PAPER – 6 : AUDITING AND ASSURANCE

Question No.1 is compulsory.

Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) Write the circumstances that indicate the possibility of fraud due to problematic or unusual
relationship between the auditor and management. (5 Marks)
(b) Write the steps that are taken for an audit to be carried out in a systematic and efficient
manner. (5 Marks)
(c) During the audit of PQR Ltd. you as an auditor requested officers of the company to have
access to secretarial records and correspondence which they refused to provide.
Comment. (5 Marks)
(d) As per the provisions of the companies Act, 2013 the report of Board of Director on annual
accounts shall also include a ‘Director’s Responsibility Statement’. Comment. (5 Marks)
Answer
(a) Problematic or unusual relationships between the auditor and management,
including:
1. Denial of access to records, facilities, certain employees, customers, vendors, or
others from whom audit evidence might be sought.
2. Undue time pressures imposed by management to resolve complex or contentious
issues.
3. Complaints by management about the conduct of the audit or management
intimidation of engagement team members, particularly in connection with the
auditor’s critical assessment of audit evidence or in the resolution of potential
disagreements with management.
4. Unusual delays by the entity in providing requested information.
5. Unwillingness to facilitate auditor access to key electronic files for testing through the
use of computer-assisted audit techniques.
6. Denial of access to key IT operations staff and facilities, including security, operations,
and systems development personnel.
7. An unwillingness to add or revise disclosures in the financial statements to make them
more complete and understandable.
8. An unwillingness to address identified deficiencies in internal control on a timely
basis.

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9. Unwillingness by management to permit the auditor to meet privately with those

charged with governance
10. Accounting Policy that appears to be variance with industry norms
11. Frequent changes in accounting estimates that do not appear to result from changed
circumstances
12. Tolerance of variations in the entity’s code of conduct
(b) In order that an audit may be carried out in a systematic and efficient manner, the
following steps should be taken:
(1) Work must be carried on regularly and record kept of time of arrival/departure of the
staff and also of the work done each day;
(2) As far as possible, a definite portion of the work should be completed each day so
that loose ends are not left over for being tied up at a later date;
(3) Entries should be made in the audit note book and the audit programme initialled as
a routine;
(4) Coloured pencils and different type of ticks must be employed to indicate the various
audit processes which have been applied and their significance must not be disclosed
to the client;
(5) All the vouchers after examination must be immediately cancelled with an audit
stamp;
(6) Staff members should refrain from discussing the client’s affairs amongst themselves
and with outsiders.
(c) Right of Access to secretarial records and correspondence:
1. Section 143(1) of the Companies Act, 2013 grants powers to the auditor that every
auditor has a right of access, at all times, to the books of account and vouchers of
the company kept at Registered or Head Office, branches and subsidiaries in the
case of a Holding Company for conducting the audit.
2. Further, he is also entitled to require from the officers of the company such
information and explanations which he considers necessary for the proper
performance of his duties as Auditor. Therefore, he has a statutory right to inspect
the secretarial records and correspondence.
3. In order to verify actions of the company and to vouch and verify some of the
transactions of the company, it is necessary for the auditor to refer to the decisions
of the shareholders and/or the directors of the company. It is, therefore, essential for
the auditor to refer to the secretarial records and correspondence which also includes
Minute book. In the absence of the same, the auditor may not be able to vouch/verify
certain transactions of the company.

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 PAPER – 6: AUDITING AND ASSURANCE 3

4. The refusal to provide access to secretarial records and correspondence shall

constitute limitation of scope as far as the auditor’s duties are concerned.
5. The auditor may examine whether by performing alternative procedures, the auditor
can substantiate the assertions or else he shall have to either qualify the report or
give a disclaimer of opinion.
(d) Director’s Responsibility Statement: According to section 134(3)(c) of the Companies
Act, 2013, the report of board of directors on annual accounts shall also include a
‘Director’s Responsibility Statement’. However, the provisions related to Director’s
Responsibility Statement are provided under section 134(5) of the Companies Act, 2013
which requires to state that-
(i) in the preparation of the annual accounts, the applicable accounting standards had
been followed along with proper explanation relating to material departures;
(ii) the directors had selected such accounting policies and applied them consistently
and made judgments and estimates that are reasonable and prudent so as to give a
true and fair view of the state of affairs of the company at the end of the financial year
and of the profit and loss of the company for that period;
(iii) the directors had taken proper and sufficient care for the maintenance of adequate
accounting records in accordance with the provisions of this Act for safeguarding the
assets of the company and for preventing and detecting fraud and other irregularities;
(iv) the directors had prepared the annual accounts on a going concern basis;
(v) the directors, in the case of a listed company, had laid down internal financial controls
to be followed by the company and that such internal financial controls are adequate
and were operating effectively.
(vi) the directors had devised proper systems to ensure compliance with the provisions
of all applicable laws and that such systems were adequate and operating effectively.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect: (Answer
any Eight)
(a) Audit notes can serve as a guide in framing Audit programme.
(b) Procedures and Techniques are often used interchangeably in an audit.
(c) For auditor’s opinion, reasonable assurance is an absolute level of assurance.
(d) The results of all cases of surprise checks are included in auditor’s report on the accounts.
(e) General CIS controls may have pervasive effect on the processing of transactions in
application system.
(f) Any item of income or expenditure which exceeds 1% of the net profit of the company or
` 2 lakh whichever is lower, is required to be disclosed in Profit & Loss A/c.

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(g) Internally generated Goodwill can be recognized as an asset.

(h) Sample size is not a valid criterion to distinguish between statistical and non -statistical
approaches.
(i) A government company which is in existence since 5 years cannot make political
contributions.
(j) The risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting one resulting from error. (8 x 2 = 16 Marks)
Answer
(a) Correct: Audit notes can serve as a guide in framing audit programme in the future as they
indicate the weaknesses in the system of the client which specially need to be watched.
(b) Correct: The two terms, procedure and techniques, are often used interchangeably.
However, a distinction does exist. Procedure may comprise a number of techniques and
represents the broad frame of the manner of handling the audit work; techniques stand for
the methods employed for carrying out the procedure.
(c) Incorrect: Reasonable assurance is a high level but not an absolute level of assurance,
because there are inherent limitations of an audit which result in most of the audit evidence
on which the auditor draws conclusions and bases the auditor’s opinion being persuasive
rather than conclusive.
(d) Incorrect: It is not necessary in all cases for the results of the surprise checks to be
included in the auditors’ report on the accounts. They should, however, be included if in
the opinion of the auditor they are material and affect a true and fair view of the accounts
on which he is reporting.
(e) Correct: The general CIS controls may have a pervasive effect on the processing of
transactions in application systems. If these controls are not effective, there may be a risk
that misstatements might occur and go undetected in the application systems.
(f) Incorrect: A Company shall disclose by way of notes additional information regarding any
item of income or expenditure which exceeds one per cent of the revenue from operations or
` 1,00,000, whichever is higher;
(g) Incorrect: As per AS-26, internally generated goodwill is not recognized as an asset
because it is not an identifiable resource controlled by the enterprise that can be measured
reliably at cost.
(h) Correct: The decision whether to use a statistical or non-statistical sampling approach is
a matter for the auditor’s judgment; however, sample size is not a valid criterion to
distinguish between statistical and non-statistical approaches.
Whatever may be the approach non-statistical or statistical sampling, the sample must be
representative. This means that it must be closely similar to the whole population although
not necessarily exactly the same. The sample must be large enough to provide statistically
meaningful results.

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(i) Incorrect: Section 182 of the Companies Act 2013 deals with prohibition and restriction
regarding political contributions. According to this section, a government company or any
other company which has been in existence for less than three financial years cannot
contribute any amount directly or indirectly to any political party.
(j) Correct: The risk of not detecting a material misstatement resulting from fraud is higher
than the risk of not detecting one resulting from error. This is because fraud may involve
sophisticated and carefully organized schemes designed to conceal it, such as forger y,
deliberate failure to record transactions, or intentional misrepresentations being made to
the auditor. Such attempts at concealment may be even more difficult to detect when
accompanied by collusion.
Question 3
How will you vouch/verify the following?
(a) Recovery of Bad debts written off
(b) Receipt of Insurance claims
(c) Payment of Taxes
(d) Sale proceeds of scrap material (4 x 4 = 16 Marks)
Answer
(a) Recovery of Bad Debts written off: Recovery of bad debts written off is verified with
reference to relevant correspondence and proper authorisation.
(i) Ascertain the total amount lying as bad debts and verify the relevant correspondence
with the trade receivables whose accounts were written off as bad debt.
(ii) Ensure that all recoveries of bad debts have been properly recorded in the books of
account.
(iii) Examine notification from the Court or from bankruptcy trustee. Letters from collecting
agencies or from account receivables should also be seen.
(iv) Check Credit Manager’s file for the amount received and see that the said amount
has been deposited into the bank promptly.
(v) Vouch acknowledgement receipts issued to account receivables or trustees.
(vi) Review the internal control system regarding writing off and recovery of bad debts
(b) Receipt of Insurance Claims: Insurance claims may be in respect of fixed assets or
current assets. While vouching the receipts of insurance claims-
(i) The auditor should examine a copy of the insurance claim lodged with the insurance
company correspondence with the insurance company and with the insurance agent
should also be seen. Counterfoils of the receipts issued to the insurance company
should also be seen.

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(ii) The auditor should also determine the adjustment of the amount received in excess
or short of the value of the actual loss as per the insurance policy.
(iii) The copy of certificate/report containing full particulars of the amount of loss s hould
also be verified.
(iv) The accounting treatment of the amount received should be seen particularly to
ensure that revenue is credited with the appropriate amount and that in respect of
claim against asset, the Statement of Profit and Loss is debited with the short fall of
the claim admitted against book value, if the claim was lodged in the previous year
but no entries were passed, entries in the Statement of Profit and Loss should be
appropriately described.
(c) Payment of Taxes:
(i) Obtain the computation of taxes prepared by the auditee and verify whether it is as
per the Income Tax Act/ Rules/ Notifications/ Circulars etc.
(ii) Examine relevant records and documents pertaining to payment of advance income
tax and self assessment tax.
(iii) Payment on account of income-tax and other taxes like GST consequent upon a
regular assessment should be verified by reference to the copy of the assessment
order, notice of demand and the receipted challan acknowledging the amount paid.
(iv) The penal interest charged for non-payment should be debited to the interest account.
(v) Nowadays, electronic payment of taxes is also in trend. Such electronic payment of
taxes by way of internet banking facility or credit or debit cards shall also be verified.
(vi) The assessee can make electronic payment of taxes also from the account of any
other person. Therefore, it should be verified that the challan for making such
payment is clearly indicating the PAN No./TAN No./TIN No./GSTIN etc. of the
assessee on whose behalf the payment is made.
(d) Sale Proceeds of Scrap Material:
(i) Review the internal control on scrap materials, as regards its generation, storage and
disposal and see whether it was properly followed at every stage.
(ii) Ascertain whether the organisation is maintaining reasonable records for the sale and
disposal of scrap materials.
(iii) Review the production and cost records for determination of the extent of scrap
materials that may arise in a given period.
(iv) Compare the income from the sale of scrap materials with the corresponding figures
of the preceding three years.
(v) Check the rates at which different types of scrap materials have been sold and
compare the same with the rates that prevailed in the preceding year.

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(vi) See that scrap materials sold have been billed and check the calculations on the
invoices.
(vii) Ensure that there exists a proper procedure to identify the scrap material and good
quality material is not mixed up with it and sold as scrap
(viii) Make an overall assessment of the value of the realisation from the sale of scrap
materials as to its reasonableness.
Question 4
Answer all questions:
(a) What are the provisions prescribed under Companies Act, 2013 in respect of ceiling on
number of audits in a company to be accepted by an auditor? (4 Marks)
(b) What are the considerations for an auditor regarding the operating effectiveness of controls
using audit evidence obtained in previous audits? (6 Marks)
(c) As an auditor, how would you consider the acceptance of a change in audit en gagement?
(6 Marks)
Answer
(a) Ceiling on number of Audits:
1. Section 141(3)(g) of the Companies Act, 2013 prescribes that a person shall not be
eligible for appointment as an auditor of a company namely – a person who is in full
time employment elsewhere or a person or a partner of a firm holding appointment as
its auditor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty companies other
than one person companies, dormant companies, small companies and private
companies having paid-up share capital less than ` 100 crore.
2. In the case of a firm of auditors, it has been further provided that ‘specified number
of companies’ shall be construed as the number of companies specified for every
partner of the firm who is not in full time employment elsewhere. This limit of 20
company audits is per person. In the case of an audit firm having 3 partners, the
overall ceiling will be 3 × 20 = 60 company audits.
3. Sometimes, a chartered accountant is a partner in a number of auditing firms. In such
a case, all the firms in which he is partner or proprietor will be together entitled to 20
company audits on his account. Subject to the overall ceiling of company audits, how
they allocate the 20 audits between themselves is their affairs.
(b) Using Audit Evidence Obtained in Previous Audits: In determining whether it is
appropriate to use audit evidence about the operating effectiveness of controls o btained in
previous audits, and, if so, the length of the time period that may elapse before retesting a
control, the auditor shall consider the following:

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(i) The effectiveness of other elements of internal control, including the control
environment, the entity’s monitoring of controls, and the entity’s risk assessment
process;
(ii) The risks arising from the characteristics of the control, including whether it is manual
or automated;
(iii) The effectiveness of general IT-controls;
(iv) The effectiveness of the control and its application by the entity, including the nature
and extent of deviations in the application of the control noted in previous audits, and
whether there have been personnel changes that significantly affect the application
of the control;
(v) Whether the lack of a change in a particular control poses a risk due to changing
circumstances; and
(vi) The risks of material misstatement and the extent of reliance on the control.
If the auditor plans to use audit evidence from a previous audit about the operating
effectiveness of specific controls, the auditor shall establish the continuing relevance of
that evidence by obtaining audit evidence about whether significant changes in those
controls have occurred subsequent to the previous audit.
(c) Acceptance of a Change in Engagement:
1. An auditor who, before the completion of the engagement, is requested to change the
engagement to one which provides a lower level of assurance, should consider the
appropriateness of doing so.
2. A request from the client for the auditor to change the engagement may result from a
change in circumstances affecting the need for the service, a misunderstanding as to
the nature of an audit or related service originally requested or a restriction on the
scope of the engagement, whether imposed by management or caused by
circumstances. The auditor would consider carefully the reason given for the request,
particularly the implications of a restriction on the scope of the engagement,
especially any legal or contractual implications.
3. If the auditor concludes that there is reasonable justification to change the
engagement and if the audit work performed complied with the SAs applicable to the
changed engagement, the report issued would be appropriate for th e revised terms
of engagement. In order to avoid confusion, the report would not include reference
to:
(1) the original engagement; or
(2) any procedures that may have been performed in the original engagement,
except where the engagement is changed to an engagement to undertake
agreed-upon procedures and thus reference to the procedures performed is a

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normal part of the report.

4. The auditor should not agree to a change of engagement where there is no
reasonable justification for doing so.
5. If the terms of the audit engagement are changed, the auditor and management shall
agree on and record the new terms of the engagement in an engagement letter or
other suitable form of written agreement.
6. If the auditor is unable to agree to a change of the terms of the audit engagement and
is not permitted by management to continue the original audit engagement, the
auditor shall:
(a) Withdraw from the audit engagement where possible under applicable law or
regulation; and
(b) Determine whether there is any obligation, either contractual or otherwise, to
report the circumstances to other parties, such as those charged with
governance, owners or regulators.
Question 5
Answer all questions:
(a) The Auditor is fully satisfied with the audit of an entity in respect of its systems and
procedures and wants to issue a report without any hesitation. What type of opinion can
be give and state give reasoning. (4 Marks)
(b) A junior accountant of a limited company has not separated transactions of one period
from those in the ensuing period. As an Auditor, state the correct procedure to be followed
and the areas in which it can be applied. (6 Marks)
(c) During the course of audit of an entity, the Auditor ascertains that the internal control
system is not effective and rather weak with certain lapses. Give in detail the
communication in this regard the Auditor will have with the management. (6 Marks)
Answer
(a) Unqualified Opinion:
1. An unqualified opinion should be expressed when the auditor concludes that the
financial statements give a true and fair view in accordance with the financial reporting
framework used for the preparation and presentation of the financial statements.
2. An unqualified opinion indicates, implicitly, that any changes in the accounting principles
or in the method of their application, and the effects thereof, have been properly
determined and disclosed in the financial statements.
3. An unqualified opinion also indicates that:
(i) the financial statements have been prepared using the generally accepted
accounting principles, which have been consistently applied;

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(ii) the financial statements comply with relevant statutory requirements and
regulations; and
(iii) there is adequate disclosure of all material matters relevant to the proper
presentation of the financial information, subject to statutory requirements,
where applicable.
(b) Cut-off Arrangement:
1. Accounting is a continuous process because the business never comes to halt. It is,
therefore, necessary that transactions of one period would be separated from those
in the ensuing period so that the results of the working of each period can be correctly
ascertained. The arrangement that is made for this purpose is technically known as
“cut-off arrangement”.
2. It essentially forms part of the internal control system of the organisation.
3. Accounts, other than sales, purchase and inventory are not usually affected by the
continuity of the business and therefore, this arrangement is generally applied only
to sales, purchase and inventory.
4. The auditor satisfies by examination and test-checks that the cut-off procedures are
adequately followed and ensure that:
(i) Goods purchased, property in which has already been passed on to the client,
have in fact been included in the inventories and that the liability has been
provided for in case credit purchase.
(ii) Goods sold have been excluded from the inventories and credit has been taken
for the sales. If the value of sales is to be received, the concerned party has
been debited.
5. The auditor may examine a sample of documents, evidencing the movemen t of
inventory into and out of stores, including documents pertaining to period shortly before
and after the cut-off date and check whether inventories represented by those
documents were included or excluded as appropriate during inventory taking for perfect
and correct presentation in the financial statements.
(c) Communication of Weaknesses in Internal Control:
1. Weakness in Internal Control: As a result of obtaining an understanding of the
accounting and internal control systems and tests of control, the auditor may become
aware of weaknesses in the systems. The auditor should make management aware,
as soon as practical and at an appropriate level of responsibility, of material
weaknesses in the design or operation of the accounting and internal control systems,
which have come to the auditor's attention. The communication to management of
material weaknesses would ordinarily be in writing. However, if the auditor judges
that oral communication is appropriate, such communication would be documented
in the audit working papers. It is important to indicate in the communication that only

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weaknesses which have come to the auditor's attention as a result of the a udit have
been reported and that the examination has not been designed to determine the
adequacy of internal control for management purposes.
2. Identification of weakness: The auditor shall determine whether, on the basis of the
audit work performed, the auditor has identified one or more deficiencies in internal
control. If the auditor has identified one or more deficiencies in internal control, the
auditor shall determine, on the basis of the audit work performed, whether,
individually or in combination, they constitute significant deficiencies.
3. Communication to the management - The auditor shall communicate in writing
significant deficiencies in internal control identified during the audit to those charged
with governance on a timely basis.
The auditor shall also communicate to management at an appropriate level of
responsibility on a timely basis:
(1) In writing, significant deficiencies in internal control that the auditor has
communicated or intends to communicate to those charged with governance,
unless it would be inappropriate to communicate directly to management in the
circumstances; and
(2) Other deficiencies in internal control identified during the audit that have not
been communicated to management by other parties and that, in the auditor’s
professional judgment, are of sufficient importance to merit management’s
attention.
4. Content of communication of weakness: The auditor shall include in the written
communication of significant deficiencies in internal control:
(1) A description of the deficiencies and an explanation of their potential effects;
and
(2) Sufficient information to enable those charged with governance and
management to understand the context of the communication. In particular, the
auditor shall explain that:
(i) The purpose of the audit was for the auditor to express an opinion on the
financial statements;
(ii) The audit included consideration of internal control relevant to the
preparation of the financial statements in order to design audit procedures
that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of internal control; and
(iii) The matters being reported are limited to those deficiencies that the auditor
has identified during the audit and that the auditor has concluded are of
sufficient importance to merit being reported to those charged with
governance.

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Question 6
Answer all questions:
(a) A limited company has disclosed Trade Receivables in its Balance Sheet as Gross
receivable less provision for Bad debts. Mention disclosure requirements of the same in
its financial statements as per Companies Act, 2013. (4 Marks)
(b) What is the basis on which the judgement is formed by Auditor to express his opinion after
the audit? (6 Marks)
(c) At the time of scrutiny of General Ledger the Auditor observes that certain expenses
essentially of a revenue nature are wrongly treated as capital expenditure. State examples
of such expenses and the duties of auditor in this regard. (6 Marks)
Answer
(a) Disclosure requirement of Trade Receivables as per the Companies Act, 2013:
(i) Aggregate amount of Trade Receivables outstanding for a period exceeding six
months from the Date they are due for payment should be separately stated.
(ii) Trade receivables shall be sub-classified as:
(a) Secured, considered good;
(b) Unsecured considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads
separately.
(iv) Debts due by directors or other officers of the company or any of them either severally
or jointly with any other person or debts due by firms or private companies
respectively in which any director is a partner or a director or a member should be
separately stated.
(b) Process of Judgement Formation by Auditor:
1. After the audit, the opinion that the auditor expresses is the result of exercise of
judgement on facts, evidence and circumstances which he comes across in the
course of audit.
2. The judgement is formed on the following basis-
a. Identification of the assertions to be examined.
b. Evaluation of the assertion as to relative importance.
c. Collection of the information or evidence about the assertions to enable him to
give an informed opinion.

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d. Evaluation of evidence as valid or invalid, pertinent or not pertinent, sufficient or

insufficient.
e. Formulation of judgement as to the fairness of the assertions under
consideration.
(c) Revenue expenses wrongly treated as capital expenditure
Expenses which are essentially of a revenue nature, if incurred for non-creation of an
asset or which do not result in achieving higher productivity of the existing asset, are to be
treated as revenue, and not as capital expenditure.
Examples of such revenue expenses which may be wrongly treated as capital expenditure
are as under
(i) Material and wages – Expenses which are incurred on the normal repairs of a building
or machinery
(ii) Legal expenses – Expenses incurred to protect existing assets
(iii) Freight – Transport expenses incurred for repairing the machinery at the
manufacturer’s site.
(iv) Repair – Repairs to existing plant & machinery which do not increase its productivity
(v) Wages – Wages paid for regular repair to plant & machinery
(vi) Interest – Interest paid on loan for the construction of a building after the qualification
period as per AS-16 i.e. after the building is constructed
Auditor’s duty: Whenever, therefore, a part of the expenditure ostensibly of a revenue
nature is wrongly capitalized, it is the duty of the auditor to assess the implications on the
financial statements and include it in his report.
Question 7
Write short notes on any four of the following:
(a) Techniques of suppressing cash receipts.
(b) Monitoring of controls.
(c) Performance audit under government accounting system.
(d) Physical verification of Fixed assets “at reasonable intervals”.
(e) External confirmation as audit procedure. (4 x 4 =16 Marks)
Answer
(a) Techniques of Supressing Receipts: Few Techniques of how receipts are suppressed
are:
(1) Teeming and Lading: Amount received from a customer being misappropriated; also
to prevent its detection the money received from another customer subsequently

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being credited to the account of the customer who has paid earlier. Similarly, moneys
received from the customer who has paid thereafter being credited to the account of
the second customer and such a practice is continued so that no one account is
outstanding for payment for any length of time, which may lead the management to
either send out a statement of account to him or communicate with him.
(2) Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to customer’
accounts and misappropriating amount paid by them.
(3) Writing off as debts in respect of such balances against which cash has already been
received but has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the
employees, etc.
(6) Writing down asset values in entirety, selling them subsequently and misappropriating
the proceeds.
(b) Monitoring of Controls:
1. The auditor shall obtain an understanding of the major activities that the entity uses
to monitor internal control over financial reporting, including those related to those
control activities relevant to the audit, and how the entity initiates remedial actions to
deficiencies in its controls.
2. Monitoring of controls is a process to assess the effectiveness of internal control
performance over time. It involves assessing the effectiveness of controls on a timely
basis and taking necessary remedial actions. Management accomplishes monitoring
of controls through ongoing activities, separate evaluations, or a combination of the
two. Ongoing monitoring activities are often built into the normal recurring activities
of an entity and include regular management and supervisory activities.
3. Management’s monitoring activities may include using information from
communications from external parties such as customer complaints and regulator
comments that may indicate problems or highlight areas in need of improvement.
4. In case of small entities, management’s monitoring of control is often accomplished
by management’s or the owner-manager’s close involvement in operations. This
involvement often will identify significant variances from expectations and
inaccuracies in financial data leading to remedial action to the control.
(c) Performance audit -
1. The scope of audit has been extended to cover efficiency, economy and effectiveness
audit or performance audit, or full scope audit.
2. Efficiency audit looks into whether the various schemes/projects are executed and
their operations conducted economically and whether they are yielding the results

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expected of them, i.e., the relationship between goods and services produced and
resources used to produce them; and examination aimed to find out the extent to
which operations are carried out in an economical and efficient manner.
3. Economy audit looks into whether government have acquired the financial, human
and physical resources in an economical manner, and whether the sanctioning and
spending authorities have observed economy.
4. Effectiveness audit is an appraisal of the performance of programmes, schemes ,
projects with reference to the overall targeted objectives as well as efficiency of the
means adopted for the attainment of the objectives. Efficiency-cum-performance
audit, wherever used, is an objective examination of the financial and operational
performance of an organisation, programme, authority or function and is oriented
towards identifying opportunities for greater economy, and effectiveness. The
procedure for conducting performance audit covers identification of topic, preliminary
study, planning and execution of audit, and reporting. While the trend towards a
comprehensive approach for conducting performance of full scope audit is visible, the
coverage and depth of evaluation vary according to the statutory limitations, and the
organisational constraints of C&AG.
(d) Physical verification of Fixed Assets at Reasonable Intervals:
1. Physical verification of fixed assets is primarily a responsibility of the management.
The management is required to carry out physical verification of fixed assets a t
appropriate intervals in order to ensure that they are in existence.
2. However, the auditor should satisfy himself that such verification was done by the
management wherever possible and by examining the relevant working papers. The
auditor should also examine whether the method of verification was reasonable in the
circumstances relating to each asset. The reasonableness of the frequency of
verification should also be examined by the auditor in the circumstances of each case.
3. The auditor should test check the book records of fixed assets with the physical
verification reports. He should examine whether discrepancies noticed on physical
verification have been properly dealt with.
4. Further, it is duty of the auditor to report as per clause 1(b) of Para 3 of CARO 2016
that whether these fixed assets have been physically verified by the management at
reasonable intervals; whether any material discrepancies were noticed on such
verification and if so, whether the same have been properly dealt with in the books of
account. What constitutes ‘reasonable interval’ depends on the circumstances of
each case.
(e) External Confirmation as audit procedure:
1. An external confirmation represents audit evidence obtained by the auditor as a direct
written response to the auditor from a third party (the confirming party), in paper form,
or by electronic or other medium.

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2. External confirmation procedures frequently are relevant when addressing assertions

associated with certain account balances and their elements. However, external
confirmations need not be restricted to account balances only.
3. For example, the auditor may request confirmation of the terms of agreeme nts or
transactions an entity has with third parties; the confirmation request may be
designed to ask if any modifications have been made to the agreement and, if so,
what the relevant details are.
4. External confirmation procedures also are used to obtain audit evidence about the
absence of certain conditions, for example, the absence of a “side agreement” that
may influence revenue recognition.

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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.

