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Tuesday, 15 November 2011

What are the secret reserves and what are the different ways of creating the secret reserves and what are the duties of an auditor in respect of secre

"A reserve which is not visible on the balance sheet is called secret reserves."
It is a surplus concealed. In case of a secret reserve existence the actual financial position of the business is better than shown in the balance sheet. In case of bank, insurance companies and financial institutions secret reserves are justified.

Secret reserves may be created in the following ways :

1. High Value Of Goodwill :-
In the balance sheet if value of good will is shown nominal or how but infact its value is high reserve may be created.

2. Shown More Bad Debts :-
If management has made excessive provisions for bad debts. Infact these are less than the reserves allocated. So keeping in view the difference secret reserves can be created.

3. Shown More Depreciation :-
By providing too much depreciation on fixed assets, management creates secret reserves.

4. More Liabilities Shown :-
By over valuing the liabilities, management may create the secret reserves. Due to this profits reduce.

5. Low Value Of Fixed Assets :-
In the balance sheet the value of fixed asset is shown very low real value is very high. In this situation secret reserves may be created.

6. Under Value Of Current Assets :-
Management shows less value of current asset in the balance sheet actual value of the current asset is greater. So the secret reserves may be created.

7. Contingent Liabilities As Red Liabilities :-
To create secret reserves management show the contingent liabilities as real liabilities in the balance sheet. So profits and reserves may be reduced equal to the secret reserves.

8. Fictitious Liabilities Shown :-
To create the secret reserves management shows the fictitious as actual liabilities.

9. Capital Expenditure To Revenue :-
Sometimes to create the secret reserves management charges the capital expenditure to revenue. The profit is reduced.

10. By Omitting :-
Sometimes management omits some assets from the balance sheet and in this way it creates the secret reserves.

Following are the important duties of an auditor :

1. Thorough Checking :-
Auditor should examine the record of the company thoroughly where secret reserves exists.

2. Examine The Articles :-
Auditor should examine the company articles. He should see the powers of the directors to create the secret reserves.

3. Best Interest Of The Company :-
If auditor finds that secret reserves are created in the best interest of the company and these are used properly for the benefit of the company. Then he may not report about the existence of the secret reserves.

4. Secret Reserves Not Justified :-
If the auditor finds that there is no justification of creating reserves then he should report the matter in detail to the shareholders.

5. To Meet Bad Debts :-
If the secret reserve is utilized by the directors to meet bad and doubtful debts if should be disclosed by the auditor to the shareholders.

6. Limited Company Case :-
To present a true and fair of the corn pany auditor has to certify the balance sheet. So no secret reserve can be created by a limited company.

IMPORTANT NOTE : Company can not restrain its auditor from reporting to the shareholders about the creation of secret reserves by its articles of association.


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