefficient manner.

(c) Factors which could have been controlled, but have not been done resulting in an increase in the cost of production, etc..