Question 1
Discuss the following:
(a) What are the circumstances that may result in other than an unqualified opinion on the
Financial Statements by an auditor? (5 Marks)
(b) Securities premium can be utilized only for certain purposes laid down in the Companies
Act, 2013. (5 Marks)
(c) Clarification on the Auditor's rights where clients and other Auditors seek access to their
audit working papers. (5 Marks)
(d) In the context of SA 560 "Subsequent events", state specific enquiries on matters by an
auditor which may have effect on Financial Statements. (5 Marks)
Answer
(a) Circumstances That May Result in Other Than an Unqualified Opinion
Limitation on Scope: If, after accepting the engagement, the auditor becomes aware
that management has imposed a limitation on the scope of the audit that the auditor
considers likely to result in the need to express a qualified opinion or to disclaim an
opinion on the financial statements, the auditor shall request that management to remove
the limitation
If management refuses to remove the limitation, the auditor shall communicate the matter
to those charged with governance and determine whether it is possible to perform
alternative procedure to obtain sufficient appropriate audit evidence.
If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor shall
determine the implications as follows:
(a) If the auditor concludes that the possible effects on the financial statements of
undetected misstatements, if any, could be material but not pervasive, the auditor
shall qualify the opinion; or
(b) If the auditor concludes that the possible effects on the financial statements of
undetected misstatements, if any, could be both material and pervasive so that a
qualification of opinion would be inadequate to communicate the gravity of the
situation, the auditor shall:
(i) Resign from the audit, where practicable and not prohibited by law or
regulation; or

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(ii) If resignation from the audit before issuing the auditor’s report is not
practicable or possible, disclaim an opinion on the financial statements
If the auditor resigns as contemplated by the above paragraph, before resigning, the
auditor shall communicate to those charged with governance any matters regarding
misstatements identified during the audit that would have given rise to a modification of
the opinion
Disagreement with Management: The auditor may disagree with management about
matters such as the acceptability of the accounting policies selected the method of their
application, or the adequacy of disclosures in the financial statements. If such
disagreements are material to the financial statements, the auditor shall express a
qualified or an adverse opinion
Other considerations relating to an Adverse Opinion or Disclaimer of Opinion
When the auditor considers it necessary to express an adverse opinion or disclaim an
opinion on the financial statements, the auditor’s report shall not also include an
unmodified opinion with respect to the same financial reporting framework on a single
financial statement or one or more specific elements, accounts or items of a financial
statement. To include such an unmodified opinion in the same report in these
circumstances would contradict the auditor’s adverse opinion or disclaimer of opinion on
the financial statements as a whole.
(b) Utilisation of Share Premium: Section 52(1) requires creation of Securities Premium
Account and states that the provisions of this Act relating to the reduction of the share
capital of a company shall, except as provided in this section, apply as if the premium
account was paid-up share capital of the company. Section 52(2) lays down that the
securities premium account may be applied by the company-
(i) in paying up unissued shares of the company to be issued to members of the
company as fully paid bonus shares;
(ii) in writing off the preliminary expenses of the company;
(iii) in writing off the expenses of, or the commission paid or discount allowed on, any
issue of shares or debentures of the company;
(iv) in providing for the premium payable on the redemption of any redeemable
preference shares or of any debentures of the company; or
(v) for the purchase of its own shares or other securities under Section 68.
Thus, it is clear from the above that share premium can be utilised only for specific
purposes.

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(c) Clarification on the Auditors' Rights where Clients and Other Auditors seek access
to their Audit Working Papers:
(1) The auditor should respect the confidentiality of information acquired in the course
of his work and should not disclose any such information to a third party without
specific authority or unless there is a legal or professional duty to disclose. SA 230
on “Audit Documentation” provides that, unless otherwise specified by law or
regulation, audit documentation is the property of the auditor. He may at his
discretion, make portions of, or extracts from, audit documentation available to
clients, provided such disclosure does not undermine the validity of the work
performed, or, in the case of assurance engagements, the independence of the
auditor or of his personnel.
(2) Clause 1 Part I of the Second Schedule to the Chartered Accountants Act, 1949,
provides that a Chartered Accountant in practice shall be deemed to be guilty of
professional misconduct, if he discloses information acquired in the course of his
professional engagement to any person other than his client, without the consent of
his client or otherwise than as required by any law for the time being in force.
(3) Requests are sometime received by the members of the Institute, who have/had
been performing the duties as the auditors of an enterprise, to provide access to
their audit working papers. The requests may be made by the clients or other
auditors of the enterprise or its related enterprise such as a parent enterprise.
(4) It is hereby clarified that except to the extent stated in para 5 below, an auditor is
not required to provide the client or the other auditors of the same enterprise or its
related enterprise such as a parent or a subsidiary, access to his audit working
papers. The main auditors of an enterprise do not have right of access to the audit
working papers of the branch auditors. In the case of a company, the statutory
auditor has to consider the report of the branch auditor and has a right to seek
clarifications and/or to visit the branch if he deems it necessary to do so for the
performance of the duties as auditor. An auditor can rely on the work of another
auditor, without having any right of access to the audit working papers of the other
auditor. For this purpose, the term 'auditor' includes 'internal auditor'.
(5) As stated in Para 4 above, the client does not have a right to access the working
papers of the auditor. However, the auditor may, at his discretion, in cases
considered appropriate by him, make portions of or extracts from his working papers
available to the client.
(d) Inquiring from Management to Evaluate Subsequent Event: As per SA 560
“Subsequent Events”, in inquiring of management and, where appropriate, those charged
with governance, as to whether any subsequent events have occurred that might affect
the financial statements, the auditor may inquire as to the current status of items that
were accounted for on the basis of preliminary or inconclusive data and may make
specific inquiries about the following matter.

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(i) Whether new commitments, borrowings or guarantees have been entered into.
(ii) Whether sales or acquisitions of assets have occurred or are planned.
(iii) Whether there have been increases in capital or issuance of debt instruments, such
as the issue of new shares or debentures, or an agreement to merge or liquidate
has been made or is planned.
(iv) Whether any assets have been appropriated by government or destroyed, for
example, by fire or flood.
(v) Whether there have been any developments regarding contingencies.
(vi) Whether any unusual accounting adjustments have been made or are
contemplated.
(vii) Whether any events have occurred or are likely to occur which will bring into
question the appropriateness of accounting policies used in the financial statements
as would be the case, for example, if such events call into question the validity of
the going concern assumption.
(viii) Whether any events have occurred that are relevant to the measurement of
estimates or provisions made in the financial statements.
(ix) Whether any events have occurred that are relevant to the recoverability of assets.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect:
(Answer any eight)
(a) The basic objective of audit does not change with reference to nature, size or form of an
entity.
(b) Depreciation is charged by the company on purchase of stand-by depreciable assets
which are ready to use.
(c) Casual vacancy of a 'Cost Auditor of a Company is filled by shareholders in general
meeting within one month.
(d) Board of Directors can contribute to any charitable and other funds any amount in a
financial year.
(e) The Managing Director of a company has shifted company's books of accounts from
Registered office (Mumbai) to Corporate Office (New Delhi).
(f) Vouching of payments is merely check proof that money has been paid.
(g) Engagement letter need not be entered for each year of the period of auditor's
appointment.
(h) There is no relation between Inherent risk, Control risk and Detection risk.

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(i) Written representation can be a substitute for other audit evidence.

(j) Negative balance of 'Reserves & Surplus' is shown on the Assets side of Balance Sheet.
(8 x 2 = 16 Marks)
Answer
(a) Correct: An audit is an independent examination of financial information of any entity,
whether profit oriented or not, and irrespective of its size or legal form, when such an
examination is conducted with a view to expressing an opinion thereon. It is clear that the
basic objective of auditing, i.e., expression of opinion on financial statements does not
change with reference to nature, size or form of an entity.
(b) Correct: As per AS 10 (Revised) property, plant and equipment, depreciation of an asset
begins when it is available for use i.e. when it is in the location and condition necessary
for it to be capable of operating in the manner intended by the management. Therefore,
depreciation charged by the company on purchase of stand-by assets which are ready to
use is correct.
(c) Incorrect: Any casual vacancy in the office of a Cost Auditor, whether due to resignation,
death or removal, shall be filled by the Board of Directors within 30 days of occurrence of
such vacancy and the company shall inform the central government in Form CRA-2
within 30 days of such appointment of cost auditor.
(d) Incorrect: Section 181 of the Companies Act, 2013 provides that the Board of Directors
of a company may contribute to bona fide charitable and other funds with prior
permission of the company in general meeting for such contribution in case any amount
the aggregate of which, in any financial year, exceed 5% of its average net profits for the
three immediately preceding financial years.
(e) Incorrect: As per section 128(1) of The Companies Act 2013, every company shall keep
at its registered office proper books of accounts. It is permissible, however, for all or any
of the books of accounts to be kept at such place in India as the Board of Directors may
decide but, when a decision in this regard is taken, the company must file within 7days of
such decision with the Registrar of Companies a notice in writing giving full address of
the other place.
(f) Incorrect: Vouching is a substantive audit procedure which aims at verifying the
genuineness and validity of a transaction contained in the accounting records. It involves
examination of documentary evidence to support the genuineness of transaction. Thus
the object of vouching is not merely to ascertain that money has been paid away; but the
auditor aims to obtain reasonable assurance in respect of assertions in regard to
transactions recorded in the books of account.
(g) Incorrect: An engagement letter may need to be entered into for each year of the period
covered by the eligibility letter issued by the auditor under Section 139 of the companies
act 2013 and the appointment letter received from the company, to supplement - update

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for any subsequent changes. This may be required because the appointment would need
to be ratified at each AGM under section 139 of the said Act.
(h) Incorrect: There is an inverse relationship between detection risks and the combined
level of inherent and control risks. When inherent and control risks are high, acceptable
detection risk needs to be low to reduce audit risk to an acceptably low level. When
inherent and control risks are low, an auditor can accept a higher detection risk and still
reduce audit risks to an acceptably low level.
(i) Incorrect: One of the objectives of the written representation is to support other audit
evidence relevant to the financial statements or specific assertions in the financial
statements by means of written representation. So it is clear that written representations
cannot be a substitute for other evidence that the auditor could expect to be reasonably
available.
(j) Incorrect: Debit balance of statement of profit and loss shall be shown as a negative
figure under the head ‘Surplus’. Similarly, the balance of ‘Reserves and Surplus’, after
adjusting negative balance of surplus, if any, shall be shown under the head ‘Reserves
and Surplus’ even if the resulting figure is in the negative.
Question 3
How will you Vouch/Verify the following?
(a) Expenditure incurred for promotion of a product.
(b) Inventories - Work-in-progress.
(c) Purchase returns.
(d) Discounted Bills receivable dishonoured. (4 x 4 = 16 Marks)
Answer
(a) Expenditure Incurred for Promotion of a Product:
(i) The expenditure incurred for promotion of a new or existing product may entail
future benefits. It may be like advertisement in the papers, television, sales
exhibition, participation in trade fair, issue of promotional pamphlets, free gifts etc.
(ii) The auditor should vouch the authority and accuracy of the transactions. He should
read the contract with advertisement agencies, promotional policies decided by the
management from the board minutes etc.
(iii) He should check the amounts paid to the agencies from bank book. He should
check the accuracy. He should ascertain whether tax had been deducted in
accordance with the tax law provisions if any applicable in this regard.
(iv) He should check whether the unpaid amounts and accrued liability towards
promotional advertisement contracts had been duly provided for in the accounts.

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(v) The huge expenditure should not be treated as deferred revenue expenditure.
According to AS 26, these are not intangible assets that may be carried over the
periods of accounting. These must be expensed with in the year in which these
arise.
(b) Inventories – Work-in-progress: The auditor may involve a technical expert in
verification of work-in-progress if necessary. He may advise his client that where possible
the work-in-progress should be reduced to the minimum before the closing date,
particularly of items the production of which have been abandoned and for items the
manufacture of which is not being actively undertaken provided cost sheets are available
in respect of individual items or lots of jobs or work orders, which cannot be identified
with physical work, these should be verified as follows:
(i) Ascertain that the cost sheets are duly attested by the Works Engineer and Works
Manager.
(ii) Test the correctness of the cost as disclosed by the cost records by verification of
quantities and cost of materials, wages and other charges included in the cost-
sheets by reference to the records maintained in respect of issues of materials,
payment of wages and its classification and original evidence in respect of all
expenditure included in the cost-sheets.
(iii) Compare the unit cost or job cost as shown by the cost sheet with the standard cost
or the estimate of cost expected to be maintained under actual operating conditions
during a limited future period (wherever these have been developed).
(iv) Ensure that the allocation of overhead expenses has been made on reasonable
basis and that total of the overhead expenses does not include any amount in
respect of selling distribution and office expenses.
(v) Compare the cost-sheet in detail with that of the previous year both in regard to the
composition of cost and the value placed on various components. If they vary
materially, investigate the causes thereof.
(c) Purchase Return:
(i) Examine debit note issued to the supplier which in turn may be confirmed by
corresponding credit note issued by the supplier acknowledging the same. The
relevant correspondence may also be examined.
(ii) Verify by reference to relevant corresponding record in good outward book or the
stores records. Further, the figures in this documentary evidence should be
compared with the supplier’s original invoices for rates and other charges and
calculation should also be checked.
(iii) Examine in depth to eliminate the possibility of fictitious purchase returns for
covering bogus purchases recorded earlier when such returns outwards are in
substantial figure either at the beginning or end of the accounting year.

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(iv) Cross-check with reference to original invoices any rebates in price or allowances if
any given by suppliers on strength of their Credit Notes.
(d) Discounted Bill Receivable Dishonoured:
(i) Obtain the schedule of discounted bills receivable dishonoured.
(ii) Check the entry in bank statement regarding the amount of bills dishonoured and
see that the bank has debited the account of client.
(iii) Verify the bills receivable returned by the bank along with bank’s advice.
(iv) See that the dishonoured bills have been noted and protested by following the
proper procedure and the account of the drawee or the trade receivable is also
debited.
(v) Check that bank commission, if any, charged by the bank has been recovered from
the party.
Question 4
Answer all questions:
(a) In the context of SA-3l5, state the assertions used by auditor to consider the different
types of potential mis-statements that may occur w.r.t. classes of transactions and events
for period under audit. (4 Marks)
(b) A person shall not be eligible for appointment as an auditor of a company where
subsidiary or associate company or any other form of entity is engaged as on the date of
appointment in consulting and specialized services as provided in Sec.144. Explain.
(6 Marks)
(c) What steps would you take into consideration in auditing the receipts from patients of a
Hospital? (6 Marks)
Answer
(a) Assertions used by the auditor to consider the different types of potential misstatements
that may occur with respect to classes of transactions and events for the period under
audit:
(i) Occurrence—transactions and events that have been recorded have occurred and
pertain to the entity.
(ii) Completeness—all transactions and events that should have been recorded have
been recorded.
(iii) Accuracy—amounts and other data relating to recorded transactions and events
have been recorded appropriately.
(iv) Cut-off—transactions and events have been recorded in the correct accounting
period.

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(v) Classification—transactions and events have been recorded in the proper accounts.
(b) Under sub-section (3) of section 141 along with Rule 10 of the Companies (Audit and
Auditors) Rules, 2014 (hereinafter referred as CAAR), the following person shall not be
eligible for appointment as an auditor of a company, namely-
any person whose subsidiary or associate company or any other form of entity, is
engaged as on the date of appointment in consulting and specialized services as
provided in section 144.
Section 144 of the Companies Act, 2013 is a new provision which prescribes certain
services not to be rendered by the auditor. An auditor appointed under this Act shall
provide to the company only such other services as are approved by the Board of
Directors or the audit committee, as the case may be, but which shall not include any of
the following services (whether such services are rendered directly or indirectly to the
company or its holding company or subsidiary company), namely:
(i) accounting and book keeping services;
(ii) internal audit;
(iii) design and implementation of any financial information system;
(iv) actuarial services;
(v) investment advisory services;
(vi) investment banking services;
(vii) rendering of outsourced financial services;
(viii) management services; and
(ix) any other kind of services as may be prescribed.
(c) Auditing the Receipts from Patients of a Hospital: Following are the steps to be
considered -
(i) Examine the internal check system as regards the receipts of bills from the patients.
(ii) Vouch the register of patients with copy of bills issued to them.
(iii) Verify bills for a selected period with the patient’s attendance record to see that the
bills have been correctly prepared.
(iv) See that bills have been issued to all the patients according to the rules of the
hospital.
(v) Check cash collections as entered in the cash book with the receipts, counterfoils
and other evidence.
(vi) Compare the total income with the amount budgeted for the same and report to the
management for significant variations which have been taken place.

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Question 5
Answer all questions:
(a) Discuss the need of CAATs in a CIS environment. (4 Marks)
(b) 'Knowledge of Client business' is one of the important principles in developing an overall
audit plan. Explain. (6 Marks)
(c) Is detection of fraud and error duty of an auditor? (6 Marks)
Answer
(a) Need of CAATs in a CIS Environment: Computer Assisted audit techniques (CAATs)
may be required in a CIS environment in the following circumstances-
♦ The absence of input documents (e.g. order entry in on-line systems) or the
generation of accounting transactions by computer programs (e.g. automatic
calculation of discounts) may preclude the auditor from examining documentary
evidence.
♦ The lack of a visible audit trail will preclude the auditor from visually following
transactions through the computerized accounting system.
♦ The lack of visible output may necessitate access to data retained on files readable
only by the computer.
The effectiveness and efficiency of auditing procedures may be improved through the
use of computer-assisted audit techniques in obtaining and evaluating audit evidence, for
example:
(i) Some transactions may be tested more effectively for a similar level of cost by using
the computer to examine all or a greater number of transactions than would
otherwise be selected.
(ii) In applying analytical review procedures, transactions or balance details may be
reviewed and reports printed of unusual items more efficiently by using the
computer than by manual methods.
(b) Knowledge of the Client’s Business: It is one of the important principles in developing
an overall audit plan. In fact without adequate knowledge of client’s business, a proper
audit is not possible. As per SA-315, “Identifying and Assessing the Risk of Material
Misstatement through Understanding the Entity and Its Environment” the auditor shall
obtain an understanding of the following:
(a) Relevant industry, regulatory, and other external factors including the applicable
financial reporting framework.
(b) The nature of the entity, including:
(i) its operations;

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(ii) its ownership and governance structures;

(iii) the types of investments that the entity is making and plans to make, including
investments in special-purpose entities; and
(iv) the way that the entity is structured and how it is financed;
to enable the auditor to understand the classes of transactions, account balances,
and disclosures to be expected in the financial statements.
(c) The entity’s selection and application of accounting policies, including the reasons
for changes thereto. The auditor shall evaluate whether the entity’s accounting
policies are appropriate for its business and consistent with the applicable financial
reporting framework and accounting policies used in the relevant industry.
(d) The entity’s objectives and strategies, and those related business risks that may
result in risks of material misstatement.
(e) The measurement and review of the entity’s financial performance.
In addition to the importance of knowledge of the client’s business in establishing the
overall audit plan, such knowledge helps the auditor to identify areas of special audit
consideration, to evaluate the reasonableness both of accounting estimates and
management representations, and to make judgements regarding the appropriateness of
accounting policies and disclosures.
(c) Detection of Fraud and Error - Duty of an Auditor: As per SA-240, “The Auditor’s
Responsibilities Relating to Fraud in an Audit of Financial Statements”, primary
responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management. It is important that management, with the
oversight of those charged with governance, place a strong emphasis on fraud
prevention, which may reduce opportunities for fraud to take place, and fraud deterrence,
which could persuade individuals not to commit fraud because of the likelihood of
detection and punishment. This involves a commitment to creating a culture of honesty
and ethical behaviour which can be reinforced by an active oversight by those charged
with governance. In exercising oversight responsibility, those charged with governance
consider the potential for override of controls or other inappropriate influence over the
financial reporting process, such as efforts by management to manage earnings in order
to influence the perceptions of analysts as to the entity’s performance and profitability.
Broadly, the general principles laid down in this regard are:
(i) An auditor conducting an audit in accordance with SAs is responsible for obtaining
reasonable assurance that the financial statements taken as a whole are free from
material misstatement, whether caused by fraud or error. As described in SA 200,
“Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, owing to the inherent limitations of an
audit, there is an unavoidable risk that some material misstatements of the financial

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statements will not be detected, even though the audit is properly planned and
performed in accordance with the SAs.
(ii) The risk of not detecting a material misstatement resulting from fraud is higher than
the risk of not detecting one resulting from error. This is because fraud may involve
sophisticated and carefully organized schemes designed to conceal it, such as
forgery, deliberate failure to record transactions, or intentional misrepresentations
being made to the auditor.
(iii) Furthermore, the risk of the auditor not detecting a material misstatement resulting
from management fraud is greater than for employee fraud, because management
is frequently in a position to directly or indirectly manipulate accounting records,
present fraudulent financial information or override control procedures designed to
prevent similar frauds by other employees.
(iv) When obtaining reasonable assurance, the auditor is responsible for maintaining an
attitude of professional skepticism throughout the audit, considering the potential for
management override of controls and recognizing the fact that audit procedures that
are effective for detecting error may not be effective in detecting fraud. The
requirements in this SA are designed to assist the auditor in identifying and
assessing the risks of material misstatement due to fraud and in designing
procedures to detect such misstatement.
It may be concluded from the above that detection of fraud and error is not the duty of the
auditor provided that he complies with the requirements given in Standards on Auditing,
maintains professional scepticism throughout the audit and is not grossly negligent in the
performance of his duties as an auditor.
Question 6
Answer all questions:
(a) State various factors that help the auditor to ascertain as to what is sufficient and
appropriate audit evidence. (4 Marks)
(b) Prior approval of the company by a special resolution is required for entering into
transaction(s) with any related party. Discuss. (6 Marks)
(c) Explain different connotation of 'Cost' in terms of inventories. (6 Marks)
Answer
(a) Factors which influence auditor’s judgement: The various factors which may influence
the auditor’s judgment as to what is sufficient and appropriate audit evidence are as
under:
(i) Degree of risk of misstatements which may be affected by factors such as the
nature of items, adequacy of internal control, nature and size of businesses carried

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out by the entity, situations which may exert an unusual influence on management
and the financial position of the entity.
(ii) The materiality of the item.
(iii) The experience gained during previous audits.
(iv) The results of auditing procedures, including fraud and errors which may have been
found.
(v) The type of information available.
(vi) The trend indicated by accounting ratios and analysis.
(b) Special resolution for entering into transaction(s) with any related party: Prior
approval of the company by a special resolution is required for entering into
transaction(s) with any related party, where transaction(s) to be entered into:-
(a) are contracts or arrangements, with criteria as mentioned below-
(i) sale, purchase or supply of any goods or materials directly or through
appointment of agents exceeding 10% of the turnover of the company or ` 100
crore, whichever is lower;
(ii) selling or otherwise disposing of or buying property of any kind, directly or
through appointment of agents, exceeding 10% of net worth of the company or
` 100 crore, whichever is lower;
(iii) leasing of property of any kind exceeding 10% of the net worth of the company
or 10% of turnover of the company or ` 100 crore, whichever is lower;
(iv) availing or rendering of any services directly or through appointment of agents
exceeding 10% of the turnover of the company or ` 50 crore, whichever is
lower;
It may be noted that the limits specified above shall apply for transaction(s) to be
entered into either individually or taken together with the previous transactions
during a financial year.
(b) is for appointment to any office or place of profit in the company, its subsidiary
company or associate company at a monthly remuneration exceeding ` 2.5 lakh;
(c) is for remuneration for underwriting the subscription of any securities or derivatives
thereof of the company exceeding 1% of the net worth.
(c) Different connotations of ‘Cost’: The significance of this term varies in different
circumstances on account of the nature of goods and the methods by which cost has
been computed. Essentially, it refers to an appropriate combination of the cost of pur-
chase, cost of conversion and other costs incurred in the normal course of business in
bringing the inventories up to the present location and condition.

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In determining the cost of inventories, it is appropriate to exclude certain costs and

recognise them as expenses in the period in which they are incurred. Examples of such
costs are:
(a) abnormal amounts of wasted materials, labour, or other production costs;
(b) storage costs, unless those costs are necessary in the production process prior to a
further production stage;
(c) administrative overheads that do not contribute to bringing the inventories to their
present location and condition; and
(d) selling and distribution costs.
The cost of inventories of items that are not ordinarily interchangeable and goods or
services produced and segregated for specific projects should be assigned by specific
identification of their individual costs.
The cost of inventories, other than those dealt with in paragraph 14 of AS-2, should be
assigned by using the first-in, first-out (FIFO), or weighted average cost formula. The
formula used should reflect the fairest possible approximation to the cost incurred in
bringing the items of inventory to their present location and condition.
Question 7
Write short notes on any four of the following:
(a) Propriety audit
(b) Narrative record
(c) Responsibility of Joint Auditors
(d) Applicable financial reporting framework
(e) Haphazard sampling. (4 x 4 = 16 Marks)
Answer
(a) Propriety Audits: The Propriety audit is to vet the expenditure in the annals of financial
wisdom and uprightness. It is to check to bring out the improper, avoidable, or
infructuous expenditure even though such expenditure has been incurred in conformity
with the existing rules and regulations. A transaction may satisfy all the requirements of
regularity audit in so far as the various formalities regarding rules and regulations are
concerned but may still be highly wasteful. It is not audit of sanction or against norms. It
is a qualitative, opinion-based expression of auditor’s findings as regards the efficiency,
effectiveness and economy dimensions of expenditure.
In this regards, the following main points should be kept for consideration:
(1) The expenditure should not be prima facie more than what the occasion demands.
Public money should be spent by the officers as of his own with utmost diligence
and care.

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(2) No order for sanction of expenditure should be made by an authority which results
in pecuniary gains directly or indirectly.
(3) Public moneys 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 for the amount could be enforced in a Court of law; or
(iii) the expenditure is in pursuance of a recognised policy or custom; and
(iv) the amount of allowances, such as travelling allowances, granted to meet
expenditure of a particular type should be so regulated that the allowances are
not, on the whole, sources of profit to the recipients.
(4) There should not be profiteering by the authority or anybody where the expenditure
is in the nature of compensating.
(5) Wastages are avoided in expenditure. The cost of administering should not eat off
the benefits of the expenditure.
(6) The expenditure should percolate down the beneficiary without corruption.
(7) The expenditure should bring out optimum, enduring benefits instead of mere
frittering away the public money on meeting day to day needs repeatedly.
(b) The Narrative Record: This is a complete and exhaustive description of the system as
found in operation by the auditor. Actual testing and observation are necessary before
such a record can be developed. It may be recommended in cases where no formal
control system is in operation and would be more suited to small business. The basic
disadvantages of narrative records are:
(i) To comprehend the system in operation is quite difficult.
(ii) To identify weaknesses or gaps in the system.
(iii) To incorporate changes arising on account of reshuffling of manpower, etc.
(c) Responsibilities of Joint Auditors: As per SA 299, in respect of audit work divided
among the joint auditors, each joint auditor is responsible only for the work allocated to
him. In respect of other works, which are not divided, all joint auditors are jointly and
severally responsible for:
(i) Audit work which is not divided and is carried on jointly by all the joint auditors
(ii) Decision taken by all joint auditors concerning the nature, timing or extent of audit
procedures to be performed by any of the joint auditors.
(iii) Matters which are brought to the notice of joint auditors by any one of them and on
which there is agreement among the joint auditors

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(iv) Examining the financial statements of the entity comply with the disclosure
requirements of the relevant statute
(v) Ensuring that the audit report complies with the requirement of the relevant statute
(d) Applicable financial reporting framework – The financial reporting framework adopted
by management and, where appropriate, those charged with governance in the
preparation and presentation of the financial statements that is acceptable in view of the
nature of the entity and the objective of the financial statements, or that is required by
law or regulation.
The applicable financial reporting framework often encompasses financial reporting
standards established by an authorised or recognised standards setting organisation, or
legislative or regulatory requirements. In some cases, the financial reporting framework
may encompass both financial reporting standards established by an authorised or
recognised standards setting organisation and legislative or regulatory requirements.
(e) Haphazard sampling:
(i) Haphazard selection, in which the auditor selects the sample without following a
structured technique.
(ii) Though no structured technique is used, the auditor would nonetheless avoid any
conscious bias or predictability (for example, avoiding difficult to locate items, or
always choosing or avoiding the first or last entries on a page)
(iii) attempt to ensure that all items in the population have a chance of selection.
(iv) Haphazard selection is not appropriate when using statistical sampling.

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Question No.1 is compulsory.

Attempt any five questions from the remaining six questions.

Question 1
(a) “A satisfactory internal control environment may help reduce the risk of fraud but is not an
absolute deterrent for fraud.” Explain. (5 Marks)
(b) Discuss with reference to SA 510, “Initial Audit Engagement – Opening Balances”, the
procedures the auditor should undertake in respect of opening balances for a new audit
engagement. (5 Marks)
(c) What are the provisions regarding appointment of auditors by rotation, after expiry of the term
of the current auditor, that a company should consider? (5 Marks)
(d) In the course of audit of Steadfast Ltd., a manufacturing company, you find that there is a sharp
fall in the rate of gross profit in comparison to the previous year. State the steps you would take
to verify the same. (5 Marks)
Answer
(a) Satisfactory Control Environment - not an absolute deterrent to fraud: The existence
of a satisfactory control environment can be a positive factor when the auditor assesses
the risks of material misstatement. However, although it may help reduce the risk of fraud,
a satisfactory control environment is not an absolute deterrent to fraud. Conversely,
deficiencies in the control environment may undermine the effectiveness of controls, in
particular in relation to fraud. For example, management’s failure to commit sufficient
resources to address IT security risks may adversely affect internal control by allowing
improper changes to be made to computer programs or to data, or unauthorized
transactions to be processed. As explained in SA 330 “The Auditor’s Responses to
Assessed Risks”, the control environment also influences the nature, timing, and extent of
the auditor’s further procedures.
The control environment in itself does not prevent, or detect and correct, a material
misstatement. It may, however, influence the auditor’s evaluation of the effectiveness of
other controls (for example, the monitoring of controls and the operation of specific control
activities) and thereby, the auditor’s assessment of the risks of material misstatement.
(b) Audit Procedures in respect of Opening Balances for a New Audit Engagement: As
per SA 510 “Initial Audit Engagements – Opening Balances”, the auditor should undertake
the following procedures in respect of opening balances in case of new audit engagement:
(i) The auditor shall read the most recent financial statements, if any, and the
predecessor auditor’s report thereon, if any, for information relevant to opening
balances, including disclosures.

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(ii) The auditor shall obtain sufficient appropriate audit evidence about whether the
opening balances contain misstatements that materially affect the current period’s
financial statements by:
(a) Determining whether the prior period’s closing balances have been correctly
brought forward to the current period or, when appropriate, any adjustments
have been disclosed as prior period items in the current year’s Statement of
Profit and Loss;
(b) Determining whether the opening balances reflect the application of appropriate
accounting policies; and
Performing one or more of the following:
(1) Where the prior year financial statements were audited, perusing the
copies of the audited financial statements including the other relevant
documents relating to the prior period financial statements;
(2) Evaluating whether audit procedures performed in the current period
provide evidence relevant to the opening balances; or
(3) Performing specific audit procedures to obtain evidence regarding the
opening balances.
If the auditor obtains audit evidence that the opening balances contain misstatements that
could materially affect the current period’s financial statements, the auditor shall perform
such additional audit procedures as are appropriate in the circumstances to determine the
effect on the current period’s financial statements. If the auditor concludes that such
misstatements exist in the current period’s financial statements, the auditor shall
communicate the misstatements with the appropriate level of management and those
charged with governance.
(c) Manner of Rotation of Auditors by the Companies on Expiry of their Term: As per the
Companies (Audit and Auditors) Rules, 2014 prescribes the manner of rotation of auditors
on expiry of their term which is given below-
(1) The Audit Committee shall recommend to the Board, the name of an individual auditor
or of an audit firm who may replace the incumbent auditor on expiry of the term of
such incumbent.
(2) Where a company is required to constitute an Audit Committee, the Board shall
consider the recommendation of such committee, and in other cases, the Board shall
itself consider the matter of rotation of auditors and make its recommendation for
appointment of the next auditor by the members in annual general meeting.
(3) For the purpose of the rotation of auditors-
(i) in case of an auditor (whether an individual or audit firm), the period for which
the individual or the firm has held office as auditor prior to the commencement

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of the Act shall be taken into account for calculating the period of five
consecutive years or ten consecutive years, as the case may be;
(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit firm
is associated with the outgoing auditor or audit firm under the same network of
audit firms.
(4) Where a company has appointed two or more individuals or firms or a combination
thereof as joint auditors, the company may follow the rotation of auditors in such a
manner that both or all of the joint auditors, as the case may be, do not complete their
term in the same year.
(d) Decrease in Rate of Gross Profit on Sales: When rate of Gross Profit on Sales of a
manufacturing company has sharply decreased in comparison to the previous year, the
auditor should satisfy the reasons for the same. Following factors should be considered
which might cause decrease in the gross profit of the manufacturing company-
(i) Undervaluation of closing inventory or overvaluation of opening inventory either due
to wrong valuation of inventory or mistake in inventory taking.
(ii) Change in the basis of inventory valuation. For example, opening inventory was
valued at market price above cost when closing inventory valued at cost which is
below the market price.
(iii) Inclusion in the current year, the amount of goods purchased in the previous year that
were received and taken in the same year.
(iv) Reversal of fictitious sale entries recorded in the previous year to boost up profit.
(v) Sales return entry passed two times or entry for purchase return has not been passed
whenever goods are returned to suppliers.
(vi) Excess provisions for wages or direct expenses have been made.
(vii) Goods sent out for sale on approval or on a consignment basis not included in closing
inventory.
(viii) Value of unusual inventory of consumable stores (fuel and packing materials) are not
shown as inventory or not adjusted from corresponding expenses.
(ix) Expenses which should be charged in the Profit and Loss Account but wrongly
charged to the Trading Account.
(x) Insurance claim received in respect of goods lost in transit or destroyed by fire, not
credited in Trading Account.
(xi) Goods sold or given as samples or destroyed, not accounted for.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect: (answer
any eight)

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(a) If financial statements are misstated, and in the auditor’s judgment such misstatement is
material and pervasive, he should issue a qualified opinion.
(b) Under the Companies Act, 2013, the financial statements of a company must be approved
by two directors out of which one shall be the managing director.
(c) A joint auditor is not bound by the views of the majority of the joint auditors regarding
matters to be covered in the auditors report.
(d) The auditor is responsible for the compliance with laws and regulations by the audit client
entity.
(e) The use of computer facilities by a small enterprise may increase the control risk.
(f) “Substantive procedures” may be defined as audit procedures designed to evaluate the
operating effectiveness of controls in preventing, detecting and correcting material
misstatements.
(g) Analytical procedure is a part of routine audit checking.
(h) NGOs registered under the Companies Act, 2013 can maintain their books on either
accrual or cash basis.
(i) Fraud against the company shall be reported by the auditor to the Central Government
within 45 days of his knowledge.
(j) If the Board of Directors fails to appoint the first auditor in case of a company other than a
Government Company, then the Central Government shall appoint the auditor.
(8 x 2 = 16 Marks)
Answer
(a) Incorrect: As per SA 705 “Modifications to the Opinion in the Independent Auditor’s
Report”, the auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually or in the
aggregate, are both material and pervasive to the financial statements. However, the
auditor shall express qualified opinion when he concludes that misstatement, individually
or in aggregate are material but not pervasive.
(b) Incorrect: As per section 134 of the Companies Act, 2013, the financial statements shall
be approved by the board of directors before they are signed on behalf of the board at
least by the following-
(i) The Chairperson of the company where he is authorised by the Board; or
(ii) By two directors out of which one shall be managing director and
(iii) The Chief Executive Officer, if he is a director in the company,
(iv) The Chief Financial Officer, wherever he is appointed; and
(v) The Company Secretary of the company, wherever he is appointed.

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(c) Correct: As per SA 299 “Responsibility of Joint Auditors”, if a joint auditor is not bound by
the views of majority of joint auditors regarding matters to be covered in the report and
should express his opinion in a separate report in case of a disagreement.
(d) Incorrect: As per SA 250 “Consideration of Laws and Regulations in an Audit of Financial
Statements”, it is the responsibility of management, with the oversight of those charged
with governance, to ensure that the entity’s operations are conducted in accordance with
the provisions of laws and regulations.
The auditor is not responsible for preventing non-compliance and cannot be expected to
detect non-compliance with all laws and regulations. However, before issuing an opinion
on financial statements auditor has to determine whether client has complied with the
provisions of applicable laws and regulations.
(e) Correct: Many controls which would be relevant to large entities are not practical in the
small business. For example, in case of small business using computer facilities,
accounting work may not be segregated and be performed by only a few persons. These
persons may have both operating and custodial responsibilities, and segregation of
functions may be missing or severely limited thereby increasing the control risk.
(f) Incorrect: ‘Substantive procedure’ may be defined as an audit procedure designed to
detect material misstatements at the assertion level whereas ‘tests of controls’ is an audit
procedure designed to evaluate the operating effectiveness of controls in preventing, or
detecting and correcting, material misstatements at the assertion level.
(g) Incorrect: By routine checking we traditionally think of extensive checking and vouching
of all entries whereas “Analytical procedure” means evaluation of financial information
through analysis of plausible relationships among both financial and non -financial data. It
includes the consideration of comparisons of the entity’s financial information. Routine
checks cannot be depended upon to disclose all the mistakes or manipulations that may
exist in accounts, certain other procedures also have to be applied.
From the above, it may be concluded that analytical procedure is not a part of routine audit
checking.
(h) Incorrect: NGOs registered under the Companies Act, 2013 must maintain their books of
account under the accrual basis as required by the provisions of section 128 of the said
Act. If the accounts are not maintained on accrual basis, it would amount to non -
compliance of the provision of the Companies Act, 2013.
(i) Incorrect: As per section 143(12) of the Companies Act, 2013 read with the Companies
(Audit and Auditors) Rules, 2014, if an offence of fraud, which involves amount of rupees
1 crore or above, is being or has been committed in the company by its officers or
employees, the auditor shall report the matter to the Board or the Audit Committee
immediately or within 2 days of his knowledge of the fraud seeking their reply or
observations within 45 days and forward the report to the Central Government within 15
days from the date of receipt of such reply or observations. However, in case of a fraud,

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which involves amount of less than rupees 1 crore, the auditor shall report the matter to
the Board or the Audit Committee.
(j) Incorrect: As per section 139(6) of the Companies Act, 2013, if Board of Directors fail to
appoint the first auditor in case of a company other than a Government company, it shall
inform the members of the company. The members of the company shall within 90 days at
an extraordinary general meeting appoint the auditor.
Question 3
How will you vouch/verify the following?
(a) Trademarks and copyrights
(b) Investments income in the case of charitable institutions
(c) Contingent liabilities
(d) Leasehold rights (4 x 4 = 16 Marks)
Answer
(a) Trademarks and Copyrights:
(i) Obtain schedule of Trade Marks and Copyrights duly signed by the responsible officer
and scrutinise the same and confirm that all of them are shown in the Balance Sheet.
(ii) Examine the written agreement in case of assignment of Copyrights and Assignment
Deed in case of transfer of trade marks. Also ensure that trademarks and copyrights
have been duly registered.
(iii) Verify existence of copyright by reference to contract between the author & the entity
and note down the terms of payment of royalty.
(iv) See that the value has been determined properly and the costs incurred for the
purpose of obtaining the trademarks and copyrights have been capitalised.
(v) Ascertain that the legal life of the trademarks and copyrights has not expired.
(vi) Ensure that amount paid for both the intangible assets is properly amortised having
regard to appropriate legal and commercial considerations, as per the principles
enunciated under AS 26 on Intangible Assets.
(b) Investment Income in the case of Charitable Institution:
(i) Vouching the amounts received with the dividend and interest counterfoils.
(ii) Checking the calculations of interest received on securities bearing fixed rates of
interest.
(iii) Checking that the appropriate dividend has been received where any investment has
been sold ex-dividend or purchased cum-dividend.
(iv) Comparing the amounts of dividend received with schedule of investments making

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special enquiries into any investments held for which no dividend has been received.
(c) Contingent liabilities:
(i) Inspect the minute books of the company to ascertain all contingent liabilities known
to the company.
(ii) Examine the contracts entered into by the company and the likelihood of contingent
liabilities emanating therefrom.
(iii) Scrutinise the lawyer’s bills to track unreported contingent liabilities.
(iv) Examine bank letters in respect of bills discounted and not matured.
(v) Examine bank letters to ascertain guarantees on behalf of other companies or
individuals.
(vi) Discuss with various functional officers of the company about the possibility of
contingent liability existing in their respective field.
(vii) Obtain a certificate from the management that all known contingent liabilities have
been included in the accounts and they have been properly disclosed.
(viii) Ensure that proper disclosure has been made as per Schedule III to the Companies
Act, 2013 and AS 29, “Provisions, Contingent Liabilities and Contingent Assets”.
(d) Leasehold Rights:
(i) Inspect the lease or assignment thereof to ascertain the amount of premium, if any,
for securing the lease, and its terms and conditions; and that the lease has been duly
registered. A lease exceeding one year is not valid unless it has been granted by a
registered instrument.
(ii) Ascertain that all the conditions, the failure to comply with which might result in the
forfeiture or cancellation of the lease, e.g., payment of ground rent on the due dates,
insurance of property, its maintenance in a satisfactory state of repairs, etc.
prescribed by the lease, are being duly complied with.
(iii) Examine the counterpart of the tenants’ agreements, if part of the leasehold property
has been sublet.
(iv) Make certain that due provisions for any claim that might arise under the dilapidation
clause on the expiry of the lease has been made, and, if no such provision has been
made, draw the client’s attention to the matter.
(v) Ensure that the outlay as well as any legal expenses incurred to acquire the leases
which are shown as an asset in the Balance Sheet is being written off at a rate which
could completely wipe off the asset over the unexpired term of the lease.

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Question 4
(a) State in brief, the management’s responsibilities relating to the audit of financial
statements. (4 Marks)
(b) Write a short note on Random Sampling. (6 Marks)
(c) What is the purpose of a Letter of Engagement? What are the important contents of a
Letter of Engagement? (6 Marks)
Answer
(a) Management’s Responsibilities relating to the Audit of Financial Statements :
(i) This section of the auditor’s report describes the responsibilities of those in the
organisation that are responsible for the preparation of the financial statements. The
auditor’s report need not refer specifically to “management”, but shall use the term
that is appropriate in the context of the legal and/or regulatory framework applicable
to the entity. In case of some entities, the appropriate reference may be to those
charged with governance.
(ii) The auditor’s report shall include a section with the heading “Management’s [or other
appropriate term] Responsibility for the Financial Statements”.
(iii) The auditor’s report shall describe management’s responsibility for the preparation of
the financial statements in the manner in which that responsibility is described in the
terms of the audit engagement. The description shall include an explanation that
management is responsible for the preparation of the financial statements in
accordance with the applicable financial reporting framework; this responsibility
includes the design, implementation and maintenance of internal control relevant to
the preparation of financial statements that are free from material misstatement,
whether due to fraud or error.
(iv) Where the financial statements are prepared in accordance with a fair presentation
framework, the explanation of management’s responsibility for the financial
statements in the auditor’s report shall refer to “the preparation and fair presentation
of these financial statements” or “the preparation of financial statements that give a
true and fair view”, as appropriate in the circumstances.
(b) Random Sampling: Random selection ensures that all items in the population or within
each stratum have a known chance of selection. It may involve use of random number
tables. Random sampling includes two very popular methods which are discussed below–
(i) Simple random sampling: Under this method each unit of the whole population e.g.
purchase or sales invoice has an equal chance of being selected. The mechanics of
selection of items may be by choosing numbers from table of random numbers by
computers or picking up numbers randomly from a drum. It is considered that random
number tables are simple and easy to use and also provide assurance that the bias
does not affect the selection. This method is considered appropriate provided the

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population to be sampled consists of reasonably similar units and fall within a

reasonable range. For example the population can be considered homogeneous, if
say, trade receivables balances fall within the range of ` 5,000 to ` 25,000 and not
in the range between ` 25 to ` 2,50,000.
(ii) Stratified Sampling: This method involves dividing the whole population to be tested
in a few separate groups called strata and taking a sample from each of them. Each
stratum is treated as if it was a separate population and if proportionate of items are
selected from each of these stratum. The number of groups into which t he whole
population has to be divided is determined on the basis of auditor judgment. For
example in the above case, trade receivables balances may be divided into four
groups as follows –
(a) balances in excess of ` 1,00,000;
(b) balances in the range of ` 75,000 to ` 1,00,000;
(c) balances in the range of ` 25,000 to ` 75,000; and
(d) balances below ` 25,000.
(c) Purpose of Letter of Engagement: The legal requirement to get the accounts audited so
far extends only to companies, co-operative societies, and registered societies. In these
cases, the respective law governs the appointment of auditors and their duties. In all other
cases, it is a matter of contract.
The client tells the auditor the nature of service he requires and the auditor, if he is
agreeable to undertake the assignment, specifies his terms. He must sign an agreement,
if he accepts the work in terms of the agreement subject to professional standards.
Clients who are not statutorily required to get their accounts audited may require
preparation of accounts for tax returns, checking of the sales tax returns, etc. besides
audit. In such cases, there may be a misunderstanding about the exact scope of the work;
the auditor may think that he is merely required to prepare accounts while the client may
think audit of accounts, is also covered. It is, therefore, of the greatest importance, both
for the accountant and client, that each party should be clear about the nature of the
engagement. It must be reduced in writing and should exactly specify the scope of the
work.
The audit engagement letter is sent by the auditor to his client, which documents the
objective and scope of the audit, the extent of his responsibilities to the client and the form
of report. The ICAI has issued SA 210, “Agreeing the Terms of Audit Engagement” on the
subject. It is in the interest of both the auditor and the client to issue an engagement letter
so that the possibility of misunderstanding is reduced to a great extent.
Important Contents of Letter of Engagement: The agreed terms of the audit
engagement shall be recorded in an audit engagement letter or other suitable form of
written agreement and shall include:

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(a) The objective and scope of the audit of the financial statements;
(b) The responsibilities of the auditor;
(c) The responsibilities of management;
(d) Identification of the applicable financial reporting framework for the preparation of the
financial statements; and
(e) Reference to the expected form and content of any reports to be issued by the auditor
and a statement that there may be circumstances in which a report may differ from
its expected form and content.
Question 5
(a) What are the important objectives of local body audits? (4 Marks)
(b) Distinguish between absolute and reasonable assurance. Identify the type of assurance
that is expected in an audit of the financial statements, clearly outlining the reasons to
justify your point of view. (6 Marks)
(c) National College, an institution managed by a trust, has received a grant of ` 2.40 crore
from Government nodal agencies for funding a project of research on rural health systems
in India. Draft an audit programme for auditing this fund in the accounts of the colle ge.
(6 Marks)
Answer
(a) Objectives of Audit of Local Bodies: The external control of municipal expenditure is
exercised by the state governments through the appointment of auditors to examine
municipal accounts. The municipal corporations of Delhi, Mumbai and a few others have
powers to appoint their own auditors for regular external audit. The important objectives
of audit are -
(i) reporting on the fairness of the content and presentation of financial statements;
(ii) reporting upon the strengths and weaknesses of systems of financial control;
(iii) reporting on the adherence to legal and/or administrative requirements;
(iv) reporting upon whether value is being fully received on money spent; and
(v) detection and prevention of error, fraud and misuse of resources.
(b) Absolute and Reasonable Assurance: Absolute assurance is the highest level of
assurance an auditor can give, if he check each and every transaction. Therefore , absolute
assurance is the level of assurance that can only be given if the auditor does not perform
sampling testing. However, it is not possible to give absolute assurance because of time
and cost involved. Therefore, auditors give reasonable assurance. Reasonable assurance
is less then absolute assurance.

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As per SA-200 overall objectives of the independent auditor, in conducting an audit of

financial statements, one of the objective of the auditor is to obtain reasonable assurance
about whether the financial statements as a whole are free from material misstatement,
whether due to fraud or error, thereby enabling the auditor to express an opinion on
whether the financial statements are prepared, in all material respects, in accordance with
an applicable financial reporting framework.
As the basis for the auditor’s opinion, SAs require the auditor to obtain reasonable
assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error. Reasonable assurance is a high level of
assurance. It is obtained when the auditor has obtained sufficient appropriate audit
evidence to reduce audit risk (i.e., the risk that the auditor expresses an inappropriate
opinion when the financial statements are materially misstated) to an acceptably low level.
However, reasonable assurance is not an absolute level of assurance, because there are
inherent limitations of an audit which result in most of the audit evidence on which the
auditor draws conclusions and bases the auditor’s opinion being persuasive rather than
conclusive.
(c) Audit Programme for Audit of Grant Fund of a College:
(i) The auditor should obtain the basic documents about the constitution of the college,
objectives of the trust, rules of college etc.
(ii) The government policy on grant should be checked with the relevant application,
brochure, and sanction advices.
(iii) The conditions stipulated in award of grant should be studied.
(iv) The receipt of grant should be vouched with bank statement.
(v) The budgeted heads of expenses for the project and actual utilization of the fund
should be checked.
(vi) The purchase of capital items covered within the project should be correctly
capitalized. The same should be properly and distinctly shown in the balance sheet
of the college. The cost of the asset should be adjusted for the grant amount.
(vii) The expenses of revenue nature incurred from and out of grant in the form of salaries
to field staff, materials purchased, travelling, survey and field work expenses and
analysis and preparation of reports etc., should be vouched with the relevant
vouchers.
(viii) The expenses should be accounted as withdrawal of amounts from the fund. It is to
be checked that these expenses are not accounted in income and expenditure of the
college.
(ix) In balance sheet, the fund account should be shown as a liability with a separate
schedule indicating the receipts, payments and balance as on the date of closing of
accounts.

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(x) The fund balance should be cross checked with the periodical statements of accounts
submitted to the nodal agencies.
(xi) The physical verification of assets pertaining to the project should be done by the
management of the college.
(xii) The progress of the project may be ascertained from the minutes, committee meeting
extracts and reports. This must be done to ensure that the project fund is genuinely
utilized for the purposes it intended for.
Question 6
(a) Specify the class of companies to whom rotation of auditor applies, under the provisions
of Companies Act, 2013. (4 Marks)
(b) With reference to SA 500, “Audit Evidence”, discuss the different sources and their
reliability, of audit evidence. (6 Marks)
(c) State the analytical review procedures normally carried out in the audit of inventories.
(6 Marks)
Answer
(a) Applicability of Provisions Related to Rotation of Auditors: The provisions related to
rotation of auditor as provided under section 139(2) of the Companies Act, 2013 are
applicable to all listed companies and other class or classes of companies as prescribed
under Companies (Audit and Auditors) Rules, 2014.
As per rules prescribed in Companies (Audit and Auditors) Rules, 2014, for applicability of
section 139(2) the class of companies shall mean the following classes of companies
excluding one person companies and small companies-
(i) all unlisted public companies having paid up share capital of ` 10 crore or more;
(ii) all private limited companies having paid up share capital of ` 20 crore or more;
(iii) all companies having paid up share capital of below threshold limit mentioned above,
but having public borrowings from financial institutions, banks or public deposits of
` 50 crores or more.
(b) Reliability of Audit Evidence: SA 500 on “Audit Evidence”, provides that the reliability of
information to be used as audit evidence, and therefore of the audit evidence itself, is
influenced by its source and its nature, and the circumstances under which it is obtained,
including the controls over its preparation and maintenance where relevant. Therefore,
generalisations about the reliability of various kinds of audit evidence are subject to
important exceptions. Even when information to be used as audit evidence is obtained
from sources external to the entity, circumstances may exist that could affect its reliability.
For example, information obtained from an independent external source may not be
reliable if the source is not knowledgeable, or a management’s expert may lack objectivity.

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While recognising that exceptions may exist, the following generalisations about the
reliability of audit evidence may be useful:
(i) The reliability of audit evidence is increased when it is obtained from independent
sources outside the entity.
(ii) The reliability of audit evidence that is generated internally is increased when the
related controls, including those over its preparation and maintenance, imposed by
the entity are effective.
(iii) Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or by
inference (for example, inquiry about the application of a control).
(iv) Audit evidence in documentary form, whether paper, electronic, or other medium, is
more reliable than evidence obtained orally (for example, a contemporaneously
written record of a meeting is more reliable than a subsequent oral representation of
the matters discussed).
(v) Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles, or documents that have been filmed, digitized
or otherwise transformed into electronic form, the reliability of which may depend on
the controls over their preparation and maintenance.
(c) Analytical Procedures for Verification of Inventories: The auditor can adopt the
following analytical procedures to verify the inventory of inventories-
(i) Quantitative reconciliation of opening inventories, purchases, production, sales and
closing inventories.
(ii) Comparison of closing inventory quantities and amounts with those of the previous
year.
(iii) Comparison of the inventory turnover ratios for the current year with that of the
previous year and with industry standards if available.
(iv) Comparison of the closing inventory (Raw materials, closing work-in-progress and
finished goods are percentage of total inventories) with the corresponding figures of
the previous year.
(v) Comparison of current year gross profit ratio with that of the previous year.
(vi) Comparison of actual inventory, purchase and sales figures with the budgeted figures
if available.
(vii) Comparison of raw material yield/wastage with previous year figures.

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Question 7
Write short notes on any four of the following:
(a) What is an Emphasis of Matter paragraph, when it is used, and manner of its use in an
audit report?
(b) Important requirements which should be kept in mind to establish a system of internal
control for application process at a service bureau.
(c) General Purpose Financial Statements.
(d) Provisions regarding re-appointment of a retiring auditor at the Annual General Meeting,
for a company not covered under auditor rotation provisions.
(e) The purpose of providing depreciation. (4 x 4 = 16 Marks)
Answer
(a) Emphasis of Matter paragraph: Sometimes the auditor considers it necessary to draw
users’ attention to a matter presented or disclosed in the financial statements that, in the
auditor’s judgment, is of such importance that it is fundamental to users’ understanding of
the financial statements, the auditor shall include an Emphasis of Matter paragraph in the
auditor’s report provided the auditor has obtained sufficient appropriate audit evidence that
the matter is not materially misstated in the financial statements.
Examples - when it is used:
 An uncertainty relating to the future outcome of an exceptional litigation or regulatory
action.
 Early application (where permitted) of a new accounting standard that has a pervasive
effect on the financial statements in advance of its effective date.
 A major catastrophe that has had, or continues to have, a significant effect on the
entity’s financial position.
Manner of its use in Audit Report: As per SA 706 “Emphasis of Matter Paragraphs and
Other Matter Paragraphs in the Independent Auditor’s Report”, the inclusion of an
Emphasis of Matter paragraph in the auditor’s report does not affect the auditor’s opinion.
When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the
auditor shall:
(i) Include it immediately after the Opinion paragraph in the auditor’s report;
(ii) Use the heading “Emphasis of Matter”, or other appropriate heading;
(iii) Include in the paragraph a clear reference to the matter being emphasised and to
where relevant disclosures that fully describe the matter can be found in the financial
statements; and
(iv) Indicate that the auditor’s opinion is not modified in respect of the matter emphasised.

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(b) Requirements of Internal Control System at a Service Bureau: Various requirements

to establish or evaluate a system of internal control for applications processed at a service
bureau are stated below-
(i) Liaison between bureau and user should be clearly defined. Senior member of the
user’s staff is appointed as liaison officer.
(ii) Need for a system testing including all clerical procedures at the user company.
(iii) Control over physical movement of data and in this respect whether a copy or
microfilm of documents sent to the service bureau is kept.
(iv) Planning procedure so that error is identified by documents provided by the bureau.
The user must ensure that prompt correction and resubmission of rejection to meet
the bureau processing schedule.
(v) Establishing a system in the user company to ensure that all exceptional reports are
received from bureau.
(vi) Establish clerical control to verify the accuracy of computer processing.
(vii) Normally, user has no physical control over the files; therefore, high control over the
maintenance of data on master files should be established.
(c) General Purpose Financial Statements: As defined in SA 700 “Forming an Opinion and
Reporting on Financial Statements”, general purpose financial statements are financial
statements prepared in accordance with a general purpose framework.
A financial reporting framework designed to meet the common financial information needs
of a wide range of users is called General purpose framework.
The term “General Purpose Financial Statements” normally includes a Balance Sheet, a
statement of profit and loss (also known as ‘income statement’), a cash flow statement and
those notes and other statements and explanatory material that are an integral part of the
financial statements. They may also include supplementary schedules and information
based on or derived from, and expected to be read with, such statements. Such schedules
and supplementary information may deal, for example, with financial information about
business and geographical segments, and disclosures about the effects of changing
prices. Financial statements do not, however, include such items as reports by directors,
statements by the chairman, discussion and analysis by management and similar items
that may be included in a financial or annual report. Such financial statements are prepar ed
and presented at least annually and are directed toward the common information needs of
a wide range of users. Some of these users may require, and have the power to obtain,
information in addition to that contained in the financial statements. Many users, however,
have to rely on the financial statements as their major source of financial information and
such financial statements should, therefore, be prepared and presented with their needs
in view. Accounting Standards are applicable to all General Purpose Financial Statements.

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(d) Provisions regarding re-appointment of a Retiring Auditor at the AGM for a Company
not covered under Auditor Rotation Provisions: A retiring auditor may be re-appointed
at an annual general meeting, if-
(a) he is not disqualified for re-appointment;
(b) he has not given the company a notice in writing of his unwillingness to be re -
appointed; and
(c) a special resolution has not been passed at that meeting appointing some other
auditor or providing expressly that he shall not be re-appointed.
Where at any annual general meeting, no auditor is appointed or re-appointed, the existing
auditor shall continue to be the auditor of the company.
(e) Purpose of Providing Depreciation: Depreciation may be defined as, "a measure of the
wearing out, consumption or other loss of value of a depreciable asset arising from use,
effluxion of time or obsolescence through technology and market changes. Depreciation is
allocated so as to charge a fair proportion of the depreciable amount in each accounting
period during the expected useful life of the asset.
The principal objective of depreciation on fixed assets is to allocate as an expense, the
related depreciation amount on a year to year basis. Depreciation has a significant effect
in determining and presenting the financial position and results of operations of an
enterprise. The main purpose of providing depreciation is as under:
(i) To keep intact the capital invested in fixed assets - This is accomplished by
retaining the amount of depreciation charged in the Statement of Profit and Loss in
the business.
(ii) To ascertain the true cost of production - As the value of fixed assets depletes
gradually by consumption during the process of production, it is necessary that such
consumption of value be charged in the accounts for determination of the true cost of
production.
(iii) To determine the profit or loss for the year - Depreciation being an expense
represented by the loss in value of fixed assets arising on use, it is charged to the
Statement of Profit and Loss for determining the profit or loss during a year.
(iv) To present a true and fair value of entity's assets in the balance sheet - Since
the original cost of fixed assets gradually decreases due to use and other factors, it
is improper to continue to carry such assets at original costs. Therefore, the amount
of depreciation charged in the Statement of Profit and Loss representing the loss in
value of the assets is deducted from the original cost on a cumulative basis so as to
reflect in the balance sheet a true and fair value of the fixed assets.

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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) Relationship between statutory auditor and internal auditor. (5 Marks)
(b) What constitutes true and fair view is a matter of auditor’s judgement, but some specific
points must be seen by the auditor to ensure true and fair view. (5 Marks)
(c) Audit against the propriety seeks to ensure that expenditure confirms to certain
principles. (5 Marks)
(d) Auditor’s job becomes simpler in CIS environment, where trial balance always tally.
(5 Marks)
Answer
(a) Relationship between Statutory Auditor and Internal Auditor: The function of an
internal auditor is an integral part of the system of internal control. It is statutory
requirement too as per section 138 of the Companies Act, 2013 where the Audit
Committee of the company or the Board shall, in consultation with the Internal Auditor,
formulate the scope, functioning, periodicity and methodology for conducting the internal
audit. However, it is obligatory for a statutory auditor to examine the scope and
effectiveness of the work carried out by the internal auditor.
Though the roles and primary objectives of internal and statutory audit differs, some of
their means of achieving their respective objectives are similar. Thus, much of the work
of the internal auditor may be useful to the statutory auditor in determining the nature,
timing and extent of his audit procedures. Depending upon such evaluation, the statutory
auditor may be able to adopt less extensive procedures.
If the statutory auditor is satisfied on an examination of the work of the internal auditor,
that the internal audit has been efficient and effective, he may accept the
checking/evaluation carried out by the internal auditor in the area of internal control,
verification of assets and liabilities etc.
It must however be mentioned that the area of co-operation between the statutory and
internal auditor is limited by the fact that both owe their allegiance to separate
authorities, the shareholders in the case of statutory auditor and the management in the
case of internal auditor.
(b) True & Fair view: This is correct that what constitutes a ‘true and fair’ view is a matter of
an auditor’s judgment in the particular circumstances of a case. In more specific terms, to
ensure true and fair view, an auditor has to see:

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(i) That the assets are neither undervalued nor overvalued, according to the applicable
accounting principles.
(ii) No material asset is omitted.
(iii) The charge, if any, on assets are disclosed.
(iv) Material liabilities should not be omitted.
(v) The profit and loss account discloses all the matters required to be disclosed by
Part II of Schedule III and the balance sheet has been prepared in accordanc e with
Part I of Schedule III.
(vi) Accounting policies have been followed consistently.
(vii) All unusual, exceptional or non-recurring items have been disclosed separately.
(c) Audit against propriety: Audit against propriety seeks to ensure that expenditure
conforms to these principles which have been stated as follows:
(1) The expenditure should not be prima facie 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.
(2) No authority should exercise its powers of sanctioning expenditure to pass an order
which will be directly or indirectly to its own advantage.
(3) Public moneys should not be utilized 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 for the amount could be enforced in a Court of law; or
(iii) The expenditure is in pursuance of a recognized policy or custom; and
(iv) The amount of allowances, such as travelling allowances, granted to meet
expenditure of a particular type should be so regulated that the allowances are
not, on the whole, sources of profit to the recipients.
(d) Audit in a Computerized Information System (CIS) Environment: Though it is true
that in CIS environment the trial balance always tallies, the same cannot imply that the
job of an auditor becomes simpler. There can still be some accounting errors like
omission of certain entries, compensating errors; duplication of entries, errors of
commission in the form of wrong account head is posted. Possibility of “Window
Dressing” and/or “Creation of Secret Reserves” where the trial balance tallied. At
present, due to complex business environment the importance of trial balance cannot be
judged only upto the arithmetical accuracy but the nature of transactions recorded in the
books and appear in the trial balance should be focused.

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The emergence of new forms of financial instruments like options and futures,
derivatives, off balance sheet financing etc. have given rise to further complexities in
recording and disclosure of transactions. In an audit, besides the tallying of a trial
balance, there are also other issue like estimation of provision for depreciation, valuation
of inventories, obtaining audit evidence, ensuring compliance procedure and carrying out
substantive procedure, verification of assets & liabilities their valuation etc. which still
requires judgment to be exercised by the auditor.
Responsibility of expressing an audit opinion and objectives of an audit are not changed
in the audit in CIS environment. Therefore, it can be said that simply because of CIS
environment and the trial balance has tallied it does not mean that the audit would
become simpler.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect:
(Answer any Eight)
(i) One of the techniques used for gathering evidence is substantial review.
(ii) The method which involves dividing the population into groups of items is knows as block
sampling.
(iii) A flow chart is a graphic presentation of each point of the company’s system of internal
control.
(iv) It is necessary for the auditor to maintain professional skepticism throughout the audit.
(v) Capital Reserve and Reserve Capital are the same.
(vi) Central Government permission is required when auditors are to be removed before
expiry of their term, but not so when auditors are changed after expiry of their term.
(vii) It is not necessary to follow standards on auditing as they are meant only for reference
purposes.
(viii) An auditor issues unqualified opinion when he concludes that the financial statements
give true and fair view.
(ix) All intangible assets are not required to be amortized.
(x) Auditor’s right of lien is unconditional. (8 x 2 = 16 Marks)
Answer
(i) Correct. For collection and accumulation of audit evidence, certain methods and means are
available and these are known as audit techniques. Some of the techniques commonly
adopted by the auditors are Posting checking, Casting Checking, Physical Examination and

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count, Confirmation, Inquiry, Year end Scrutiny, Re-computation, Tracing in subsequent

period, Bank reconciliation.
Substantial review is examination of accounts having large amounts, value and
importance. Substantial review can be used for gathering evidence.
(ii) Incorrect. The method which involves dividing the population into groups of items is
known as cluster sampling whereas block sampling involves the selection of a defined
block of consecutive items.
(iii) Correct. Flow chart is a graphic presentation of each part of the entity’s system of
internal control. It minimizes the amount of narrative explanation and thereby achieves a
presentation not possible in any other form. It gives bird’s eye view of system for
suggestion
(iv) Correct. As per SA 200, “Overall Objectives of the Independent Auditor and the Conduct
of an Audit in Accordance with Standards on Auditing”, professional skepticis m is an
attitude that includes a questioning mind, being alert to conditions which may indicate
possible misstatement due to error or fraud, and a critical assessment of audit evidence.
Thus, it is necessary for the auditor to maintain professional skeptic ism throughout the
audit.
(v) Incorrect. Capital reserve represent surplus profit earned in respect of certain types of
transactions e.g. Profit on sale of fixed assets etc. which is not available for distribution
as dividend. Reserve Capital is that part of Capital which shall not be called up except
when Company is being wound up.
(vi) Correct. Removal of auditor before expiry of his term i.e. before he has submitted his
report is a serious matter and may adversely affect his independence. Hence, the
permission of the Central Government is required when auditors are removed before
expiry of their term and the same is not needed when they are not re -appointed after
expiry of their term.
(vii) Incorrect. While discharging attestation functions, it will be the duty of auditor to ensure
that the standards on auditing are followed in the audit of financial information covered
by their audit reports. If for any reason member has not been able to perform an audit in
accordance with standards, his report should draw attention to the material departures.
(viii) Correct. An unqualified opinion should be expressed when the auditor concludes that the
financial statements give a true and fair view in accordance with the financial reporting
framework used for the preparation and presentation of the financial statements.
It indicates, implicitly, that any changes in the accounting principles or in the method of
their application, and the effects thereof, have been properly determined and disclosed in
the financial statements.

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(ix) Incorrect. As per AS -26, the depreciable amount of an intangible asset should be
allocated on a systematic basis over the best estimate of its useful life. The useful life of
an intangible asset may be very long but it is always finite.
(x) Incorrect. In terms of the general principles of law, any person having the lawful
possession of somebody else’s property, on which he has worked, may retain the
property for non-payment of his dues on account of the work done on the property.
On this premise, auditor can exercise lien on books and documents placed at his
possession by the client for non-payment of fees for work done on the books and
documents.
Question 3
How will you vouch/verify the following?
(a) Foreign Travel Expenses
(b) Receipt of Capital subsidy
(c) Royalties received
(d) Goods sent out on Sale or Return basis. (4 x 4 = 16 Marks)
Answer
(a) Foreign Travel Expenses:
(i) Examine Travelling Allowance bills submitted by the employees stating the details of
tour, details of expenses, etc.
(ii) Verify that the tour programme was properly authorized by the competent authority.
(iii) Check the T.A. bills along with accompanying supporting documents such as air
tickets, travel agents bill and hotel bills with reference to the internal rules for
entitlement of the employees and also make sure that the bills are properly passed.
(iv) See that the tour report accompanies the T.A. bill. The tour report will show the
purpose of the tour. Satisfy that the purpose of the tour as shown by the tour report
conforms to the authorization for the tour.
(v) Check Reserve Bank of India’s permission, if necessary, for withdrawing the foreign
exchange. For a company, the amount of foreign exchange spent is to be disclosed
separately in the accounts as per requirement of Schedule III to the Companies Act,
2013 and Accounting Standard 11 “The Effects of Changes in Foreign Exchange
Rates”.
(b) Receipt of Capital Subsidy:
(i) Refer to application made for the claim of subsidy to ascertain the purpose and the
scheme under which the subsidy has been made available.

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(ii) Examine documents for the grant of subsidy and note the conditions attached with
the same relating to its use, etc.
(iii) See that conditions to be fulfilled and other terms especially whether the same is for
a specific asset or is for setting up a factory at a specific location.
(iv) Check relevant entries for receipt of subsidy.
(v) Check compliance with requirements of AS 12 on “Accounting for Government
Grants” i.e. whether it relates to specific amount or in the form of promoters’
contribution and accordingly accounted for as also compliance with the disclosure
requirements.
(c) Royalties received:
(i) Verify the relevant contract and ascertain the provisions relating to the conditions of
royalty such as rate, mode of calculation and due date.
(ii) Check the periodical statements received in respect of books printed, sold and
inventory lying at different locations.
(iii) Check the computation in the royalty statement and ensure that any deduction or
adjustment made from the royalty due is as per agreement conditions.
(iv) Verify the provisions for the royalty to be received as at the end of the year.
(d) Goods Sent Out on Sale or Return Basis:
(i) Check whether a separate memoranda record of goods sent out on sale or return
basis is maintained. The party accounts are debited only after the goods have been
sold and the sales account is credited.
(ii) See that price of such goods is unloaded from the sales account and the trade
receivable’s record. Refer to the memoranda record to confirm that on the receipt of
acceptance from each party, his account has been debited and the sales account
correspondingly credited.
(iii) Ensure that the goods in respect of which the period of approval has expired at the
close of the year either have been received back subsequently or customers’
accounts have been debited.
(iv) Confirm that the inventory of goods sent out on approval, the period of approval in
respect of which had not expired till the close of the year lying with the party, has
been included in the closing inventory.
Question 4
(a) State the services which are not to be rendered by an auditor as per the provisions of
Companies Act, 2013. (6 Marks)
(b) Mention the purposes for which capital expenditure is incurred. (6 Marks)

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(c) What is the difference between Narrative records and Check-list? (4 Marks)
Answer
(a) Services not to be rendered by the auditor: Section 144 of the Companies Act, 2013 is
a new provision which prescribes certain services not to be rendered by the auditor. An
auditor appointed under this Act shall provide to the company only such other services as
are approved by the Board of Directors or the audit committee, as the case may be, but
which shall not include any of the following services (whether such services are rendered
directly or indirectly to the company or its holding company or subsidiary company),
namely:
(i) Accounting and book keeping services;
(ii) Internal audit;
(iii) Design and implementation of any financial information system;
(iv) Actuarial services;
(v) Investment advisory services;
(vi) Investment banking services;
(vii) Rendering of outsourced financial services;
(viii) Management services; and
(ix) Any other kind of services as may be prescribed.
(b) Capital Expenditure: A capital expenditure is that which is incurred for the under
mentioned purposes-
(i) Acquiring fixed assets, i.e., assets of a permanent or a semi-permanent nature,
which are held not for resale but for use with a view to earning profits.
(ii) Making additions to the existing fixed assets.
(iii) Increasing earning capacity of the business.
(iv) Reducing the cost of production.
(v) Acquiring a benefit of enduring nature of a valuable right.
(c) Difference between Narrative records and Check-list:
(i) The Narrative Record is a complete and exhaustive description of the system as found
in operation by the auditor whereas checklist is a series of instructions and/or questions
which a member of the auditing staff must follow and/or answer. When he completes
instruction, he initials the space against the instruction. Answers to the check list
instructions are usually Yes, No or Not Applicable
(ii) The Narrative Record may be recommended in cases where no formal control system
is in operation and would be more suited to small business whereas check list is an on
the job requirement and instructions are framed having regard to the desirable
elements of control.

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Question 5
(a) Discuss which class of companies are specifically exempt from the applicability of CARO
2015. (6 Marks)
(b) As one of the Joint auditors of X Ltd. for the immediately preceding three financial years,
you have been considered for ratification by the members in the AGM as the so le auditor,
while the said Joint auditors are not re-appointed. Comment. (6 Marks)
(c) State the disclosure requirements in respect of Statement of profit and Loss as per
Schedule III of Companies Act, 2013, in case of Employee benefits expenses. (4 Marks)
Answer
(a) CARO 2015 specifically exempts the following class of companies:
CARO 2015 specifically exempts the following class of companies-
(i) A banking company as defined in clause (c) of section 5 of the Banking Regulation
Act, 1949;
(ii) An insurance company as defined under the Insurance Act,1938;
(iii) A company licensed to operate under section 8 of the Companies Act;
(iv) A One Person Company as defined under clause (62) of section 2 of the Companies
Act;
(v) A small company as defined under clause (85) of section 2 of the Companies Act;
and
(vi) A private limited company with a paid up capital and reserves not more than ` 50
lakhs and which does not have loan outstanding exceeding ` 25 lakhs from any
bank or financial institution and does not have a turnover exceeding ` 5 crores at
any point of time during the financial year.
(b) Joint Auditors: When one of the joint auditors of the previous years is considered for
ratification by the members as the sole auditor for the next year, it is similar to nonre -
appointment of one of the retiring joint auditors. As per sub-section 4 of section 140 of
the Companies Act, 2013, special notice shall be required for a resolution at an annual
general meeting appointing as auditor a person other than a retiring auditor, or providing
expressly that a retiring auditor shall not be re-appointed, except where the retiring
auditor has completed a consecutive tenure of five years or, as the case may be, ten
years, as provided under sub-section (2) of section 139 of the said Act.
Accordingly, provisions of the Companies Act, 2013 to be complied with are as under-
(i) Ascertain that special notice u/s 140(4) of the Companies Act, 2013 was received
by the company from such number of members holding not less than one percent of
total voting power or holding shares on which an aggregate sum of not less than five
lakh rupees has been paid up on the date of the notice not earlier than 3 months but

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at least 14 days before the AGM date as per Section 115 of the Companies Act,
2013 read with the Companies (Management and Administration) Rules, 2014.
(ii) Check whether the said notice has been sent to all the members at least 7 days
before the date of the AGM as per Section 115 of the Companies Act, 2013 read
with the Companies (Management and Administration) Rules, 2014.
(iii) Verify the notice contains an express intention of a member for proposing the
resolution for appointing a sole auditor in place of both the joint auditors who retire
at the meeting but are eligible for re-appointment.
(iv) The notice is also sent to the retiring auditor as per Section 140(4)(ii) of the
Companies Act, 2013.
(v) Verify whether any representation, received from the retiring auditor was sent to the
members of the company to whom notice of the meeting was sent.
(vi) Verify from the minutes book whether the representation received from the retiring
joint auditor was considered at the AGM.
(c) Employee benefits expenses: The Company shall disclose by way of notes additional
information regarding aggregate expenditure on the Employee benefits expenses: -
(i) Salaries and wages.
(ii) Contribution to provident and other funds.
(iii) Expense on Employee Stock Option Scheme (ESOP) and Employee Stock
Purchase Plan (ESPP).
(iv) Staff welfare expenses.
Question 6
(a) What audit points are to be borne in mind in case of issue of “Sweat Equity Shares” by a
limited company? (6 Marks)
(b) Is there any statutory necessity to make disclosure of depreciation in company’s
accounts? (6 Marks)
(c) Discuss external confirmation procedure as per SA-505. (4 Marks)
Answer
(a) Issue of Sweat Equity Shares: As per section 54 of the Companies Act, 2013, the
employees may be compensated in the form of ‘Sweat Equity Shares”.
“Sweat Equity Shares” means equity shares issued by the company to employees or
directors at a discount or for consideration other than cash for providing know-how or
making available right in the nature of intellectual property rights or value additions, by
whatever name called.

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The auditor may see that the Sweat Equity Shares issued by the company are of a class
of shares already issued and following conditions are fulfilled-
(i) The issue is authorized by a special resolution passed by the company;
(ii) The resolution specifies the number of shares, the current market price,
consideration, if any, and the class or classes of directors or employees to whom
such equity shares are to be issued;
(iii) Not less than one year has, at the date of such issue, elapsed since the date on
which the company had commenced business; and
(iv) Where the equity shares of the company are listed on a recognized sto ck
exchange, the sweat equity shares are issued in accordance with the regulations
made by the Securities and Exchange Board in this behalf and if they are not so
listed, the sweat equity shares are issued in accordance with such rules as may be
prescribed.
The rights, limitations, restrictions and provisions as are for the time being applicable to
equity shares shall be applicable to the sweat equity shares issued under this section
and the holders of such shares shall rank paripassu with other equity shareholders.
(b) Statutory necessity to make disclosure of depreciation:
(i) The Schedule II to the Companies Act, 2013 needs disclosure in the financial
statements about the depreciation method used and the useful lives of the assets
for computing depreciation, if they are different from the life specified in the
Schedule II.
(ii) Schedule III “General Considerations for preparation of Balance Sheet and
Statement of Profit and Loss of a Company”, to the Companies Act, 2013, requires
separate disclosure of depreciation charged and impairment losses/reversals along
with a reconciliation of the gross and net carrying amounts of each class of assets
at the beginning and end of the reporting period showing additions, disposals,
acquisitions through business combinations and other adjustments.
(iii) Accounting Standard 6 requires following information to be disclosed in the financial
statements;
(1) The historical cost or other amount substituted for historical cost of each class of
depreciable assets;
(2) Total depreciation for the period for each class of assets; and
(3) The related accumulated depreciation.
(iv) It also requires following disclosure of information in the financial statements alongwith
the disclosure of other accounting policies;
(1) Depreciation method used; and

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(2) The useful lives of the assets for computing depreciation, if they are different
from the life specified in the Schedule.
(c) External Confirmation Procedures:
(i) Determining the Information to be confirmed or Requested: External
confirmation procedures frequently are performed to confirm or request information
regarding account balances and their elements. They may also be used to confirm
terms of agreements, contracts, or transactions between an entity and other parties,
or to confirm the absence of certain conditions, such as a “side agreement”.
(ii) Selecting the Appropriate Confirming Party: Responses to confirmation requests
provide more relevant and reliable audit evidence when confirmation requests are
sent to a confirming party the auditor believes is knowledgeable about th e
information to be confirmed. For example, a financial institution official who is
knowledgeable about the transactions or arrangements for which confirmation is
requested may be the most appropriate person at the financial institution from whom
to request confirmation.
(iii) Designing Confirmation Requests: The design of a confirmation request may
directly affect the confirmation response rate, and the reliability and the nature of
the audit evidence obtained from responses.
(iv) Follow-Up on Confirmation Requests: The auditor may send an additional
confirmation request when a reply to a previous request has not been received
within a reasonable time. For example, the auditor may, having re -verified the
accuracy of the original address, send an additional or follow-up request.
Question 7
Write short notes on any four of the following:
(a) Written communication in respect of deficiencies of internal control.
(b) Audit enquiry w.r.t. Companies Act, 2013.
(c) Compilation engagement.
(d) Scrutiny of General Ledger.
(e) Management representation. (4 x 4 = 16 Marks)
Answer
(a) Written Communication in respect of deficiencies of internal control: If the auditor
has identified one or more deficiencies in internal control, the auditor shall determine, on
the basis of the audit work performed, whether, individually or in combination, they
constitute significant deficiencies.
The auditor shall communicate in writing significant deficiencies in internal control
identified during the audit to those charged with governance on a timely basis.

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The auditor shall also communicate to management at an appropriate level of

responsibility on a timely basis: In writing, significant deficiencies in internal control that
the auditor has communicated or intends to communicate to those charged with
governance, unless it would be inappropriate to communicate directly to management in
the circumstances.
The auditor shall include in the written communication of significant deficiencies in
internal control:
(i) A description of the deficiencies and an explanation of their potential effects; and
(ii) Sufficient information to enable those charged with governance and management to
understand the context of the communication. In particular, the auditor shall explain
that:
(1) The purpose of the audit was for the auditor to express an opinion on the
financial statements;
(2) The audit included consideration of internal control relevant to the preparation
of the financial statements in order to design audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of internal control; and
(3) The matters being reported are limited to those deficiencies that the auditor has
identified during the audit and that the auditor has concluded are of sufficient
importance to merit being reported to those charged with governance.
(b) Audit enquiry w.r.t. Companies Act, 2013: According to Section 143(1) of the
Companies Act, 2013, it is the duty of auditor to inquire into the following matters -
(i) 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
prejudicial to the interests of the company or its members.
(ii) Whether transactions of the company which are represented merely by book entries
are prejudicial to the interests of the company.
(iii) Where the company not being an investment company 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 that at which they were
purchased by the company.
(iv) Whether loans and advances made by the company have been shown as deposits.
(v) Whether personal expenses have been charged to revenue account.
(vi) Where it is stated in the books and documents 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.

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(c) Compilation Engagement: An engagement in which a practitioner applies accounting

and financial reporting expertise to assist management in preparation and presentation of
financial information of an entity in accordance with an applicable financial reporting
framework and reports as required by the SRS.
Since, a compilation engagement is not an assurance engagement; a compilation
engagement does not require the practitioner to verify the accuracy or the completeness
of the information provided by management for the compilation or otherwise to gather
evidence to express an audit opinion or a review conclusion on the preparation of
financial information.
(d) Scrutiny of General Ledger:
(i) The General Ledger contains all the balances which are ultimately included in the
Statement of Profit and Loss and the Balance Sheet. Its examination therefore is
undertaken last of all.
(ii) The scrutiny of General Ledger should be carried out with due care in as much as it
is the final review of balances which, on inclusion in Final Accounts, cumulatively
reflect the financial position of the concern.
(iii) Entries in the General Ledger usually are posted in a summary form from the books
of original entries such as Cash Book, Journal, Sales Book, Purchas e Book and
other subsidiary books. Therefore, it should be confirmed that all the postings on
various accounts have been verified, totals, etc. checked.
(iv) It should also be ascertained that balances in all the income and expense accounts
have been adjusted: (a) according to standard accounting practices (i.e., all unpaid,
prepaid expenses have been adjusted and accrued Income and pre -recorded
income is properly adjusted); and (b) on a consideration of the legal provisions
which are applicable to the concern.
(v) The balances in the General Ledger should be traced to the trial balance and from
the trial balance to the final accounts.
(e) Management Representation: SA 580 “Written Representations” deals with the
auditor’s responsibility to obtain written representations from management and, where
appropriate, those charged with governance. Audit evidence is all the information used
by the auditor in arriving at the conclusions on which the audit opinion is based. Written
representations are necessary information that the auditor requires in connection with the
audit of the entity’s financial statements. Accordingly, similar to responses to inquiries,
written representations are audit evidence. In certain instances such as where knowledge
of facts is confined to management or where matter is principally of intention, a
representation by management may be the only audit evidence which can reasonably be
expected to be available for example, intention of management to hold a specific
investment for long term. However, it cannot be a substitute for other audit evidences
expected to be available.

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Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) With reference to SA-550, “Identification of significant related party transaction outside
the entity’s normal course of business”. (5 Marks)
(b) With reference to SA-530, meaning of audit sampling and requirements relating to
sample design, sample size and selection of items for testing. (5 Marks)
(c) How does an audit programme help to plan and perform the audit? (5 Marks)
(d) What are the specific risks related to internal control in an IT environment? (5 Marks)
Answer
(a) Identification of significant related party transaction outside business: As per SA
550 on “Related Parties”, for identified significant related party transactions outside the
entity’s normal course of business, the auditor shall:
(i) Inspect the underlying contracts or agreements, if any, and evaluate whether:
1. The business rationale (or lack thereof) the transactions suggests that they
may have been entered into to engage in fraudulent financial reporting or to
conceal misappropriation of assets;
2. The terms of the transactions are consistent with management’s explanations;
and
3. The transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework; and
(ii) Obtain audit evidence that the transactions have been appropriately authorized and
approved.
(b) Audit Sampling: As per SA 530 on “Audit Sampling” the meaning of the term “Audit
Sampling” is the application of audit procedures to less than 100% of items within a
population of audit evidence such that all sampling units have a chance of selection in
order to provide the auditors with a reasonable basis on which to draw conclusions about
the entire population.
According to the said SA, requirements relating to sample design, sample size and
selection of items for testing are explained below:
Sample design – When designing an audit sample, the auditor shall consider the
purpose of the audit procedure and the characteristics of the population from which the
sample will be drawn.

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Sample size – The auditor shall determine a sample size sufficient to reduce sampling
risk to an acceptably low level.
Selection of items for testing – The auditor shall select items for the sample in such a
way that each sampling unit in the population has a chance of selection.
(c) The role of Audit Programme in audit plan and performance: The audit programme is
helpful both in planning and performance stages of audit as follows:
(i) The audit programme lists down areas of audit before commencement.
(ii) The audit timing is built therein; thereby it becomes a schedule of audit plan.
(iii) The staff that is entrusted with the audit assignment is also specified. It is a plan of
resources allocation of the firm.
(iv) It specifies the procedures to be checked during the audit.
(v) As the audit work is split into various elements of procedures to be performed, the
audit programme acts as a guiding chart or check list during the performance of
audit.
(vi) Since the staff in charge of each work is specified and they sign the programme, it
extracts the responsibility from the audit assistants.
(vii) The working papers of the audit staff can be reviewed against the audit programme
which helps a base of reference for evaluation of the performance before reporting
on the financial statements.
(viii) It also helps in preparing a diary of the performance and plan also base for billing
the clients for the time manpower involved in the audit.
(d) Risks related to internal control in IT environment: The specific risks related to
internal control in an IT environment includes the following:
(i) Reliance on systems or programs that are inaccurately processing data, processing
inaccurate data, or both.
(ii) Unauthorized access to data that may result in destruction of data or improper
changes to data, including the recording of unauthorized or non-existent
transactions, or inaccurate recording of transactions. Particular risks may arise
where multiple users access a common database.
(iii) The possibility of IT personnel gaining access privileges beyond those necessary to
perform their assigned duties thereby breaking down segregation of duties.
(iv) Unauthorized changes to data in master files.
(v) Unauthorized changes to systems or programs.
(vi) Failure to make necessary changes to systems or programs.
(vii) Inappropriate manual intervention.

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(viii) Potential loss of data or inability to access data as required.

Question 2
State with reasons (in short) whether the following statements are correct or incorrect (Answer
any eight):
(a) The scope of work of an internal auditor may extend even beyond the financial
accounting.
(b) An auditor has nothing to do with prudence or profitability of a company.
(c) Evaluating responses to enquiries is an integral part of the inquiry process.
(d) Internal control questionnaires are a good source of identifying weakness in internal
control system.
(e) Cluster sampling is less effective than random sampling.
(f) Errors of duplication affects the Trial Balance.
(g) Substantive procedures do not test the balances of accounts.
(h) The first auditors of a Government company was appointed by the Board of Directors.
(i) The members of XYZ Ltd. preferred a complaint against the auditor stating that he has
failed to send the auditor’s report to them.
(j) Mr. Pawan, a practising Chartered Accountant, is appointed as “Tax-Consultant” of ABC
Ltd., in which his father Mr. Singh is the Managing Director. (8 x 2 = 16 Marks)
Answer
(a) Correct. The scope of work of an internal auditor may extend even beyond the financial
accounting and may include cost investigation, inquiries relating to losses and wastages,
production audit, performance audit, etc.
(b) Incorrect. Companies Act, 2013 requires the company auditor to go beyond the
functions of reporting and express an opinion about the propriety or prudence of certain
transactions. Also, the auditor shall remain alert throughout the audit for audit evidence
of events or conditions that may cast significant doubt on the entity’s ability to continue
as a going concern. Therefore it would not be correct to say that an auditor has nothing
to do with prudence or profitability of a company because it may impact the going
concern.
(c) Correct. Evaluating responses to inquiries is an integral part of the inquiry process.
Responses to inquiries may provide the auditor with information not previously
possessed or with corroborative audit evidence. Alternatively, responses might provide
information that differs significantly from other information that the auditor has obtained.
In some cases, responses to inquiries provide a basis for the auditor to modify or perform
additional audit procedures.

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(d) Correct. The questionnaire form provides an orderly means of disclosing control defects.
It is the general practice to review the internal control system annually and record the
review in detail. In the questionnaire, generally questions are so framed that a ‘Yes’
answer denotes satisfactory position and a ‘No’ answer suggests weakness.
(e) Correct. In cluster sampling population is divided into group called cluster and a number
of cluster is selected on random basis. In case of random sampling, each item is
randomly chosen and so every item has an equal chance of being selected. Thus, cluster
sampling is less effective.
(f) Incorrect. Error of duplication is another type of error of commission which means
recording the same transaction twice. Therefore, this error will not affect the trial balance.
(g) Incorrect. Substantive procedure is an audit procedure designed to detect material
misstatements at the assertion level. It comprise (i) tests of details (of classes of
transactions, account balances, and disclosures), and (ii) substantive analytical
procedures.
(h) Incorrect. As per section 139(7) of the Companies Act, 2013, in the case of a
Government company, the first auditor shall be appointed by the Comptroller and
Auditor-General of India within 60 days from the date of registration of the company.
Alternatively, the statement would be correct in case C&AG does not appoint the first
auditor within 60 days, Board of Directors of the company shall appoint the first auditor
within next 30 days.
(i) Incorrect. As per the provisions of the Companies Act, 2013, it is no part of the auditor’s
duty to send a copy of his report to members of the company. The auditor’s duty
concludes once he forwards his report to the company. It is the responsibility of company
to send the report to every member of the company.
(j) Correct. A Chartered Accountant appointed as an auditor of a company, should ensure
the independence in respect of his appointment. In this case, Mr. Pawan is a "Tax
Consultant" and not a "Statutory Auditor" or "Tax Auditor" of ABC Ltd., hence he is not
subject to the above requirements.
Question 3
How you will vouch/verify the following?
(a) Preliminary expenses
(b) Customs & Excise Duties
(c) Floating assets
(d) Recovery of bad debts written-off. (4 x 4 = 16 Marks)

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Answer
(a) Preliminary Expenses:
(i) Check Board’s minutes book containing the resolution approving the expenses
claimed by promoters as having been spent in formation of the company.
(ii) Examine supporting papers and vouchers, contracts, agreements, etc. to support
the promoters’ claims. Also check bills and receipts issued by the printer of the
memorandum and articles of association, share certificates, etc.
(iii) Check receipt for the registration fee paid for registration of the company.
(iv) Verify rates of stamp required to be affixed on the memorandum and articles of
association.
(v) Examine the compliance of AS 26 with regard to treatment of such preliminary
expenses in the books of account i.e. Expenditure in connection with the preliminary
expenses should be treated as an expense in the year of incurring and not to be
carry forward for writing off in future years.
(vi) Check that no expenses other than those constitute preliminary expenses are
booked under this head, e.g. underwriting commission and brokerage paid.
(vii) The auditor can cross check the amount of preliminary expenses with that disclosed
in the prospectus, statutory report and the balance-sheet. Any amount paid in
excess of the amount disclosed in prospectus should have been approved by the
shareholders.
(b) Customs & Excise Duties
Custom Duty:
(i) Examine the cash book to ensure payment of custom duty with reference to Bill of
entry to check whether the amount was calculated correctly.
(ii) If the duty has been paid by clearing and forwarding agent, examine bill of entry
with reference to agent’s bill.
(iii) If the duty has been paid by the client directly, examine bill of entry together with
receipt evidencing payment of custom duty.
(iv) Make a list of disputed cases to have knowledge of the amount of duty payable and
the provisional payment. The auditor should determine the duty payable and ensure
any additional duty to be paid or refund expected should have been adjusted.
(v) The auditor should also verify the duty drawback.
Excise Duty:
(i) Ensure that excise duty is paid at the time of issue of excisable goods from the
godown at factory of the producer. The duplicate copy of the challan as issued by
the bank is forwarded for the purpose of issue of the excisable goods.

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(ii) Verify the amount of duty paid with the corresponding value of the goods issued
from the inventory register of the producer by applying test check. In case where the
client maintains an advance deposit with Excise Department, the auditor should see
that the permits are issued for delivery of the goods against the advance deposit
and corresponding adjustment.
(iii) Ascertain the rates of excise duty and apply it to the total sales and see that the
amount actually paid does not exceed the amount thus calculated.
(iv) Ascertain that in case of dispute about the amount of duty payable, a provisional
amount may be paid in lieu of final amount. In such cases, the final amount
determined as payable should be verified. If the provisional payment was more than
the actual amount, the refund of such excess amount should be vouched.
(v) The auditor may also physically verify requisite registers maintained with actual and
see reconciliation of financial records with sales tax records.
(c) Floating Assets: Floating assets are acquired for resale with a view to earning profits or
are those that come into existence during the processes of trade or manufacture. All
those, in the normal course of business, are quickly convertible into cash, e.g., inventory,
trade receivable, bills receivable, etc.
The auditor is required to verify the floating assets by:
(i) Examination of records;
(ii) Attendance at inventory-taking;
(iii) Obtaining confirmations from third parties;
(iv) Examination of valuation and disclosure;
(v) Analytical review procedures.
(d) Recovery of bad debts written off:
(i) Verify the relevant correspondence with the trade receivable whose accounts were
written off as bad.
(ii) See that the amount recovered is credited to a separate account recovery of bad
debts written off.
(iii) Verify the acknowledgement receipt issued to debtors.
(iv) Examine notification from the court, bankruptcy trustee and all correspondence from
debtors and collecting agencies.
(v) Check credit manager’s file for the amount received and see that the amount has
been deposited in the bank promptly.
(vi) Review the internal control system regarding writing off and recovery of bad debts.

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Question 4
(a) Mention the disclosure requirement of current investments as per Schedule III of the
Companies Act, 2013. (6 Marks)
(b) What are the significant matters observed during the course of audit, a record of which
should be kept in the Audit Note Book? (6 Marks)
(c) Write short note on the use of flowcharts in evaluation of internal control. (4 Marks)
Answer
(a) Disclosure requirements of current investment: In Schedule III Part I of the
Companies Act, 2013, Current Investments are shown under the head Current Assets.
Further, Schedule III requires that company shall disclose “Current Investments” in notes
to accounts as follows-
(i) Current Investments shall be classified as:
(a) Investments in equity instruments;
(b) Investments in preference shares;
(c) Investments in government or trust securities;
(d) Investments in debentures or bonds;
(e) Investment in mutual funds;
(f) Investments in partnership firms;
(g) Other investments (specify nature).
Under each classification, details shall be given of names of the bodies corporate
(indicating separately whether bodies are subsidiaries, associates, joint ventures or
controlled special purpose entities) in whom investments have been made and the
nature and extent of the investment so made in each such body corporate (showing
separately investments which are partly paid). In regards to investments in the
capital of partnership firms, the names of the firms (with the names of all their
partners, total capital and the shares of each partner) shall be given.
(ii) The following shall also be disclosed:
(a) The basis of valuation of individual investments.
(b) Aggregate amount of quoted investments and market value thereof.
(c) Aggregate amount of unquoted investments.
(d) Aggregate provision made for diminution in value of investments.
(b) Significant matters to be recorded in Audit Note Book: Significant matters observed
during the course of audit, a record of which should be kept in the Audit Note Book are
as follows:

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(i) Audit queries not cleared immediately e.g. missing receipts, vouchers, etc.
(ii) The mistakes or irregularities observed during the course of audit e.g. cases of
failure to comply with the requirements of the Companies Act, 2013 or the
provisions contained in the Memorandum or articles, a chance in the basis of
valuation of finished inventory and work-in-progress or in computation of
depreciation; failure to provide adequate depreciation, etc.
(iii) Unsatisfactory book-keeping arrangements, costing method, internal or financial
administration or organization.
(iv) Important information about the company which is not apparent from the accounts.
(v) Special points requiring consideration at the time of verification of final accounts.
(vi) Important matters for future reference.
(c) Use of flow chart in evaluation of internal control: Flow chart is a graphic
presentation of each part of the company’s system of internal control. It is considered to
be the most concise way of recording the auditor’s review of the system. It minimizes the
amount of narrative explanation and thereby achieves a consideration or presentation not
possible in other form. It gives bird’s eye view of the system and flow of transaction and
integration and in documentation, can be easily spotted and improvement can be
suggested.
It is also necessary for the auditor to study the significant features of the business carried
on by the concern; the nature of its activities and various channels of goods and
materials as well as cash, both inward and outward; and also a comprehensive study of
the entire process of manufacturing, trading and administration. This will help him
understand and evaluate the internal controls in the correct perspective.
Question 5
(a) Mention any six special points which you as an auditor would look into while auditing the
books of a partnership firm. (6 Marks)
(b) Draft an audit programme for conducting audit of accounts of a local body. (6 Marks)
(c) What precautions should be taken by an auditor while applying test check techniques?
(4 Marks)
Answer
(a) Audit of books of accounts of Partnership Firm: Matters which should be specially
considered in the audit of accounts of a partnership firm are as under -
(i) Confirming that the letter of appointment, signed by a partner, duly authorized,
clearly states the nature and scope of audit contemplated by the partners, specially
the limitation, if any, under which the auditor shall have to function.

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(ii) Examine the partnership deed signed by all partners and its registration with the
registrar of firms. Also ascertain from the partnership deed about capital contribution,
profit sharing ratios, interest on capital contribution, powers and responsibilities of the
partners, etc.
(iii) Studying the minute book, if any, maintained to record the policy decision taken by
partners specially the minutes relating to authorization of extra ordinary and capital
expenditure, raising of loans, purchase of assets, extraordinary contracts entered
into and other such matters as are not of a routine nature.
(iv) Verifying that the business in which the partnership is engaged is authorized by the
partnership agreement; or by any extension or modification thereof agreed to
subsequently.
(v) Examining whether books of account appear to be reasonable and are considered
adequate in relation to the nature of the business of the partnership.
(vi) Verifying generally that the interest of no partner has suffered prejudicially by an
activity engaged in by any violation of a provision in the partnership agreements.
(vii) Confirming that a provision for the firm’s tax payable by the partnership has been
made in the accounts before arriving at the amount of profit divisible among the
partners.
(viii) Verifying that the profits and losses have been divided among the partners in their
agreed profit sharing ratio.
(b) Audit Programme of a Local Body
(i) The Local Fund Wing of the State Government is generally in charge of the audit of
municipal accounts. Sometimes bigger municipal corporations e.g. Delhi, Mumbai
etc. have power to appoint their own auditors for regular external audit. So, the
auditor should ensure his appointment.
(ii) The auditor while auditing the local bodies should report on the fairness of the
contents and presentation of financial statements, the strengths and weaknesses of
system of financial control, the adherence to legal and/or administrative
requirements; whether value is being fully received on money spent. His objective
should be to detect errors and fraud and misuse of resources.
(iii) The auditor should ensure that the expenditure incurred conforms to the relevant
provisions of the law and is in accordance with the financial rules and regulations
framed by the competent authority.
(iv) He should ensure that all types of sanctions, either special or general, are accorded
by the competent authority.
(v) He should ensure that there is a provision of funds and the expenditure is incurred
from the provision and the same has been authorized by the competent authority.

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(vi) The auditor should check that the different scheme, programmes and projects,
where large financial expenditure has been incurred, are running economically and
getting the expected results.
(c) Precautions to be taken while applying test check technique: The precautions to be
taken while adopting test check technique are following-
(i) The transactions of the concern should be classified under appropriate heads and
may be stratified if wide variations are there between transactions of the same kind.
(ii) Authorisations, documentations, recording of the transactions should be studied
right from the beginning to end.
(iii) Evaluating the system of internal control for its efficiency, soundness and capability
to produce reliable accounting and financial data.
(iv) Preparation of test check plan with clear audit objective understood by the audit
staff.
(v) Un-biased selection of the transactions with reference to the random number tables
or other statistical methods.
(vi) Identification of the areas where test check may not be done.
(vii) Based on degree of reliance and the confidence level required in the audit, the
number of transactions to be selected for each test plan should be pre-determined.
(viii) Setting up criteria to judge what constitute material or immaterial errors. Further
investigation of only material errors be carried out and all immaterial errors may be
avoided.
Question 6
(a) What are the matters to be included in Director’s Responsibility statement? (6 Marks)
(b) Discuss the provisions of Section 134 of the Companies Act, 2013 regarding the
authentication of financial statements. (6 Marks)
(c) State the factors to be considered to verify the validity of any transaction. (4 Marks)
Answer
(a) Matters to be included in Director’s Responsibility Statement: The provisions related
to the Director’s responsibility under section 134(5) of the Companies Act, 2013 are as
under:
(i) In the preparation of the annual accounts, the applicable accounting standards had
been followed along with proper explanation relating to material departures;
(ii) The directors had selected such accounting policies and applied them consistently
and made adjustments and estimates that are reasonable and prudent so as to give
a true and fair view of the state of affairs of the company at the end of the financial
year and of the profit and loss of the company for that period;

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(iii) The directors had taken proper and sufficient care for the maintenance of adequate
accounting records in accordance with the provisions of this act for safeguarding the
assets of the company and for preventing and detecting frauds and other
irregularities;
(iv) The directors had prepared the annual accounts on a going concern basis;
(v) The directors, in the case of a listed company, had laid down internal financial
controls to be followed by the company and that such internal financial controls are
adequate and were operating effectively;
(vi) The directors had devised proper system to ensure compliance with the provisions
of all applicable laws and that such systems were adequate and operating
effectively.
(b) Authentication of Financial Statements: Section 134(1) of the Companies Act,
2013 provides that the financial statements, including consolidated financial
statement, if any, shall be approved by the board of directors before they are signed on
behalf of the board at least by the following:
(i) chairperson of the company where he is authorized by the Board; or
(ii) By two directors out of which one shall be managing director and the
Chief Executive Officer, if he is a director in the company,
(iii) The Chief Financial Officer and the company secretary of the company,
wherever they are appointed.
However, in the case of a one person company, the financial statement shall be signed
by only one director, for submission to the auditor for his report thereon.
According to section 134(7) of the Companies Act, 2013, a signed copy of
every financial statement, including consolidated financial statement, if any, shall be
issued, circulated or published along with a copy each of
(i) Any notes annexed to or forming part of such financial statement;
(ii) The auditor’s report; and
(iii) The Board’s report
(c) Validity of any transaction: For checking the validity of a transaction, it is usually
necessary to refer to documentary evidence. It may exist in any of the following forms-
(i) The legal provisions, if any, having bearing on the accounts of the entity under audit.
(ii) The rules or regulations governing the internal working of the organization, e.g., the
Articles of Association, Partnership Deed, Trust Deed, etc.
(iii) Minutes of the proceedings of a meeting of members of the company, that of the
directors or that of the Managing committee.
(iv) Copy of an agreement, e.g., Managing Director’s agreement, Lease Deed, vendor’s
agreement, agency agreement, contract with an employee, etc.

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(v) Well recognized accounting principles and practices e.g., distinction between capital
and revenue, accrual system of accounting, valuation principles etc.
An auditor should have a clear and precise knowledge of legal provisions under which
the concern was registered or is functioning, as well as those which constitutes the basis
of various transactions entered into, more particularly the provisions as regards
maintenance and audit of its accounts. He should also study the rules, if any, framed for
regulating the internal management of the entity; these may be embodied in some of the
documents mentioned above. If he has any doubt on any legal point, by way of guidance,
he should call for legal opinion. However, unless he is convinced of the reasonableness
of the legal opinion, he should not act on it.
Question 7
Write short notes on any four of the following:
(a) Provisions for applicability of internal audit as per Companies Act, 2013.
(b) Prohibition to buy-back its own securities in certain circumstances.
(c) Advantages of CAAT.
(d) Changes in accounting policies.
(e) Recognition of interest on deposits. (4 x 4 = 16 Marks)
Answer
(a) Provisions for applicability of Internal Audit: As per section 138 of the Companies
Act, 2013 the following class of companies rules, shall be required to appoint an internal
auditor or a firm of internal auditors namely -
(i) Every listed company;
(ii) Every unlisted public company public company having -
(a) Paid up share capital of fifty crore rupees or more during the preceding
financial year; or
(b) Turnover of two hundred crore rupees or more during preceding financial year;
or
(c) Outstanding loan or borrowing from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year; or
(d) Outstanding deposits of twenty five crore rupees or more at any point of time
during the preceding financial year; and
(iii) Every private company having-
(a) Turnover of two hundred crore rupees or more during the preceding financial
year; or
(b) Outstanding loans or borrowings from banks or public financial institutions

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exceeding one hundred crore rupees or more at any point of time during the
preceding financial year.
(b) Prohibition on buy-back of own shares: As per provisions of section 70 of The
Companies Act, 2013-
(i) No company shall directly or indirectly purchase its own shares or other specified
securities:
(a) Through any subsidiary company including its own subsidiary companies; or
(b) Through any investment company or group of investment companies; or
(c) If a default, by the company, in repayment of deposit or interest payable
thereon, redemption of debentures or preference shares or payment of
dividend to any shareholder or repayment of any term loan or interest payable
thereon to any financial institution or bank, is subsisting.
Provided that the buy-back is not prohibited if the default is remedied and a
period of 3 years has elapsed since the cessation of the default.
(ii) No company shall directly or indirectly purchase its own shares or other specified
securities in case such company has not complied with the prescribed provisions of
Sections.
(c) Advantages of CAAT: Following are the advantages of Computer Aided Audit
Techniques-
(i) Audit effectiveness: The effectiveness and efficiency of auditing procedures will be
improved through the use of CAAT in obtaining and evaluating audit evidence, for
example.
(a) Some transaction may be tested more effectively for a similar level of cost by
using the computer and
(b) In applying analytical review procedures, transactions or balance details of
unusual items may be reviewed and reports got printed efficiently by using the
computer.
(ii) Saving in time: The auditor can save time by reviewing the CIS controls using
CAAT than through other audit procedures.
(iii) Effective test checking and examination in depth: CAAT permits effective
examination in depth of selected transactions since the auditor constructs the last
audit trail.
(d) Changes in accounting policy: A change in an accounting policy should be made only
if
(i) the adoption of a different accounting policy is required by statute or
(ii) for compliance with an accounting standard or

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(iii) if it is considered that the change would result in a more appropriate presentation of
the financial statements of the enterprise.
Disclosure of change in accounting policy: Any change in an accounting policy which
has a material effect should be disclosed. The impact of and the adjustments resulting
from, such change, if material, should be shown in the financial statements of the period
in which such change is made, to reflect the effect of such change. Where the effect of
such change is not ascertainable, wholly or in part, the fact should be indicated. If a
change is made in the accounting policies which has no material effect on the financial
statements for the current period but which is reasonably expected to have a material
effect in later periods, the fact of such change should be appropriately disclosed in the
period in which the change is adopted.
(e) Recognition of Interest on deposits
(i) AS - 9 on “Revenue Recognition” requires that the revenue arising from interest
should be recognized on a time proportion basis taking into account the amount
outstanding and the rate applicable. Such revenue should only be recognized when
no significant uncertainty as to measurability or collectability exists.
(ii) Further, according to section 128 of the Companies Act, 2013 books are to be
maintained on accrual basis. Again, accrual method of accounting is a fundamental
assumption of accounting policies.
(iii) Interest accrued but not due should be shown under current assets in the balance
sheet.
(iv) If interest on deposits is not recognized on accrual basis, the profits and current
assets will be understated and true and fair views of the accounts, thus vitiated.
(v) On considerations of materiality of the item, the auditor may appropriately qualify
the report.

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Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) With reference to SA 320 indicate the factors which may affect the identification of an
appropriate bench mark in determining materiality for the financial statement as a whole.
(5 Marks)
(b) The assertions used by auditor to consider potential misstatements about account
balances at the period end. (5 Marks)
(c) ‘P’ an auditor decides not to send a new audit engagement letter to G Ltd. every year.
Whether he is right in his approach? State the circumstances where sending new
engagement letter, would be appropriate. (5 Marks)
(d) State the principal aspects to be covered in an audit concerning financial statement of
account. (5 Marks)
Answer
(a) Factors that may affect the Identification of an Appropriate Benchmark in
Determining Materiality: As per SA 320 “Materiality in Planning and Performing an
Audit”, determining materiality involves the exercise of professional judgment. A
percentage is often applied to a chosen benchmark as a starting point in determining
materiality for the financial statements as a whole. Factors that may affect the
identification of an appropriate benchmark include the following-
(i) The elements of the financial statements (for example, assets, liabilities, equity,
revenue, expenses);
(ii) Whether there are items on which the attention of the users of the particular entity’s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
(iii) The nature of the entity, where the entity is at in its life cycle, and the industry and
economic environment in which the entity operates;
(iv) The entity’s ownership structure and the way it is financed (for example, if an entity
is financed solely by debt rather than equity, users may put more emphasis on
assets, and claims on them, than on the entity’s earnings); and
(v) The relative volatility of the benchmark.
(b) Assertions used by Auditor to Consider Potential Misstatements about Account
Balances at the Period End: According to SA 315 “Identifying and Assessing the Risk of
Material Misstatement through understanding the Entity and its Environment”, the

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assertions used by the auditor to consider the different types of potential misstatements
that may occur about account balances at the period end are-
(i) Existence—assets, liabilities, and equity interests exist.
(ii) Rights and obligations—the entity holds or controls the rights to assets and
liabilities are the obligations of the entity.
(iii) Completeness—all assets, liabilities and equity interests that should have been
recorded have been recorded.
(iv) Valuation and allocation—assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
(c) New Audit Engagement Letter: As per SA 210, “Agreeing the Terms of Audit
Engagements”, on recurring audits, the auditor shall assess whether circumstances
require the terms of the audit engagement to be revised and whether there is a need to
remind the entity of the existing terms of the audit engagement.
It is not necessary to issue audit engagement letter each year for repetitive audit. It is
enough if the same had been issued at the time of taking initial engagement. Therefore,
Mr. P is right in his approach.
However, the following factors may make it appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms:
(i) Any indication that the entity misunderstands the objective and scope of the audit.
(ii) Any revised or special terms of the audit engagement.
(iii) A recent change of senior management.
(iv) A significant change in ownership.
(v) A significant change in nature or size of the entity’s business.
(vi) A change in legal or regulatory requirements.
(vii) A change in the financial reporting framework adopted in the preparation of the
financial statements.
(viii) A change in other reporting requirements.
(d) Aspects to be covered in Audit: The principal aspects to be covered in an audit
concerning financial statement of account are the following-
(i) An examination of the system of accounting and internal control to ascertain
whether it is appropriate for the business and helps in properly recording all
transactions. This is followed by such tests and enquiries as are considered
necessary to ascertain whether the system is in actual operation. These steps are
necessary to form an opinion as to whether reliance can be placed on the records
as a basis for the preparation of final statements of account.

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(ii) Reviewing the system and procedures to find out whether they are adequate and
comprehensive and incidentally whether material inadequacies and weaknesses
exist to allow frauds and errors going unnoticed.
(iii) Checking of the arithmetical accuracy of the books of account by the verification of
postings, balances, etc.
(iv) Verification of the authenticity and validity of transactions entered into by making an
examination of the entries in the books of accounts with the relevant supporting
documents.
(v) Ascertaining that a proper distinction has been made between items of capital and
of revenue nature and that the amounts of various items of income and expenditure
adjusted in the accounts corresponding to the accounting period.
(vi) Comparison of the balance sheet and profit and loss account or other statements
with the underlying record in order to see that they are in accordance therewith.
(vii) Verification of the title, existence and value of the assets appearing in the balance
sheet.
(viii) Verification of the liabilities stated in the balance sheet.
(ix) Checking the result shown by the profit and loss and to see whether the results
shown are true and fair.
(x) Where audit is of a corporate body, confirming that the statutory requirements have
been complied with.
(xi) Reporting to the appropriate person/body whether the statements of account
examined do reveal a true and fair view of the state of affairs and of the profit and
loss of the organization.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect:
(Answer any eight)
(i) AB & Co. is an audit firm having partners Mr. A and Mr. B. Mr. C, the relative of Mr. B is
holding securities having face value of ` 2,00,000 in XYZ Ltd. AB & Co. is qualified for
being appointed as an auditor of XYZ Ltd.
(ii) Working papers are property of client, as it contains client’s information.
(iii) The auditor of a Ltd. Company wanted to refer to the minute books during audit but board
of directors refused to show the minute books to the auditors.
(iv) The auditor has to report to Central Govt. within 90 days of his knowledge of an offence
involving fraud.

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(v) Manner of rotation of auditor will not be applicable to company A, which is having paid up
share capital of ` 15 crores and having public borrowing from nationalized bank of
` 50 crore because it is a Private Limited Company.
(vi) The auditor should study the Memorandum and Articles of Association to see the validity
of his appointment.
(vii) Teeming and lading is one of the techniques of inflating cash payments.
(viii) Managing director of A Ltd. himself appointed the first auditor of the company.
(ix) A Chartered Accountant holding securities of S Ltd. having face value of ` 950 is
qualified for appointment as an auditor of S Ltd.
(x) Mr. N, a member of the Institute of Chartered Accountants of England and Wales, is
qualified to be appointed as auditor of Indian Companies. (8 x 2 = 16 Marks)
Answer
(i) Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to
be appointed as an auditor of a company if his relative is holding any security of or
interest in the company of face value exceeding ` 1 lakh.
Therefore, AB & Co. shall be disqualified for being appointed as an auditor of XYZ Ltd.
as Mr. C, the relative of Mr. B who is a partner in AB & Co., is holding securities in
XYZ Ltd. having face value of ` 2 lakh.
(ii) Incorrect: Working papers are the property of the auditor and he is entitled to retain
them. He may, at his discretion, make portions of or extracts from his working papers
available to clients.
(iii) Incorrect: The provisions of Companies Act, 2013 grant rights to the auditor to access
books of account and vouchers of the company. He is also entitled to require information
and explanations from the company. Therefore, he has a statutory right to inspect the
minute book.
(iv) Incorrect: If an auditor of a company, in the course of the performance of his duties as
auditor, has reason to believe that an offence involving fraud is being or has been
committed against the company by officers or employees of the company, he shall
immediately report the matter to the Central Government within 60 days of his knowledge
and after following the prescribed procedure.
(v) Incorrect: According to section 139 of the Companies Act, 2013, the provisions related
to rotation of auditor are applicable to all private limited companies having paid up share
capital of ` 20 crore or more; and all companies having paid up share capital of below
threshold limit mentioned above, but having public borrowings from financial institutions,
banks or public deposits of ` 50 crore or more.

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Although company A is a private limited company yet it is having public borrowings from
nationalized bank of ` 50 crores, therefore it would be governed by provisions of rotation
of auditor.
(vi) Incorrect: The auditor should study the Memorandum of Association to check the
objective of the company to be carried on, amount of authorized share capital etc. and
Articles of Association to check the internal rules, regulations and ensuring the validity of
transactions relating to accounts of the company.
To see the validity of appointment, the auditor should ensure the compliance of the
provisions of section 139, 140 and 141 of the Companies Act, 2013.
Alternative reasoning: The auditor should study the appointment letter & the prescribed
form submitted to the Registrar of the Companies to see the validity of his appointment.
(vii) Incorrect: Teeming and Lading is one of the techniques of suppressing cash receipts
and not of inflating cash payments. Money received from one customer is
misappropriated and the account is adjusted with the subsequent receipt from another
customer and so on.
(viii) Incorrect: As per section 139(6) of the Companies Act, 2013, the first auditor of a
company, other than a government company, shall be appointed by the Board of
directors within 30 days from the date of registration of the company.
Therefore, the appointment of first auditor made by the managing director of A Ltd. is in
violation of the provisions of the Companies Act, 2013.
(ix) Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to
be appointed as an auditor of a company if he is holding any security of or interest in the
company.
As the chartered accountant is holding securities of S Ltd. having face value of ` 950, he
is not eligible for appointment as an auditor of S Ltd.
(x) Incorrect: A person shall be eligible for appointment as an auditor of a company only if
he is a chartered accountant.
It may be noted that a firm whereof majority of partners practising in India are qualified for
appointment as aforesaid may be appointed by its firm name to be auditor of a company.
Thus, Mr. N is disqualified to be appointed as an auditor of Indian Companies.
Question 3
How will you vouch/verify the following:
(a) Refund of General Insurance premium paid
(b) Payment of Taxes
(c) Sale Proceeds of junk material
(d) Intangible Assets. (4 x 4 = 16 Marks)

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Answer
(a) Refund of General Insurance Premium Paid: The refund of insurance premium may be
because of earlier provisional payment of premium or may be a policy might have been
cancelled at a later date. The auditor should take following steps while vouching such
refunds-
(i) Ascertain the reasons for refund of insurance premium.
(ii) Examine insurance policy or cover note to find out the amount of premium.
(iii) Verify advice of refund received from the insurance company. When refund is
admitted, the insurance company sends the advice. This will be evidence as a
covering letter to the cheque for the refund. Sometimes, a cheque is issued after a
receipt is sent in advance to the insurance company.
(iv) Scrutinise correspondence between the insurance company and the client.
(v) Check entries in the bank book or the bank statement. If necessary, the counterfoil
of the pay-in-slips can also be verified.
(b) Payment of Taxes:
(i) Payment on account of income-tax and other taxes consequent upon a regular
assessment should be verified by reference to the copy of the assessment order,
assessment form, notice of demand and the receipted challan.
(ii) Payments or advance payments of income-tax should also be verified with the
notice of demand and the receipted challan acknowledging the amount paid.
(iii) The interest allowed on advance payments of income-tax should be included as
income and penal interest charged for non-payment should be debited to the
interest account.
(iv) Nowadays, electronic payment of taxes is also in trend. Electronic payment of taxes
means payment of taxes by way of internet banking facility or credit or debit cards.
(v) The assessee can make electronic payment of taxes also from the account of any
other person. However, the challan for making such payment must clearly indicate
the Permanent Account Number (PAN) of the assessee on whose behalf the
payment is made.
(vi) It is not necessary for the assessee to make payment of taxes from his own account
in an authorized bank. While vouching such E-Payment, the auditor should cross
verify the payments of taxes through the receipted challan along with PAN No./TAN
No. etc.
(c) Sale Proceeds of Junk Material:
(i) Review the internal control on junk materials, as regards its generation, storage and
disposal and see whether it was properly followed at every stage.

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(ii) Ascertain whether the organisation is maintaining reasonable records for the sale
and disposal of junk materials.
(iii) Review the production and cost records for the determination of the extent of junk
materials that may arise in a given period.
(iv) Compare the income from the sale of junk materials with the corresponding figures
of the preceding three years.
(v) Check the rates at which different types of junk materials have been sold and
compare the same with the rates that prevailed in the preceding year.
(vi) See that all junk materials sold have been billed and check the calculations on the
invoices.
(vii) Ensure that there exists a proper procedure to identify the junk material and good
quality material is not mixed up with it.
(viii) Make an overall assessment of the value of the realisation from the sale of junk
materials as to its reasonableness. Ensure that proper accounting has been done
for it.
(d) Intangible Assets: The auditor should verify the following points in this regard-
(i) An intangible asset should be measured at cost. After initial recognition an
intangible asset should be carried at its cost less any accumulated amortisation and
any impairment losses.
(ii) If an item covered does not meet the definition of an intangible asset, expenditure to
acquire it or generate it internally is recognised as an expense when it is incurred.
(iii) Some intangible assets may be contained in or on a physical substance such as a
compact disk (in the case of computer software), legal documentation (in the case
of a license or patent) or film (in the case of motion pictures). The cost of the
physical substance containing the intangible assets is usually not significant.
Accordingly, the physical substance containing an intangible asset, though tangible
in nature, is commonly treated as a part of the intangible asset contained in or on it.
(iv) In some cases, an asset may incorporate both intangible and tangible elements that
are, in practice, inseparable. In determining whether such an asset should be
treated under AS 10, Accounting for Fixed Assets, or as an intangible asset under
this Statement, judgement is required to assess as to which element is
predominant.
(v) As per AS-26, internally generated goodwill is not recognized as an asset because it
is not an identifiable resource controlled by the enterprise that can be measured
reliably at cost.
(vi) Auditor should also ensure that proper disclosure is made in the financial
statements about the carrying amount, amortisation methods, useful lives, etc.

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Question 4
(a) Mention the points/area in which all the joint auditors are jointly and severally
responsible. (6 Marks)
(b) Mr. A was appointed statutory auditor of P Ltd., but he was not able to gather the
sufficient audit evidences. Discuss how he should proceed to gather more audit
evidences. (6 Marks)
(c) Discuss the recognition principles of contingent liability. (4 Marks)
Answer
(a) Points/Areas in which all the Joint Auditors are Jointly and Severally Responsible: As
per SA 299 “Responsibility of Joint Auditors”, in respect of audit work divided among the
joint auditors, each joint auditor is responsible only for the work allocated to him, whether
or not he has prepared a separate report on the work performed by him. On the other
hand, all the joint auditors are jointly and severally responsible –
(i) in respect of the audit work which is not divided among the joint auditors and is
carried out by all of them.
(ii) in respect of decisions taken by all the joint auditors concerning the nature, timing
or extent of the audit procedures to be performed by any of the joint auditors.
(iii) in respect of matters which are brought to the notice of the joint auditors by any one
of them and on which there is an agreement among the joint auditors.
(iv) for examining that the financial statements of the entity comply with the disclosure
requirements of the relevant statute.
(v) for ensuring that the audit report complies with the requirements of the relevant
statute.
(vi) it is the separate and specific responsibility of each joint auditor to study and
evaluate the prevailing system of internal control relating to the work allocated to
him, the extent of enquiries to be made in the course of his audit.
(vii) the responsibility of obtaining and evaluating information and explanation from the
management is generally a joint responsibility of all the auditors.
(viii) each joint auditor is entitled to assure that the other joint auditors have carried out
their part of work in accordance with the generally accepted audit procedures and
therefore it would not be necessary for joint auditor to review the work performed by
other joint auditors.
(b) Audit Evidence: According to SA 500 “Audit Evidence”, audit procedures to gather more
audit evidence would include -
Inspection: Inspection involves examining records or documents, whether internal or
external, in paper form, electronic form, or other media, or a physical examination of an

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asset. Inspection of records and documents provides audit evidence of varying degrees
of reliability, depending on their nature and source and, in the case of internal records
and documents, on the effectiveness of the controls over their production. An example of
inspection used as a test of controls is inspection of records for evidence of
authorisation.
Observation: Observation consists of looking at a process or procedure being performed
by others, for example, the auditor’s observation of inventory counting by the entity’s
personnel, or of the performance of control activities.
External Confirmation: An external confirmation represents audit evidence obtained by
the auditor as a direct written response to the auditor from a third party (the confirming
party), in paper form, or by electronic or other medium. External confirmation procedures
frequently are relevant when addressing assertions associated with certain account
balances and their elements. However, external confirmations need not be restricted to
account balances only.
Recalculation: Recalculation consists of checking the mathematical accuracy of
documents or records. Recalculation may be performed manually or electronically.
Re-performance: Re-performance involves the auditor’s independent execution of
procedures or controls that were originally performed as part of the entity’s internal
control.
Analytical Procedures: Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among both financial and non-
financial data. Analytical procedures also encompass the investigation of identified
fluctuations and relationships that are inconsistent with other relevant information or
deviate significantly from predicted amounts.
Inquiry: Inquiry consists of seeking information of knowledgeable persons, both financial
and non-financial, within the entity or outside the entity. Inquiry is used extensively
throughout the audit in addition to other audit procedures. Inquiries may range from
formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is an
integral part of the inquiry process.
(c) Recognition Principles of Contingent Liability: An enterprise should not recognize the
contingent liability but it should be disclosed in financial statement, unless the possibility
of an outflow of resource embodying economic benefit is remote. In some cases an
enterprise is jointly and severally liable for an obligation in that case, the part of the
obligation that is expected to be met by other parties is treated as contingent liability.
Contingent liabilities are continuously assessed and if it becomes probable that an
outflow of future economic benefit will be required to settle obligation which is previously
assessed as contingent liabilities, a provision is recognized.

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 38 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

From the auditing point of view, the auditor should verify that a proper disclosure about
contingent liabilities is made in financial statement as required by AS 29. An enterprise
should disclose for each class of contingent liability at the balance sheet date:
 A brief description of the nature of the contingent liability, where practicable.
 An estimate of the amount as per measurement principle.
 Indication of the uncertainty relating to outflow.
 The possibility of any reimbursement.
Where any of the information as required above is not disclosed because it is not
practicable to do so, that fact should be stated.
Question 5
(a) Discuss about the provisions for removal of auditor before expiry of term. (6 Marks)
(b) As the statutory auditor of A Ltd., you have observed that the gross profit of the company
has decreased in comparison to last years. Mention the possible factors which may be
responsible for decrease in gross profit. (6 Marks)
(c) State the precautions to be taken to avoid the disadvantage of a continuous audit. (4 Marks)
Answer
(a) Removal of Auditor Before Expiry of Term: According to section 140 of the Companies
Act, 2013, the auditor appointed under section 139 may be removed from his office
before the expiry of his term only by a special resolution of the company, after obtaining
the previous approval of the Central Government in that behalf as per Companies (Audit
and Auditors) Rules, 2014 -
(i) The application to the Central Government for removal of auditor shall be made in
Form ADT-2 and shall be accompanied with prescribed fees.
(ii) The application shall be made to the Central Government within thirty days of the
resolution passed by the Board.
(iii) The company shall hold the general meeting within sixty days of receipt of approval
of the Central Government for passing the special resolution.
It is important to note that before taking any action for removal before expiry of terms, the
auditor concerned shall be given a reasonable opportunity of being heard.
(b) Factors which decreases the Gross Profit: Factors which may be responsible for
decrease in gross profit are-
(i) Over valuation of the opening inventory or undervaluation of closing inventory either
due to mistakes made in taking inventory or in its valuation.

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(ii) Alteration of the basis of valuation of inventory, e.g., closing inventory having been
valued at cost, which is below the market price, when the opening inventory was
valued at market price above cost.
(iii) Inclusion in the year of the amount of goods purchased in the previous year, that
were received and taken in the same year.
(iv) Reversal of the fictitious sale entries recorded in the previous year to boost up
profit.
(v) Entry of sales returns twice or failure to account for purchase returns when the
goods in question have been sent back.
(vi) Excessive provisions have been made for wages or direct expenses.
(vii) Failure to include in closing inventory goods sent out for sale on approval or on a
consignment basis.
(viii) Omission to adjust the value of unused inventory of consumables stores, such as
fuel and packing material or inclusion in Trading Account expenses which should
have been included in the Profit in the Loss Account.
(ix) Failure to take credit for the amount of an insurance claim in respect of a
consignment of goods lost in transit or destroyed by fire.
(x) Failure to account for goods sold or destroyed or given away as samples.
(c) Precautions to be taken to Avoid Disadvantages of a Continuous Audit: The
disadvantages of a continuous audit can be avoided if the following precautions are taken -
(i) During the course of each visit, work should be completed upto a definite stage so
as to avoid loose ends.
(ii) At the end of each visit, important balances should be noted down and the same
should be compared at the time of the next visit.
(iii) The visits should be at irregular intervals of time so that the client’s staff may not in
advance know the exact date when the audit would be resumed and thus may be
able to prepare themselves in advance for the same.
(iv) The nominal accounts should be checked only at the time of final closing.
(v) The client’s staff should be instructed not to alter or correct audited figures. The
auditor should also device a special form of ticks for being placed against figures
which have been altered and neither its purpose nor significance should be dis-
closed to the client’s staff.
Question 6
(a) The form, contents and extent of audit documents depend on certain factors. Explain with
reference to SA 230. (4 Marks)
(b) Why Tests of Control are performed? Also explain what does they include. (4 Marks)

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 40 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

(c) State the Standards issued by AASB which are collectively known as engagement
standards. (4 Marks)
(d) State the factors which are to be considered in determining materiality. (4 Marks)
Answer
(a) Form, Contents and Extent of Audit Documentation: Working papers should record
the audit plan, nature, timing and extent of auditing procedures performed, and the
conclusions drawn from the evidence obtained.
According to SA 230 “Audit Documentation”, the form, content and extent of working
papers depend on factors such as:
(i) The size and complexity of the entity.
(ii) The nature of the audit procedures to be performed.
(iii) The identified risks of material misstatement.
(iv) The significance of the audit evidence obtained.
(v) The nature and extent of exceptions identified.
(vi) The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained.
(vii) The audit methodology and tools used.
(b) Tests of Control: Tests of control are performed to obtain audit evidence about the
effectiveness of the -
(i) design of the accounting and internal control systems, that is, whether they are
suitably designed to prevent or detect and correct material misstatements; and
(ii) operation of the internal controls throughout the period.
Tests of control include tests of elements of the control environment where strengths in
the control environment are used by auditors to reduce control risk.
Tests of control may include:
 Inspection of documents supporting transactions and other events to gain audit
evidence that internal controls have operated properly, for example, verifying that a
transaction has been authorised.
 Inquiries about, and observation of, internal controls which leave no audit trail, for
example, determining who actually performs each function and not merely who is
supposed to perform it.
 Re-performance of internal controls, for example, reconciliation of bank accounts, to
ensure they were correctly performed by the entity.

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 Testing of internal control operating on specific computerised applications or over

the overall information technology function, for example, access or program change
controls.
(c) Engagement Standards: The following standards issued by the Auditing and Assurance
Standards Board under the authority of the Council are collectively known as the
Engagement Standards-
(i) Standards on Auditing (SAs), to be applied in the audit of historical financial
information.
(ii) Standards on Review Engagements (SREs), to be applied in the review of historical
financial information.
(iii) Standards on Assurance Engagements (SAEs), to be applied in assurance
engagements, dealing with subject matters other than historical financial
information.
(iv) Standards on Related Services (SRSs), to be applied to engagements involving
application of agreed-upon procedures to information, compilation engagements,
and other related services engagements, as may be specified by the ICAI.
(d) Factors to be considered for Determining Materiality:
(i) Item of materiality may be determined individually or in aggregate.
(ii) The materiality depends on the regulatory or legal considerations.
(iii) Materiality is not often reckoned with respect to quantitative details only. It has
qualitative dimensions as well.
(iv) Even insignificant items in terms of quality may be material in special
circumstances.
(v) Sometimes the materiality of an item in terms of quantity is described in law itself. For
example, Schedule III requires disclosure of items of expenditures which are in excess
of one percent of the revenue from operations or ` 1,00,000, whichever is higher.
(vi) An item whose impact is insignificant at present, but in future it may be significant,
may be material item.
Question 7
Write short notes on any four of the following:
(a) Remuneration paid to directors in case of a public limited company
(b) Payment for acquisition of assets
(c) A qualified opinion
(d) Fraudulent financial reporting
(e) Surprise checks. (4 x 4 = 16 Marks)

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 42 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

Answer
(a) Remuneration Paid to Directors: The following points must be considered regarding
the directors’ remuneration in case of a public company–
(i) Examine the Entitlement: The directors are not automatically entitled to
remuneration. It is paid either according to the terms of articles of association or in
accordance with a resolution of the general meeting.
(ii) Examine Adherence to Legal Provisions: The auditor should examine adherence
to relevant sections of the Act such as –
(1) Section which deals with manner of payment of managerial remuneration.
(2) Section which deals with payment of sitting fees.
(3) Section which has prescribed the overall limit to managerial remuneration.
(4) Schedule V to the Act that has laid down conditions for payment of
remuneration for companies having no profits or inadequate profits and
companies having negative effective capital.
(5) Proviso to section which provides for increase in remuneration with the
approval of the Central Government.
(b) Payment for Acquisition of Assets: The following points must be considered regarding
payment for acquisition of assets–
(i) The purchase of an asset must be duly supported by the receipt for the amount
paid.
(ii) In case of an immovable property the auditor must also inspect the title deeds. The
title of an immovable property passes only on registration. It is therefore essential
for an auditor to see that property has been registered in the purchaser’s name as
required by the relevant regulations and also that the title of the transfer to sell
property has been verified by a solicitor or an advocate.
(iii) In the case of movable property requiring registration of ownership, e.g., a car or a
ship, it must be verified that such a registration has been made in favour of the
purchaser. It is necessary for the auditor to satisfy himself generally as regards
existence, value and title of the assets acquired.
(iv) It must also be verified that the assets were purchased only by a person who had
the authority to do so. Companies Act, 2013 provides that only the Board of
Directors can invest the funds of the company. Thus the Board alone can sanction
the purchase of a fixed asset.
(v) If the benefit of an item of expense has been acquired by the purchaser along with
the asset, its value should be debited to a separate account, e.g., when a motor car
has been purchased on which certain taxes and insurance charges were paid by the
seller for a period that had not expired.

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(vi) In the case of an asset constructed or manufactured by the client himself, e.g.,
where a building has been constructed or a plant or machinery manufactured by the
concern with its labour and materials, it must be verified that the cost of labour,
materials and other direct expenses incurred has been charged as cost of the asset
on a proper allocation of the total expenditure debited under these heads.
(vii) It must also be seen that neither expenses on repairs and maintenance have been
capitalised nor the cost of additions to assets charged off as revenue expenses.
(c) Qualified Opinion: The auditor shall express a qualified opinion when -
(i) The auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive, to
the financial statements; or
(ii) The auditor is unable to obtain sufficient appropriate audit evidence on which to
base the opinion, but the auditor concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be material but not pervasive.
(d) Fraudulent Financial Reporting: Fraudulent financial reporting involves intentional
misstatements including omissions of amounts or disclosures in financial statements to
deceive financial statement users. It can be caused by the efforts of management to
manage earnings in order to deceive financial statement users by influencing their
perceptions as to the entity’s performance and profitability. Such earnings management
may start out with small actions or inappropriate adjustment of assumptions and changes
in judgments by management. Pressures and incentives may lead these actions to
increase to the extent that they result in fraudulent financial reporting.
In some entities, management may be motivated to reduce earnings by a material
amount to minimize tax or to inflate earnings to secure bank financing.
Fraudulent financial reporting may be accomplished by the following:
(i) Manipulation, falsification (including forgery), or alteration of accounting records or
supporting documentation from which the financial statements are prepared.
(ii) Misrepresentation in or intentional omission from, the financial statements of events,
transactions or other significant information.
(iii) Intentional misapplication of accounting principles relating to amounts,
classification, manner of presentation, or disclosure.
Fraudulent financial reporting often involves management override of controls that
otherwise may appear to be operating effectively.
(e) Surprise Checks: Surprise checks are a part of normal audit procedures. An element of
surprise can significantly improve the audit effectiveness. Wherever practical, an element
of surprise should be incorporated in the audit procedures.

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The element of surprise in an audit may be, both in regard to the time of audit, i.e.
selection of date, when the auditor will visit the client’s office for audit and selection of
areas of audit.
Surprise checks are mainly intended to ascertain whether the internal control system is
working effectively and whether the accounting and other records are kept up to date as
per the statutory regulations. Surprise checks can exercise good moral check on the
client’s staff. It helps in determining whether errors or frauds exist and if they exist, brings
the matter promptly to the management’s attention, so that corrective action can be taken
at the earliest. Surprise checks are very effective in verification of cash and investments,
test checking of inventory, verification of accounting records, statutory registers and
internal control system. The frequency of surprise checks may be determined by the
auditor in the circumstances of each audit but should normally be at least once in the
course of an audit.

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 DISCLAIMER
The Suggested Answers hosted in the website do not constitute the basis for evaluation of the
students’ answers in the examination. The answers are prepared by the Faculty of the Board
of Studies with a view to assist the students in their education. While due care is taken in
preparation of the answers, if any errors or omissions are noticed, the same may be brought to
the attention of the Director of Studies. The Council of the Institute is not in anyway
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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) Advantages of independent audit. (5 Marks)
(b) The auditor's report is considered to be modified under certain circumstances. (5 Marks)
(c) Is detection of fraud and error duty of an auditor? (5 Marks)
(d) Mention any four information which assists the auditor in accepting and continuing of
relationship with the client as per SA 220. (5 Marks)
Answer
(a) Advantages of Independent Audit: The chief utility of audit lies in reliable financial
statements on the basis of which the state of affairs may be easy to understand. Apart
from this obvious utility, there are other advantages of audit. Some or all of these are of
considerable value even to those enterprises and organisations where audit is not
compulsory, these advantages are given below-
(i) It safeguards the financial interest of persons who are not associated with the
management of the entity, whether they are partners or shareholders.
(ii) It acts as a moral check on the employees from committing defalcations or
embezzlement.
(iii) Audited statements of account are helpful in settling liability for taxes, negotiating
loans and for determining the purchase consideration for a business.
(iv) These are also useful for settling trade disputes for higher wages or bonus as well
as claims in respect of damage suffered by property by fire or some other calamity.
(v) An audit can also help in the detection of wastages and losses to show the different
ways by which these might be checked especially those that occur due to the
absence or inadequacy of internal checks or internal control measures.
(vi) Audit ascertains whether the necessary books of account and allied records have
been properly kept and helps the client in making good deficiencies or inadequacies
in this respect.
(vii) As an appraisal function, audit reviews the existence and operations of various
controls in the organisations and reports weaknesses, inadequacies, etc., in them.
(viii) Audited accounts are of great help in the settlement of accounts at the time of
admission or death of partner.

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(ix) Government may require audited and certified statement before it gives assistance
or issues a license for a particular trade.
(b) Modified Report: An auditor’s report is considered to be modified when it includes -
(A) Matters That Do Not Affect the Auditor’s Opinion
(i) Emphasis of Matter paragraph: Sometimes the auditor considers it
necessary to draw users’ attention to a matter presented or disclosed in the
financial statements that, in the auditor’s judgment, is of such importance that
it is fundamental to users’ understanding of the financial statements, the
auditor shall include an Emphasis of Matter paragraph in the auditor’s report
provided the auditor has obtained sufficient appropriate audit evidence that the
matter is not materially misstated in the financial statements.
(ii) Other Matter paragraph: If the auditor considers it necessary to communicate
a matter other than those that are presented or disclosed in the financial
statements that, in the auditor’s judgment, is relevant to users’ understanding
of the audit, the auditor’s responsibilities or the auditor’s report and this is not
prohibited by law or regulation, the auditor shall do so in a paragraph in the
auditor’s report, with the heading “Other Matter”, or other appropriate heading.
(B) Matters that Do Affect the Auditor’s Opinion
(i) Qualified Opinion: The auditor shall express a qualified opinion when-
(1) The auditor, having obtained sufficient appropriate audit evidence,
concludes that misstatements, individually or in the aggregate, are
material, but not pervasive, to the financial statements; or
(2) The auditor is unable to obtain sufficient appropriate audit evidence on
which to base the opinion, but the auditor concludes that the possible
effects on the financial statements of undetected misstatements, if any,
could be material but not pervasive.
(ii) Disclaimer of Opinion: The auditor shall disclaim an opinion when the auditor
is unable to obtain sufficient appropriate audit evidence on which to base the
opinion, and the auditor concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be both material and
pervasive.
(iii) Adverse Opinion: The auditor shall express an adverse opinion when the
auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are both material and
pervasive to the financial statements.
The auditor shall modify the opinion in the auditor’s report when:
(1) The auditor concludes that, based on the audit evidence obtained, the financial

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 28 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

statements as a whole are not free from material misstatement; or

(2) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that
the financial statements as a whole are free from material misstatement.
(c) Detection of Fraud and Error - Duty of an Auditor: As per SA-240, “The Auditor’s
Responsibilities Relating to Fraud in an Audit of Financial Statements”, primary
responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management. It is important that management, with the
oversight of those charged with governance, place a strong emphasis on fraud
prevention, which may reduce opportunities for fraud to take place, and fraud deterrence,
which could persuade individuals not to commit fraud because of the likelihood of
detection and punishment. This involves a commitment to creating a culture of honesty
and ethical behaviour which can be reinforced by an active oversight by those charged
with governance. In exercising oversight responsibility, those charged with governance
consider the potential for override of controls or other inappropriate influence over the
financial reporting process, such as efforts by management to manage earnings in order
to influence the perceptions of analysts as to the entity’s performance and profitability.
Broadly, the general principles laid down in this regard are:
(i) An auditor conducting an audit in accordance with SAs is responsible for obtaining
reasonable assurance that the financial statements taken as a whole are free from
material misstatement, whether caused by fraud or error. As described in SA 200,
“Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, owing to the inherent limitations of an
audit, there is an unavoidable risk that some material misstatements of the financial
statements will not be detected, even though the audit is properly planned and
performed in accordance with the SAs.
(ii) The risk of not detecting a material misstatement resulting from fraud is higher than
the risk of not detecting one resulting from error. This is because fraud may involve
sophisticated and carefully organized schemes designed to conceal it, such as
forgery, deliberate failure to record transactions, or intentional misrepresentations
being made to the auditor.
(iii) Furthermore, the risk of the auditor not detecting a material misstatement resulting
from management fraud is greater than for employee fraud, because management
is frequently in a position to directly or indirectly manipulate accounting records,
present fraudulent financial information or override control procedures designed to
prevent similar frauds by other employees.
(iv) When obtaining reasonable assurance, the auditor is responsible for maintaining an
attitude of professional skepticism throughout the audit, considering the potential for
management override of controls and recognizing the fact that audit procedures that
are effective for detecting error may not be effective in detecting fraud. The
requirements in this SA are designed to assist the auditor in identifying and

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assessing the risks of material misstatement due to fraud and in designing

procedures to detect such misstatement.
It may be concluded from the above that detection of fraud and error is not the duty of the
auditor provided that he complies with the requirements given in Standards on Auditing,
maintains professional skepticism throughout the audit and is not grossly negligent in the
performance of his duties as an auditor.
(d) Information which assist the Auditor in accepting and continuing of relationship
with Client: As per SA 220, “Quality Control for an Audit of Financial Statements” the
auditor should obtain information considered necessary in the circumstances before
accepting an engagement with a new client, when deciding whether to continue an
existing engagement and when considering acceptance of a new engagement with an
existing client. The following information would assist the auditor in accepting and
continuing of relationship with the client:
(i) The integrity of the principal owners, key management and those charged with
governance of the entity;
(ii) Whether the engagement team is competent to perform the audit engagement and
has the necessary capabilities, including time and resources;
(iii) Whether the firm and the engagement team can comply with relevant ethical
requirements; and
(iv) Significant matters that have arisen during the current or previous audit
engagement, and their implications for continuing the relationship.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect:
(Answer any eight)
(i) C & AG orders to conduct test audit of the accounts of a Government company.
(ii) The auditor shall not modify the opinion in the auditor's report.
(iii) The first auditor of a Government company was appointed by the Board in its meeting
after 10 days from the date of registration.
(iv) As per section 138 of the Companies Act, 2013 private companies are not required to
appoint internal auditor.
(v) Written representation by management as to the quality of inventory is substitute for
verification.
(vi) Letter of weakness is issued by the Management.
(vii) Scrutiny of Bank Reconciliation statement is one of the audit techniques.
(viii) The basic objective of audit does not change with reference to nature, size or form of an
entity.

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(ix) Director's relative can act as an auditor of the company.

(x) If an LLP (Limited Liability Partnership Firm) is appointed as an auditor of a company,
every partner of a firm shall be authorized to act as an auditor. (8 x 2 = 16 Marks)
Answer
(i) Correct: Comptroller and Auditor- General of India may, in case of a government
company, if he considers necessary, by an order, cause test audit to be conducted of the
accounts of such company.
(ii) Incorrect: The auditor shall modify the opinion in the auditor’s report when the auditor
concludes that, based on the audit evidence obtained, the financial statements as a
whole are not free from material misstatement or the auditor is unable to obtain sufficient
appropriate audit evidence to conclude that the financial statements as a whole are free
from material misstatement.
(iii) Incorrect: According to section 139(7) of the Companies Act, 2013, in the case of a
Government company, the first auditor shall be appointed by the Comptroller and
Auditor-General of India within 60 days from the date of registration of the company. If
CAG fails to make the appointment within 60 days, the Board shall appoint in next 30
days.
(iv) Incorrect: Section 138 of the Companies Act, 2013 requires every private company to
appoint an internal auditor having turnover of ` 200 crore or more during the preceding
financial year; or outstanding loans or borrowings from banks or public financial
institutions exceeding ` 100 crore or more at any point of time during the preceding
financial year.
(v) Incorrect: Inspecting inventory when attending physical inventory counting assists the auditor
in ascertaining the existence of the inventory (though not necessarily its ownership) and in
identifying its quality for example, obsolete, damaged or ageing inventory. Written
representations cannot be a substitute for other evidence that the auditor could expect to
be reasonably available.
Alternative Reason for incorrect answer may be given as: One of the objectives of
the written representation is to support other audit evidence relevant to the financial
statements or specific assertions in the financial statements by means of written
representation. So it is clear that written representations cannot be a substitute for other
evidence that the auditor could expect to be reasonably available.
(vi) Incorrect: Letter of weakness is a report issued by auditor stating the weakness in
internal control mechanism. It also suggests measures by which the weakness in the
system to be corrected and the control system be made better protected.
(vii) Correct: For collection and accumulation of audit evidence, certain methods and means
are available and these are known as audit techniques. The scrutiny of Bank

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Reconciliation Statement is one of the Audit techniques commonly adopted by the audi-
tors.
(viii) Correct: An audit is an independent examination of financial information of any entity,
whether profit oriented or not, and irrespective of its size or legal form, when such an
examination is conducted with a view to expressing an opinion thereon. It is clear that the
basic objective of auditing, i.e., expression of opinion on financial statements does not
change with reference to nature, size or form of an entity.
(ix) Incorrect: As per section 141(3) of the Companies Act, 2013, a person shall not be
eligible for appointment as an auditor of a company whose relative is a Director or is in
the employment of the Company as a director or key Managerial Personnel.
(x) Incorrect: As per section 141(2) of the Companies Act, 2013, where a firm including a
limited liability partnership (LLP) is appointed as an auditor of a company, only the
partners who are Chartered Accountants shall be authorised to act and sign on behalf of
the firm.
Question 3
How will you vouch/verify the following?
(a) Rental Receipts
(b) Repair to assets
(c) Work-in-progress
(d) Insurance claims. (4 x 4 = 16 Marks)
Answer
(a) Rental Receipts:
(i) Check copies of bills or rent receipts issued to the tenant with reference to tenancy
agreement and bills of charges paid by the landlord on behalf of tenants.
(ii) The entries in the rental register in respect of rent accrued should be traced with
reference to copies of rental bills.
(iii) Scrutinize the account of collecting agent when the rent is collected by such agent.
(iv) Vouch the entries for rent received in advance and ensure proper adjustment is
made.
(v) Investigate abnormal rent outstanding, if any.
(vi) Reconcile the outstanding rent and check that proper provision is made if
unrecoverable.
(vii) If rent is received net of TDS, check that the rental income is shown at gross
amount and TDS is shown in Balance Sheet as per Schedule III to the Companies
Act, 2013.

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(b) Repair to Assets:

(i) Since the line demarcating repairs from renewals is slender, usually it is not a
simple matter to determine the amount of the expenditure, if any, included as
charges for repairs, which should be considered as that incurred for renewal of an
asset and added to its cost.
(ii) It may sometimes be possible to determine this on a consideration of the nature of
repairs carried out. The proportion of the charges which had the effect of increasing
the value of an asset or enhancing its capacity or life should be treated as capital
expenditure.
(iii) Where, however, it is not possible to form an opinion accurately on the basis of
evidence as regards the nature of repairs, a certificate from the engineer under
whose supervision the repairs were carried out, confirming the classification of
expenditure should be obtained.
(iv) It should be ensured that Repairs to ‘Certain Assets’ like Building and Machinery
have been separately disclosed as per the requirements of Schedule III to the
Companies Act, 2013.
(c) Work in Progress:
(i) Involve a technical expert in verification and valuation of WIP, if necessary.
(ii) Ensure that cost sheets are duly attested by the works manager.
(iii) Test the correctness of the cost as disclosed by the cost records by verification of
quantities and cost of materials, wages and other charges included in the cost-
sheets by reference to the records maintained in respect of issues of materials,
payment of wages and its classification and original evidence in respect of all
expenditure included in the cost-sheets.
(iv) Verify stage of completion with component of cost involved with underlying records.
(v) Compare the unit cost as shown by the cost sheet with standard cost for any large
variations.
(vi) Ensure that the allocation of overhead expenses has been made on reasonable
basis and is same as used in earlier period.
(vii) Compare the cost sheet with that of the previous year and if there is any large
variation, investigate the reason thereof.
(d) Insurance Claims: While vouching the receipts of insurance claims, following points may
be considered-
(i) The auditor should examine a copy of the insurance claim lodged with the insurance
company. Correspondence with the insurance company and with the insurance
agent should also be seen. Counterfoils of the receipts issued to the insurance
company should also be seen.

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(ii) The auditor should also determine the adjustment of the amount received in excess
or short of the value of the actual loss as per the insurance policy.
(iii) The copy of certificate/report containing full particulars of the amount of loss should
also be verified.
(iv) The accounting treatment of the amount received should be seen particularly to
ensure that revenue is credited with the appropriate amount and that in respect of
claim against asset, the profit and loss account is debited with the short fall of the
claim admitted against book value.
(v) If the claim was lodged in the previous year but no entries were passed, entries in
the profit and loss account should be appropriately described.
Question 4
(a) State the significant difficulties encountered during audit with reference to SA-260
(communication with those charged with governance). (6 Marks)
(b) The auditor may exercise his judgement to identify which risks are significant risks.
Explain the above in context of SA-315. (6 Marks)
(c) State the manner of rotation of auditors on expiry of their term. (4 Marks)
Answer
(a) Significant Difficulties Encountered During the Audit: As per SA 260 “Communication
with Those Charged with Governance”, significant difficulties encountered during the
audit may include such matters as:
 Significant delays in management providing required information.
 An unnecessarily brief time within which to complete the audit.
 Extensive unexpected effort required to obtain sufficient appropriate audit evidence.
 The unavailability of expected information.
 Restrictions imposed on the auditor by management.
 Management’s unwillingness to make or extend its assessment of the entity’s ability
to continue as a going concern when requested.
(b) Identification of Significant Risks: SA 315 “Identifying and Assessing the Risk of
Material Misstatement through understanding the Entity and its Environment” defines
‘significant risk’ as an identified and assessed risk of material misstatement that, in the
auditor’s judgment, requires special audit consideration.
As part of the risk assessment, the auditor shall determine whether any of the risks
identified are, in the auditor’s judgment, a significant risk. In exercising this judgment, the
auditor shall exclude the effects of identified controls related to the risk.

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 34 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

In exercising judgment as to which risks are significant risks, the auditor shall consider at
least the following-
(i) Whether the risk is a risk of fraud;
(ii) Whether the risk is related to recent significant economic, accounting or other
developments like changes in regulatory environment etc. and therefore requires
specific attention;
(iii) The complexity of transactions;
(iv) Whether the risk involves significant transactions with related parties;
(v) The degree of subjectivity in the measurement of financial information related to the
risk, especially those measurements involving a wide range of measurement
uncertainty; and
(vi) Whether the risk involves significant transactions that are outside the normal course
of business for the entity or that otherwise appear to be unusual.
(c) Manner of Rotation of Auditors on Expiry of their Term: Prescribed manner of
rotation of auditors on expiry of their term is given below-
(1) The Audit Committee shall recommend to the Board, the name of an individual
auditor or of an audit firm who may replace the incumbent auditor on expiry of
the term of such incumbent.
(2) Where a company is required to constitute an Audit Committee, the Board shall
consider the recommendation of such committee and in other cases, the Board
shall itself consider the matter of rotation of auditors and make its
recommendation for appointment of the next auditor by the members in annual
general meeting.
(3) For the purpose of the rotation of auditors-
(i) in case of an auditor (whether an individual or audit firm), the period for which
the individual or the firm has held office as auditor prior to the commencement of
the Act shall be taken into account for calculating the period of five consecutive
years or ten consecutive years, as the case may be;
(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit
firm is associated with the outgoing auditor or audit firm under the same
network of audit firms.
The term “same network” includes the firms operating or functioning, hitherto or
in future, under the same brand name, trade name or common control.
Further, for the purpose of rotation of auditors,-
(a) a break in the term for a continuous period of five years shall be
considered as fulfilling the requirement of rotation;

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 PAPER – 6: AUDITING AND ASSURANCE 35

(b) if a partner, who is in charge of an audit firm and also certifies the financial
statements of the company, retires from the said firm and joins another
firm of chartered accountants, such other firm shall also be ineligible to be
appointed for a period of five years.
(4) Where a company has appointed two or more individuals or firms or a combination
thereof as joint auditors, the company may follow the rotation of auditors in such a
manner that both or all of the joint auditors, as the case may be, do not complete
their term in the same year.
Question 5
(a) Audit documentation serves a number of purposes. Explain with reference to SA-230.
(6 Marks)
(b) Explain the inherent limitations of Internal Control. (6 Marks)
(c) Point out any eight areas where external confirmation used as an audit procedure.
(4 Marks)
Answer
(a) Audit Documentation: As per SA 230 “Audit Documentation”, audit working papers are
the record of audit procedures performed, relevant audit evidence obtained and
conclusions the auditor reached.
(i) Working papers are the evidence of the auditor’s basis for a conclusion about the
achievement of the overall objective of the auditor and evidence that the audit was
planned and performed in accordance with SAs and applicable legal and regulatory
requirements.
(ii) Assisting the engagement team to plan and perform the audit.
(iii) Assisting members of the engagement team responsible for supervision to direct
and supervise the audit work, and to discharge their review responsibilities in
accordance with SA 220.
(iv) Enabling the engagement team to be accountable for its work.
(v) Retaining a record of matters of continuing significance to future audits.
(vi) Enabling the conduct of quality control reviews and inspections in accordance with
SQC 1.
(vii) Enabling the conduct of external inspections in accordance with applicable legal,
regulatory or other requirements.

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 36 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(b) Inherent Limitations of Internal Control: The following are the inherent limitations of
Internal Control -
(i) Management’s consideration that cost of an internal control does not exceed the
expected benefits.
(ii) Most controls do not tend to be directed at unusual transactions.
(iii) The potential of human error due to carelessness, misjudgment and
misunderstanding of instructions.
(iv) The possibility that control may be circumvented through collusion with employees
or outsiders.
(v) The possibility that a person responsible for exercising control may abuse that
authority.
(vi) Compliance with procedures may deteriorate because the procedures becoming
inadequate due to change in condition.
(vii) Manipulation by management with respect to transactions or estimates and
judgements required in the preparation of financial statements.
(viii) Inherent limitations of Audit.
(c) External Confirmation as an Audit Procedure: SA 505, “External Confirmations”, lays
down standards for external confirmation of balances. External confirmations are
frequently used in relation to account balances and their components but need not be
restricted to these items. For example, the auditor may request external confirmation of
the terms of agreements or transactions an entity has with third parties. The confirmation
request is designed to ask if any modifications have been made to the agreement, and if
so, the relevant details thereof. Other areas where external confirmations may be used
include the following:
 Bank balances and other information from bankers.
 Accounts receivable balances.
 Inventories held by third parties.
 Property title deeds held by third parties.
 Investments purchased but delivery not taken.
 Loans from lenders.
 Accounts payable balances.
 Long outstanding share application money.

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 PAPER – 6: AUDITING AND ASSURANCE 37

Question 6
(a) What are the advantages of the audit of the accounts of a partnership firm? (6 Marks)
(b) What are the objectives and functions of Auditing and Assurance Standards Board
(AASB)? Explain. (6 Marks)
(c) State the important objectives of local body’s audit. (4 Marks)
Answer
(a) Advantages of audit of accounts of a partnership firm: The following are the
advantages of audit of accounts of partnership firm -
(i) Audited accounts provide a convenient and reliable means of settling accounts
between the partners and thereby possibility of dispute among them is mitigated.
(ii) On the retirement/death of a partner, audited accounts constitutes a reliable
evidence for computing the amount due to the retiring partner or representative of
deceased partner.
(iii) Audited accounts are generally accepted by the Income tax authorities for
computing the assessable income.
(iv) Audited accounts are relied upon by banks for advancing loan.
(v) Audited accounts can be helpful in the negotiation for sale or admission of a new
partner.
(vi) It is an effective safeguard against any undue advantage being taken by a working
partner as against the non working partners.
(b) Objectives and Functions of the Auditing and Assurance Standards Board: The
following are the objectives and functions of the Auditing and Assurance Standards
Board-
(i) To review the existing and emerging auditing practices worldwide and identify areas
in which Standards on Quality Control, Engagement Standards and Statements on
Auditing need to be developed.
(ii) To formulate Engagement Standards, Standards on Quality Control and Statements
on Auditing so that these may be issued under the authority of the Council of the
Institute.
(iii) To review the existing Standards and Statements on Auditing to assess their
relevance in the changed conditions and to undertake their revision, if necessary.
(iv) To develop Guidance Notes on issues arising out of any Standard, auditing issues
pertaining to any specific industry or on generic issues, so that those may be issued
under the authority of the Council of the Institute.
(v) To review the existing Guidance Notes to assess their relevance in the changed
circumstances and to undertake their revision, if necessary.

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 38 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(vi) To formulate General Clarifications, where necessary, on issues arising from

Standards.
(vii) To formulate and issue Technical Guides, Practice Manuals, Studies and other
papers under its own authority for guidance of professional accountants in the
cases felt appropriate by the Board.
(c) Objectives of Audit of Local Bodies: The external control of municipal expenditure is
exercised by the state governments through the appointment of auditors to examine
municipal accounts. The municipal corporations of Delhi, Mumbai and a few others have
powers to appoint their own auditors for regular external audit. The important objectives
of audit are-
(i) reporting on the fairness of the content and presentation of financial statements;
(ii) reporting upon the strengths and weaknesses of systems of financial control;
(iii) reporting on the adherence to legal and/or administrative requirements;
(iv) reporting upon whether value is being fully received on money spent; and
(v) detection and prevention of error, fraud and misuse of resources.
Question 7
Write short notes on any four of the following:
(a) Fundamental Accounting Assumptions.
(b) Methods to obtain audit evidence.
(c) Importance of working papers.
(d) Random sampling.
(e) Defalcation of cash with examples. (4 x 4 = 16 Marks)
Answer
(a) Fundamental Accounting Assumptions: AS 1 states that certain fundamental
accounting assumptions underlie the preparation and presentation of financial
statements. They are usually not specifically stated because their acceptance and use
are assumed. Disclosure is necessary if they are not followed. The following have been
generally accepted as fundamental accounting assumptions:
(1) Going Concern: The enterprise is normally viewed as a going concern, that is, as
continuing in operation for the foreseeable future. It is assumed that the enterprise
has neither the intention nor the necessity of liquidation or of curtailing materially
the scale of the operations.
(2) Consistency: It is assumed that accounting policies are consistent from one period
to another.

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 PAPER – 6: AUDITING AND ASSURANCE 39

(3) Accrual: Revenues and costs are accrued, that is, recognised as they are earned
or incurred (and not as money is received or paid) and recorded in the financial
statements of the periods to which they relate.
Thus, if the fundamental accounting assumptions, viz., Going Concern, Consistency and
Accrual are followed in financial statements, specific disclosure is not required. If a
fundamental accounting assumption is not followed, the fact should be disclosed.
(b) Methods of Obtaining Audit Evidence: The auditor obtains evidence by one or more of
the following methods -
Inspection: Inspection involves examining records or documents, whether internal or
external, in paper form, electronic form, or other media, or a physical examination of an
asset. Inspection of records and documents provides audit evidence of varying degrees
of reliability, depending on their nature and source and in the case of internal records
and documents, on the effectiveness of the controls over their production. An example of
inspection used as a test of control is inspection of records for evidence of authorisation.
Observation: Observation consists of looking at a process or procedure being performed
by others, for example, the auditor’s observation of inventory counting by the entity’s
personnel, or of the performance of control activities. Observation provides audit
evidence about the performance of a process or procedure, but is limited to the point in
time at which the observation takes place, and by the fact that the act of being observed
may affect how the process or procedure is performed.
External Confirmation: An external confirmation represents audit evidence obtained by
the auditor as a direct written response to the auditor from a third party (the confirming
party), in paper form, or by electronic or other medium. External confirmation procedures
frequently are relevant when addressing assertions associated with certain account
balances and their elements. However, external confirmations need not be restricted to
account balances only.
Recalculation: Recalculation consists of checking the mathematical accuracy of
documents or records. Recalculation may be performed manually or electronically.
Reperformance: Reperformance involves the auditor’s independent execution of
procedures or controls that were originally performed as part of the entity’s internal
control.
Analytical Procedures: Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among both financial and non-
financial data. Analytical procedures also encompass the investigation of identified
fluctuations and relationships that are inconsistent with other relevant information or
deviate significantly from predicted amounts.
Inquiry: Inquiry consists of seeking information of knowledgeable persons, both financial
and non- financial, within the entity or outside the entity. Inquiry is used extensively
throughout the audit in addition to other audit procedures. Inquiries may range from

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 40 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is an

integral part of the inquiry process.
(c) Importance of Working Papers: Working papers are very useful to the auditor as
discussed below-
(i) It provides guidance to the audit staff with regard to manner of checking the
schedules.
(ii) The auditor is able to fix responsibility on the staff members who signs each
schedule.
(iii) It acts as an evidence in the court of law when a charge of negligence is brought
against the auditor.
(iv) It acts as the process of planning for the auditor so that he can estimate the time
that may be required for checking the schedules.
(d) Random Sampling: Random selection ensures that all items in the population or within
each stratum have a known chance of selection. It may involve use of random number
tables. Random sampling includes two very popular methods which are discussed
below–
(i) Simple random sampling: Under this method each unit of the whole population
e.g. purchase or sales invoice has an equal chance of being selected. The
mechanics of selection of items may be by choosing numbers from table of random
numbers by computers or picking up numbers randomly from a drum. It is
considered that random number tables are simple and easy to use and also provide
assurance that the bias does not affect the selection. This method is considered
appropriate provided the population to be sampled consists of reasonably similar
units and fall within a reasonable range. For example the population can be
considered homogeneous, if say, trade receivables balances fall within the range of
` 5,000 to ` 25,000 and not in the range between ` 25 to ` 2,50,000.
(ii) Stratified Sampling: This method involves dividing the whole population to be
tested in a few separate groups called strata and taking a sample from each of
them. Each stratum is treated as if it was a separate population and if proportionate
of items are selected from each of these stratum. The number of groups into which
the whole population has to be divided is determined on the basis of auditor
judgment. For example in the above case, trade receivables balances may be
divided into four groups as follows -
(a) balances in excess of ` 1,00,000;
(b) balances in the range of ` 75,000 to ` 1,00,000;
(c) balances in the range of ` 25,000 to ` 75,000; and
(d) balances below ` 25,000.

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 PAPER – 6: AUDITING AND ASSURANCE 41

(e) Defalcation of Cash: Defalcation of cash has been found to perpetrate generally in the
following ways -
(i) By inflating cash payments.
Examples of inflation of payments:
(1) Making payments against fictitious vouchers.
(2) Making payments against vouchers, the amounts whereof have been inflated.
(3) Manipulating totals of wage rolls either by including therein names of dummy
workers or by inflating them in any other manner.
(4) Casting a larger totals for petty cash expenditure and adjusting the excess in
the totals of the detailed columns so that cross totals show agreement.
(ii) By suppressing cash receipts. Few Techniques of how receipts are suppressed are:
(1) Teeming and Lading: Amount received from a customer being
misappropriated; also to prevent its detection the money received from another
customer subsequently being credited to the account of the customer who has
paid earlier. Similarly, money received from the customer who has paid
thereafter being credited to the account of the second customer and such a
practice is continued so that no one account is outstanding for payment for any
length of time, which may lead the management to either send out a statement
of account to him or communicate with him.
(2) Adjusting unauthorised or fictitious rebates, allowances, discounts etc. to
customer’ accounts and misappropriating amount paid by them.
(3) Writing off as debts in respect of such balances against which cash has
already been received but has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts e.g. sale of scrap, quarters allotted
to the employees etc.
(6) Writing down asset values in entirety, selling them subsequently and
misappropriating the proceeds.
(iii) By casting wrong totals in the cash book.

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 DISCLAIMER
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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) Advantages and disadvantages of Joint Audit. (5 Marks)
(b) Disclosure requirement relating to Trade Receivables under. Revised Schedule VI to the
Companies Act, 1956. (5 Marks)
(c) Indicate the factors which make it appropriate for an auditor to send a new Engagement
Letter for a recurring audit. (5 Marks)
(d) Inquiry from Management is helpful for Auditor to evaluate subsequent events. Discuss
specific enquiries in reference of SA 560, which might have effect on the financial
statements. (5 Marks)
Answer
(a) Joint Audit: SA 299 “Joint Audit” deals with duties, rights and professional
responsibilities of joint auditors. Advantages and disadvantages of joint audit are as
follows:
Advantages of Joint Audit
(i) Pooling and sharing of expertise.
(ii) Advantage of mutual consultation.
(iii) Lower work load.
(iv) Better quality of work performance.
(v) Improved service to the client.
(vi) Displacement of the auditor of the company taken over in a take-over often
obviated.
(vii) In respect of multinational companies, the work can be spread using the expertise if
the local firms which are in a better position to deal with detailed work and the local
laws and regulations.
(viii) Lower staff development costs.
(ix) Lower costs to carry out the work.
(x) A sense of healthy competition towards a better performance.
Disadvantages of Joint Audit
(i) The fees being shared.

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 (ii) Psychological problem where firms of different standing are associated in the joint
audit.
(iii) General superiority complexes of some auditors.
(iv) Problems of coordination of the work.
(v) Areas of work of common concern being neglected.
(vi) Uncertainty about the liability for the work done.
(vii) Lack of clear definition of responsibility.
(b) Disclosure requirement relating to Trade Receivables under Revised Schedule VI to
the Companies Act, 1956: As per the general instructions for preparation of Balance
Sheet given under Part I of Revised Schedule VI to the Companies Act, 1956, the
company shall disclose “Trade Receivables” as follows:
1. Aggregate amount of outstanding trade receivables exceeding 6 months shown
separately.
2. Sub-classification of Trade Receivables:
- Secured, considered good
- Unsecured, considered good
- Doubtful
3. Allowance for bad and doubtful debts disclosed under relevant heads:
4. Debts due from:
- Directors or other officers of the company
- Amounts due by firms in which any director is a partner
- Amounts due by private companies in which any director is a director or member
- To be aggregated and separately stated
Further, a receivable shall be classified as a ‘trade receivable’ if it is in respect of the
amount due on account of goods sold or services rendered in the normal course of
business.
(c) Factors which make it Appropriate for Sending a New Engagement Letter for
Recurring Audit: As per SA 210, “Agreeing the Terms of Audit Engagements”, it is not
necessary to issue audit engagement letter each year for repetitive audit. It is enough if
the same had been issued at the time of taking initial engagement. However, the
following factors may make it appropriate to send a new engagement letter:
(i) When it appears that the client has misunderstood the objective and scope of audit.
(ii) Where there has been change in management, board, or ownership so that it is felt
that it is pertinent to remind them of the engagement terms again.

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 (iii) Where any revision by way of addition, deletion, or modifications had been
contemplated in the engagement letter originally issued.
(iv) Where significant changes had occurred in nature, volume of the business
transactions of the client which warrant the scope and terms of engagement to be
altered to be in tune with them.
(v) Where there has been necessity to modify audit approach to be in line with the
pronouncements of ICAI, the Companies Act and the like.
(d) Enquiring from Management to Evaluate Subsequent Event: As per SA 560,
“Subsequent Events”, in inquiring of management and, where appropriate, those charged
with governance, as to whether any subsequent events have occurred that might affect
the financial statements, the auditor may inquire as to the current status of items that
were accounted for on the basis of preliminary or inconclusive data and may make
specific inquiries about the following matters:
(i) Whether new commitments, borrowings or guarantees have been entered into.
(ii) Whether sales or acquisitions of assets have occurred or are planned.
(iii) Whether there have been increases in capital or issuance of debt instruments, such
as the issue of new shares or debentures, or an agreement to merge or liquidate
has been made or is planned.
(iv) Whether any assets have been appropriated by government or destroyed, for
example, by fire or flood.
(v) Whether there have been any developments regarding contingencies.
(vi) Whether any unusual accounting adjustments have been made or are
contemplated.
(vii) Whether any events have occurred or are likely to occur which will bring into
question the appropriateness of accounting policies used in the financial statements
as would be the case, for example, if such events call into question the validity of
the going concern assumption.
(viii) Whether any events have occurred that are relevant to the measurement of
estimates or provisions made in the financial statements.
(ix) Whether any events have occurred that are relevant to the recoverability of assets.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect:
(Answer any eight)
(i) Emphasis of Matter paragraph in the Auditor's Report is a substitute of Disclaimer of
Opinion.
(ii) The primary objective of an audit is to detect fraud and errors in Financial Statements.

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 (iii) The Statutory-Auditor is required to verify inventory physically.
(iv) It is the responsibility of the Auditor to ensure that Statement of Profit and Loss and
Balance Sheet of the company shall comply with the Accounting Standards.
(v) An Auditor's external expert is not subjected to quality control policies and procedures of
an audit firm.
(vi) Extracts and copies of important legal documents, agreements and minutes relevant to
the audit is part of current audit file.
(vii) The Auditor shall express an unqualified opinion if the Auditor is unable to obtain
sufficient audit evidence regarding the opening balances.
(viii) The first Auditor is generally appointed by the company at a General Meeting.
(ix) Surprise checks are part of internal check.
(x) An Auditor is bound to provide copies of the working papers to the CEO of the company.
(8 x 2 = 16 Marks)
Answer
(i) Incorrect: As per SA 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs
in the Independent Auditor’s Report”, the inclusion of an Emphasis of Matter paragraph in
the auditor’s report does not affect the auditor’s opinion. Whereas the auditor shall
disclaim an opinion when he is unable to obtain sufficient appropriate audit evidence on
which to base the opinion, and the auditor concludes that the possible effects on the
financial statements of undetected misstatements could be both material and pervasive.
Therefore, an Emphasis of Matter paragraph is not a substitute for the auditor expressing
a disclaimer of opinion.
(ii) Incorrect: Detection of fraud and errors in the financial statements is not the primary
objective of audit. The primary objective of an audit is to obtain reasonable assurance
about whether the financial statements are free from material misstatements thereby
enabling the auditor to express an opinion on the financial statements.
(iii) Incorrect: Physical verification of inventories is the responsibility of the management of
the entity. However, where the inventories are material and the auditor is placing reliance
upon the physical count by the management, the auditor should attend the stock-taking.
(iv) Incorrect: It is the responsibility of the company to ensure that statement of profit and
loss and balance sheet of the company shall comply with the accounting standards.
However, according to Section 227 of the Companies Act, 1956, it is the duty of the
auditor to report that the statement of profit and loss and balance sheet of the Company
are complying with the accounting standards.
(v) Correct: As per SA 620 “Using the Work of an Auditor’s Expert”, an auditor’s external
expert is not a member of the engagement team and is not, therefore, subject to quality
control policies and procedures of the audit firm.

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 (vi) Incorrect: Extracts and copies of important legal documents, agreements and minutes
relevant to the audit is part of a permanent audit file. Current audit file contains
information, documents, statements etc. relevant for use only for current period audit
assignment.
(vii) Incorrect: As per SA 510 “Initial Audit Engagements—Opening Balances”, if the auditor
is unable to obtain sufficient appropriate audit evidence regarding the opening balances,
the auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate.
(viii) Incorrect: As per Section 224(5) of the Companies Act, 1956, the first auditor(s) of a
company shall be appointed by the Board of Directors within one month of the date of
registration of the company.
(ix) Incorrect: Surprise checks are part of normal audit procedures and the results of such
checks are important to the auditor in deciding the scope of his audit and submitting his
report thereon.
(x) Incorrect: Working papers are the property of the auditor, thus he is not bound to
provide copies of the working papers to anyone unless otherwise specified by law or
regulation. However, the auditor may, at his discretion, make portions of or extracts from
his working papers available to CEO of the Company or any third party.
Question 3
How you will vouch/verify the following?
(a) Assets acquired on lease.
(b) Investment in the shares and debentures of subsidiary.
(c) Provision for income tax.
(d) Retirement gratuity to employees. (4 x 4 = 16 Marks)
Answer
(a) Verification of Assets acquired on Lease:
(i) Examine the terms and conditions of the lease deed.
(ii) If a part of the leasehold property has been sublet, examine the tenant’s agreement.
(iii) Verify relevant document to check the cost of property.
(1) In case of acquisition of an asset is on operating lease, lease payment should
be recognized as an expense in the statement of profit and loss account on a
straight line basis over the lease term, in case of operating lease;
(2) In case of acquisition of an asset is on finance lease, ensure all the substantial
risks and rewards to ownership are transferred, considering the indication as
prescribed in AS-19, the lessee should recognize the lease as an asset and as
a liability. Such recognition should be at an amount equal to the fair value of
the leased assets at the inception of the lease. Ensure contingent rents are

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 recognized as expense in the statement of profit & loss for the period in case
of Finance lease.
(iv) Ensure assets acquired under finance lease are segregated from the assets owned.
(v) Ensure that the assets under lease have been properly disclosed as per
requirement of Schedule VI.
(b) Investment in the Shares and Debentures of Subsidiary:
(i) The auditor should obtain a complete schedule of all such investments held,
showing particulars as regards the name of the subsidiary company, class of shares
or debenture, date of purchase, number of units and denoting numbers, book value,
dividend received etc.
(ii) All the particulars entered in the schedule should be verified with the relevant
account in the General Ledger.
(iii) The auditor should, at the same time, examine all the investments by inspection of
the securities, share scrips or certificates, debenture bonds, etc. If any of the
securities are held by bankers, he should verify them with their certificate which
should disclose the charge, if they are subject to any such charge.
(iv) The provisions contained in Part I, Revised Schedule VI to the Companies Act,
1956 requires that the shares held in a subsidiary should be shown separately.
(v) The shares or debentures of a subsidiary are valued at cost.
(vi) If the subsidiary has suffered a loss, then a provision for the proportionate part of
the loss should be made in the accounts of the holding company.
(c) Provision for Income Tax:
(i) Obtain the computation of income prepared by the auditee and verify whether it is
as per the Income-tax Act, 1961 and Rules made thereunder.
(ii) Review adjustments, expenses, disallowed special rebates, etc. with particular
reference to the last available completed assessment.
(iii) Examine relevant records and documents pertaining to advance tax, self
assessment tax and other demands.
(iv) Compute tax payable as per the latest applicable rates in the Finance Act.
(v) Ensure that overall provisions on the date of the balance sheet is adequate having
regard to current year provision, advance tax paid, assessment orders, etc.
(vi) Ensure that the requirements of AS 22 on Accounting for Taxes on Income have
been appropriately followed for the period under audit.

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 (d) Retirement Gratuity to Employees:
(i) Examine the basis on which the gratuity payable to employees is worked out. The
liability for gratuity may either be worked out on actuarial rules or agreement or on
the presumption that all employees retire on the balance sheet date.
(ii) Verify computation of liability of gratuity on the aggregate basis.
(iii) Check the amount of gratuity paid to employees who retired during the year with
reference to number of years of service rendered by them.
(iv) See that the annual premium has been charged to Profit and Loss account, in case
if the concern has taken a policy.
(v) Ensure that the accounting treatment is in accordance with AS 15, “Employee
Benefits”.
Question 4
(a) Discuss in brief the types of audit risk and inter relationship of components of audit risk.
(6 Marks)
(b) State the matters to be specified in the Auditor's Report in terms of provisions of Section
227(3) of the Companies Act, 1956. (6 Marks)
(c) Verification of issue of Bonus Shares. (4 Marks)
Answer
(a) Types of Audit Risk: Audit risk is the risk that an auditor may give an inappropriate
opinion on financial information which is materially misstated. For example, an auditor
may give an unqualified opinion on financial statements without knowing that they are
materially misstated. Such risk may exist at overall level, while verifying various
transactions and balance sheet items.
Three components of audit risk are:
♦ Inherent risk (risk that material errors will occur);
♦ Control risk (risk that the client’s system of internal control will not prevent or correct
such errors); and
♦ Detection risk (risk that any remaining material errors will not be detected by the
auditor).
As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with Standards on Auditing”, the risks of material misstatement at
the assertion level consist of two components: inherent risk and control risk. Inherent risk
and control risk are the entity’s risks; they exist independently of the audit of the financial
statements.

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 (i) Inherent risk: It is the susceptibility of an account balance or class of transactions
to misstatement that could be material either individually or, when aggregated with
misstatements in other balances or classes, assuming that there were no related
internal controls. External circumstances giving rise to business risks may also
influence inherent risk.
(ii) Control Risk: It is the risk that a misstatement that could occur in an assertion
about a class of transaction, account balance or disclosure and that could be
material, either individually or when aggregated with other misstatements, will not
be prevented, or detected and corrected, on a timely basis by the entity’s internal
control. It is a function of the effectiveness of the design, implementation and
maintenance of internal control by management to address identified risks that
threaten the achievement of the entity’s objectives relevant to preparation of the
entity’s financial statements.
(iii) Detection Risk: It is the risk that the procedures performed by the auditor to reduce
audit risk to an acceptably low level will not detect a misstatement that exists and
that could be material, either individually or when aggregated with other
misstatements. Detection risk relates to the nature, timing, and extent of the
auditor’s procedures that are determined by the auditor to reduce audit risk to an
acceptably low level. It is therefore a function of the effectiveness of an audit
procedure and of its application by the auditor.
Inter-relationship of components of Audit Risk: Audit risk is a function of the risks of
material misstatement and detection risk. The inherent and control risks are functions of
the entity’s business and its environment and the nature of the account balances or
classes of transactions, regardless of whether an audit is conducted. Even though
inherent and control risks cannot be controlled by the auditor, the auditor can assess
them and design his substantive procedures to produce on acceptable level of detection
risk, thereby reducing audit risk to an acceptably low level.
As per SA 200, for a given level of audit risk, the acceptable level of detection risk bears
an inverse relationship to the assessed risks of material misstatement at the assertion
level. For example, the greater the risks of material misstatement the auditor believes
exists, the less the detection risk that can be accepted and, accordingly, the more
persuasive the audit evidence required by the auditor.
(b) Matters to be reported by auditor under section 227(3): Under Section 227(3) of the
Companies Act, 1956, the report of the auditor shall state -
(i) Whether he has obtained all the information and explanations which to the best of
his knowledge and belief were necessary for the purposes of his audit;
(ii) Whether, in his opinion, proper books of accounts as required by law have been
kept by the company so far as appears from his examination of those books;

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 whether proper returns adequate for the purposes of his audit have been received
from the branches not audited by him;
(iii) Whether the report on the accounts of the branches audited by branch auditors
under Section 228 has been forwarded to him and how he had dealt with the same
in preparing the auditor's report;
(iv) Whether the company's balance sheet and profit and loss account are in agreement
with the books of accounts and returns;
(v) Whether in his opinion the profit and loss account and balance sheet comply with
the accounting standards referred to in Section 211(3C);
(vi) In thick type or in italics the observations or comments of auditors which have any
adverse effect on the functioning of the company;
(vii) Whether any director is disqualified from being appointed as director under section
274(1)(g);
(viii) Whether the cess payable under Section 441A had been paid and if not details of
amount of cess not so paid.
(c) Verification of Issue of Bonus Shares: Primarily, it should be ascertained whether the
Articles permit capitalization of profits; also whether the company had a sufficient number
of unissued shares for allotment as bonus shares. In addition, the following steps should
be taken:
(i) Inspect the Minute book of Shareholders for the resolution authorising declaration of
the Bonus and Director’s Minute for the resolution appropriating profits for being
applied in payment of shares to be allotted to shareholders as bonus shares;
(ii) Trace the allotment of shares as per particulars contained in the Allotment Book or
sheets into the Register of Members; and
(iii) Confirm that all statutory requirements relevant to the issue of shares have been
complied with, viz., the filing of the particulars of the bonus shares allotted with the
Registrar together with a copy of the resolution pursuant to which allotment has
been made.
(iv) Confirm that the issue of fully paid up bonus shares in pursuance of sub-section (3)
of Section 205 has been kept in abeyance in respect of shares where any
instrument of transfer of such shares has been delivered to the company for
registration and the transfer of such shares has not been registered by the company
as required by the provisions of section 206A of the Companies (Amendment) Act,
1988.
(v) Ensure that SEBI Guidelines relating to issue of bonus shares have been complied
with.

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 Question 5
Discuss with reference to SAs:
(a) “The degree of reliance that a Statutory Auditor can place on the work of the Internal
Auditor is a matter of individual judgement”. (8 Marks)
(b) Explain the audit procedures when Principal Auditor is using the work of another Auditor.
(8 Marks)
Answer
(a) Reliance on the Work of Internal Auditor: The external auditor should as a part of his
audit, carryout general evaluation of the internal audit function to determine the extent to
which he can place reliance upon the work of the internal auditor. As per SA 610 “Using
the Work of Internal Auditors", factors that may affect the external auditor’s determination
of whether the work of the internal auditors is likely to be adequate for the purposes of
the audit include:
Objectivity:
● The status of the internal audit function within the entity and the effect such status
has on the ability of the internal auditors to be objective.
● Whether the internal audit function reports to those charged with governance or an
officer with appropriate authority, and whether the internal auditors have direct
access to those charged with governance.
● Whether the internal auditors are free of any conflicting responsibilities.
● Whether those charged with governance oversee employment decisions related to
the internal audit function.
● Whether there are any constraints or restrictions placed on the internal audit
function by management or those charged with governance.
● Whether, and to what extent, management acts on the recommendations of the
internal audit function, and how such action is evidenced.
Technical competence:
● Whether the internal auditors are members of relevant professional bodies.
● Whether the internal auditors have adequate technical training and proficiency as
internal auditors.
• Compliance with the mandatory/recommendatory Standards on Internal Audit (SIAs)
issued by Internal Audit Standards Board of the Institute of Chartered Accountants
of India (ICAI).
• Whether there are established policies for hiring and training internal auditors.

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 Due professional care:
● Whether activities of the internal audit function are properly planned, supervised,
reviewed and documented.
● The existence and adequacy of audit manuals or other similar documents, work
programs and internal audit documentation.
Communication: Communication between the external auditor and the internal auditors
may be most effective when the internal auditors are free to communicate openly with the
external auditors, and:
● Meetings are held at appropriate intervals throughout the period;
● The external auditor is advised of and has access to relevant internal audit reports
and is informed of any significant matters that come to the attention of the internal
auditors when such matters may affect the work of the external auditor; and
● The external auditor informs the internal auditors of any significant matters that may
affect the internal audit function
The degree of reliance that a statutory auditor can place on the work done by the internal
auditor is also a matter of individual judgement in a given set of circumstances. The
ultimate responsibility for reporting on the financial statements is that of the statutory
auditor. It must be clearly understood that the statutory auditor’s responsibility is absolute
and any reliance he places upon the internal audit system is part of his audit approach or
technique and does not reduce his sole responsibility.
(b) Using the Work of Another Auditor: As per SA 600, “Using the Work of Another
Auditor” when the principal auditor plan to use the work of another auditor:
(i) The principal auditor should perform procedures to obtain sufficient audit evidence,
that the work of the other auditor is adequate for the principal auditor’s purpose, in
the context of the specific assignment.
(ii) The principal auditor should consider the professional competence of the other
auditor in the context of specific assignment if the other auditor is not a member of
the Institute of Chartered Accountants of India.
(iii) When principal auditor decides to use the work of another auditor he should perform
following procedures:
(1) Advise the other auditor of the use that is to be made of the other auditor’s
work and report and make sufficient arrangements for co-ordination of their
efforts at the planning stage of the audit.
(2) Advise the other auditor of the significant accounting, auditing and reporting
requirements and obtain representation as to compliance with them.

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 (iv) The principal auditor might discuss with the other auditor the audit procedures
applied or review a written summary of the other auditor’s procedure and findings
which may be in the form of a completed questionnaire or check list.
(v) The principal auditor may conclude that it is not necessary to apply procedures
because sufficient appropriate audit evidence previously obtained that acceptable
quality control policies and procedures are complied with in the conduct of the other
auditor’s practices.
(vi) The principal auditor should consider the significant findings of the other auditor.
(vii) Discuss with the other auditor and the management of the component, audit
findings or other matters of supplemental tests of the records or the financial
statement of the component.
(viii) Principal auditor should document the significant findings of the component whose
financial statements was audited by the other auditor, name of the auditor,
conclusions reached that the individual component is not material, performed
procedures and conclusions reached, how he deals with the qualifications or
adverse remarks contained in the other auditor’s report.
Question 6
(a) Mention any eight important points which an Auditor will consider while conducting the
audit of a school. (8 Marks)
(b) Purpose of providing depreciation. (4 Marks)
(c) Casting or totaling is an important tool of audit for an Auditor. (4 Marks)
Answer
(a) Audit of School: The special steps involved in the audit of school are the following:
(i) Examine the Trust Deed or Regulations in the case of school or college and note all
the provisions affecting accounts. In the case of a university, refer to the Act of
Legislature and the Regulations framed thereunder.
(ii) Read through the minutes of the meetings of the Managing Committee or Governing
Body, noting resolutions affecting accounts to see that these have been duly
complied with, specially the decisions as regards the operation of bank accounts
and sanctioning of expenditure.
(iii) Check names entered in the Students’ Fee Register for each month or term, with
the respective class registers, showing names of students on rolls and test amount
of fees charged; and verify that there operates a system of internal check which
ensures that demands against the students are properly raised.
(iv) Check fees received by comparing counterfoils of receipts granted with entries in
the cash book and tracing the collections in the Fee Register to confirm that the
revenue from this source has been duly accounted for.

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 (v) Total up the various columns of the Fees Register for each month or term to
ascertain that fees paid in advance have been carried forward and the arrears that
are irrecoverable have been written off under the sanction of an appropriate
authority.
(vi) Check admission fees with admission slips signed by the head of the institution and
confirm that the amount had been credited to a Capital Fund, unless the Managing
Committee has taken a decision to the contrary.
(vii) See that free studentship and concessions have been granted by a person
authorised to do so, having regard to the prescribed Rules.
(viii) Confirm that fines for late payment or absence, etc., have either been collected or
remitted under proper authority.
(ix) Confirm that hostel dues were recovered before students’ accounts were closed and
their deposits of caution money refunded.
(x) Verify rental income from landed property with the rent rolls, etc.
(xi) Vouch income from endowments and legacies, as well as interest and dividends
from investment; also inspect the securities in respect of investments held.
(xii) Verify any Government or local authority grant with the relevant papers of grant. If
any expense has been disallowed for purposes of grant, ascertain the reasons and
compliance thereof.
(xiii) Report any old heavy arrears on account of fees, dormitory rents, etc, to the
Managing Committee.
(xiv) Confirm that caution money and other deposits paid by students on admission have
been shown as liability in the balance sheet and not transferred to revenue.
(xv) See that the investments representing endowment funds for prizes are kept
separate and any income in excess of the prizes has been accumulated and
invested along with the corpus.
(xvi) Verify that the Provident Fund money of the staff has been invested in appropriate
securities.
(xvii) Vouch donations, if any, with the list published with the annual report. If some
donations were meant for any specific purpose, see that the money was utilised for
the purpose.
(xviii)Vouch all capital expenditure in the usual way and verify the same with the sanction
for the Committee as contained in the minute book.
(xix) Vouch in the usual manner all establishment expenses and enquire into any unduly
heavy expenditure under any head.

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 (xx) See that increase in the salaries of the staff have been sanctioned and minuted by
the Committee.
(xxi) Ascertain that the system ordering inspection on receipt and issue of provisions,
foodstuffs, clothing and other equipment is efficient and all bills are duly authorised
and passed before payment.
(xxii) Verify the inventories of furniture, stationery, clothing, provision and all equipment,
etc. These should be checked by reference to Stock Register and values applied to
various items should be test checked.
(xxiii)Confirm that the refund of taxes deducted from the income from investment (interest
on securities, etc.) has been claimed and recovered since the institutions are
generally exempted from the payment of income-tax.
(xxiv) Verify the annual statements of accounts and while doing so see that separate
statements of account have been prepared as regards Poor Boys Fund, Games
Fund, Hostel and Provident Fund of Staff, etc.
(b) Purpose of Providing Depreciation: The main purpose of providing depreciation is as
under-
(i) To keep intact the capital invested in fixed assets - This is accomplished by
retaining the amount of depreciation charged in the profit and loss account in the
business.
(ii) To ascertain the true cost of production - As the value of fixed assets depletes
gradually by consumption during the process of production, it is necessary that such
consumption of value be charged in the accounts for determination of the true cost
of production.
(iii) To determine the profit or loss for the year - Depreciation being an expense
represented by the loss in value of fixed assets arising on use, it is charged to the
profit and loss account for determining the profit or loss during a year;
(iv) To present a true and fair value of entity's assets in the balance sheet, since the
original costs of fixed assets gradually decreases due to use and other factors, it is
improper to continue to carry such assets at original costs. Therefore, the amount
of depreciation charged in the profit and loss account representing the loss in value
of the assets is deducted from the original cost on a cumulative basis so as to
reflect in the balance sheet a true and fair value of the fixed assets.
(c) Casting or Totaling as an Audit tool: Casting or totaling is an important tool of audit for
an auditor as sometimes the totals of a wage bill are inflated by over totaling the column
in which the wages payable are entered. Such a fraud can be detected only if the totals
of the wage bill are checked. Similarly, a cashier may misappropriate receipts from
customers by under-totaling the receipts column of the cash book. At times, shortages in

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 cash have also been covered up by over totaling. Such frauds can be detected only if the
totals of the cash book and the general ledger are checked.
On these considerations, where totals of the cash book or the ledger are found to have
been made in pencil, the book keeper should be asked to ink the totals before their
verification is commenced. This would deter him from altering the totals on the totaling
mistakes being discovered.
Sometimes a fraud is committed in the following manner:
(a) under casting the receipt side of the cash book;
(b) Over casting the payment side of the cash;
(c) fictitious entries being made in the cash column to show that amounts have been
deposited in the account when, in fact, no deposit has been made;
(d) posting an amount of cash sale to the credit of a party and subsequently
withdrawing the amount; and
(e) wrong totals or balances being carried forward in the cash book or in the ledger.
Question 7
Write short notes on any four of the following:
(a) Power of Comptroller and Auditor General of India in performance of duties.
(b) Self-revealing errors and four illustrations thereof.
(c) Substantive procedures.
(d) Materiality and audit risk.
(e) Companies not covered under Companies (Auditor's Report) Order, 2003.
(4 x 4 16 Marks)
Answer
(a) Powers of Comptroller and Auditor General of India in performance of duties: The
Comptroller and Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971
gives the following powers to the C&AG in connection with the performance of his duties-
(i) To inspect any office of accounts under the control of the Union or a State
Government including office responsible for the creation of the initial or subsidiary
accounts.
(ii) To require that any accounts, books, papers and other documents which deal with
or are otherwise relevant to the transactions under audit, be sent to specified
places.

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 (iii) To put such questions or make such observations as he may consider necessary to
the person in charge of the office and to call for such information as he may require
for the preparation of any account or report which is his duty to prepare.
In carrying out the audit, the C&AG has the power to dispense with any part of detailed
audit of any accounts or class of transactions and to apply such limited checks in relation
to such accounts or transactions as he may determine.
(b) Self-revealing errors: These are such errors the existence of which becomes apparent
in the process of compilation of accounts.
A few illustrations of such errors are given hereunder, showing how they become
apparent.
(i) Omission to post a part of a journal Trial balance is thrown out of agreement.
entry to the ledger.
(ii) Wrong totaling of the Purchase Control Account (e.g., the Sundry
Register. Creditors Account) balances and the
aggregate of the balances in the personal
ledger will disagree.
(iii) A failure to record in the cash book Bank reconciliation statement will show up
amounts paid into or withdrawn from error.
the bank.
(iv) A mistake in recording amount Statements of account of parties will
received from X in the account of Y. reveal mistake.
From the above, it is clear that certain apparent errors balance almost automatically by
double entry accounting procedure and by following established practices that lie within
the accounting system but not being generally considered to be a part of it, like bank
reconciliation or sending monthly statements of account for confirmation.
(c) Substantive Procedures: These procedures are audit tests designed to obtain evidence
to verify balance of an account or a specific financial statement assertion i.e. they test
the validity and propriety of the accounting treatment of the transaction. They can be
classified as either test of details of transactions and balances or as analytical review
procedures. They provide assurance to the auditor in respect of the following assertions-
(i) The asset or a liability should exist at a given date.
(ii) The asset should be owned by the entity and the liability is an obligation of the
entity at a given date.
(iii) There should not be any unrecorded assets, liabilities or transactions.
(iv) Assets or liabilities should be recorded at appropriate carrying values.
(v) Transaction or event that took place should pertain to the entity during the relevant
period.

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 (vi) Transaction should be recorded in the proper amount and revenue or expense
should be allocated to the proper period.
(vii) Various items should be disclosed, classified, and described in accordance with
recognised accounting policies and practices and relevant statutory requirements, if
any.
(d) Materiality and Audit Risk: SA 320 on 'Materiality in Planning and Performing an Audit'
requires that the auditor should consider materiality and its relationship with audit risk
when conducting an audit. Materiality depends on the size and the nature of the items
judged in the particular circumstances of its misstatement.
The audit should be planned so that audit risk is kept at an acceptably low level. There is
an inverse relationship between Materiality and the degree of audit risk. Higher the
materiality level the lower the audit risk and vice-versa. After the auditor has assessed
the inherent and control risks, he should consider the level of detection risk that he is
prepared to accept and, based upon his judgment, select appropriate substantive audit
procedures. If the auditor does not perform any substantive procedures, detection risk,
that is, the risk that the auditor will fail to detect a misstatement, will be high.
The auditor's assessment of audit risk may change during the course of an audit
according to the need and development of the circumstances.
(e) Companies not Covered under Companies (Auditor’s Report) Order 2003:
(i) a banking company as per the Banking Regulation Act, 1949;
(ii) an insurance company as per the Companies Act, 1956;
(iii) a company licensed to operate under section 25 of the Companies Act, 1956; and
(iv) a private limited company with a paid-up capital and reserves not more than rupees
fifty lakh and which does not have outstanding loan exceeding rupees twenty five
lakhs from any bank or financial institution and does not have a turnover exceeding
rupees five crores at any point of time during the financial year.

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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) "Statements" and "Guidance Notes" of ICAI-whether mandatory or recommendatory?
(5 Marks)
(b) As an auditor what are the essential points to be borne in mind while examining a
voucher? (5 Marks)
(c) Payment of interest out of capital during construction period. (5 Marks)
(d) What is Modified Reports? Discuss disclosure pattern when the auditor includes an
Emphasis of Matter paragraph in the Auditor's Report. (5 Marks)
Answer
(a) Statements and Guidance Notes of ICAI –whether mandatory or recommendatory:
(i) Statements: The ‘Statements’ have been issued with a view to securing compliance
by members on matters which, in the opinion of the Council, are critical for the
proper discharge of their functions. ‘Statements’ therefore are mandatory.
Accordingly, while discharging their attest function, it will be the duty of the
members of the Institute to ensure that statements are followed and complied with.
(ii) Guidance Notes: ‘Guidance Notes’ are primarily designed to provide guidance to
members on matters which may arise in the course of their professional work and
on which they may desire assistance in resolving issues which may pose difficulty.
Guidance Notes are recommendatory in nature. A member should ordinarily follow
recommendations in a guidance note relating to an auditing matter except where he
is satisfied that in the circumstances of the case, it may not be necessary to do so.
Similarly, while discharging his attest function, a member should examine whether
the recommendations in a guidance note relating to an accounting matter have been
followed or not. If the same have not been followed, the member should consider
whether keeping in view the circumstances of the case, a disclosure in his report is
necessary.
There are, however a few guidance notes in case of which the Council has
specifically stated that they should be considered as mandatory on members while
discharging their attest function.
(b) Examining a Voucher: The essential points to be borne in mind while examining a
voucher are:

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 26 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(i) that the date of the voucher falls within the accounting period;
(ii) that the voucher is made out in the client’s name;
(iii) that the voucher is duly authorised;
(iv) that the voucher comprised all the relevant documents which could be expected to
have been received or brought into existence on the transactions having been
entered into, i.e., the voucher is complete in all respects; and
(v) that the account in which the amount of the voucher is adjusted is the one that
would clearly disclose the character of the receipts or payments posted thereto on
its inclusion in the final accounts.
After the examination is over, each voucher should be either impressed with a rubber
stamp or initialed so that it may not be presented again in support of another entry.
(c) Payment of Interest out of Capital during Construction: Under the provisions of
section 208 of the Companies Act, 1956, a company which has raised money by issue of
shares to meet the cost of construction of any work or building or provision of any plant
which cannot be made profitable for a long time, can pay interest on paid-up capital for a
period and subject to conditions specified in section 208. Accordingly, the payment of
interest should be verified as follows:—
(i) Authorisation: Ascertain that payment is authorised by the articles or special
resolution.
(ii) Approval: Verify that prior sanction of the Central Government has been obtained.
(iii) Payment Period: Verify that interest has been paid only for the period authorized
by the Central Government.
(iv) Rate of Interest: Verify that rate of interest does not exceeds such rate as notified by
the Central Government.
(v) Presentation in Financial Statements: Verify that interest paid has been added to
the cost of assets created out of capital.
(d) Modified Reports: As per SA 705 “Modifications to the Opinion in the Independent
Auditor’s Report”, an auditor’s report is considered to be modified when it includes:
(i) Matters That Do Not Affect the Auditor’s Opinion
9 emphasis of matter
9 Other Matter
(ii) Matters That Do Affect the Auditor’s Opinion
9 qualified opinion
9 disclaimer of opinion
9 adverse opinion

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 PAPER- 6 : AUDITING AND ASSURANCE 27

Therefore, Modified Reports can be of two types (a) Matters that affect auditor’s opinion
(b) Matters that do not affect auditor’s opinion.
The auditor shall modify the opinion in the auditor’s report when the auditor concludes
that, based on the audit evidence obtained, the financial statements as a whole are not
free from material misstatement; or the auditor is unable to obtain sufficient appropriate
audit evidence to conclude that the financial statements as a whole are free from material
misstatement.
Further, as per SA 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in
the Independent Auditor’s Report”, the inclusion of an Emphasis of Matter paragraph in
the auditor’s report does not affect the auditor’s opinion. When the auditor includes an
Emphasis of Matter paragraph in the auditor’s report, the auditor shall:
(i) Include it immediately after the Opinion paragraph in the auditor’s report;
(ii) Use the heading “Emphasis of Matter”, or other appropriate heading;
(iii) Include in the paragraph a clear reference to the matter being emphasised and to
where relevant disclosures that fully describe the matter can be found in the
financial statements; and
(iv) Indicate that the auditor’s opinion is not modified in respect of the matter
emphasised.
Examples:
™ An uncertainty relating to the future outcome of an exceptional litigation or
regulatory action.
™ Early application (where permitted) of a new accounting standard that has a
pervasive effect on the financial statements in advance of its effective date.
™ A major catastrophe that has had, or continues to have, a significant effect on
the entity’s financial position.
Question 2
State with reasons (in short) whether the following statements are correct or incorrect.
(Answer any eight)
(i) The Revised Schedule VI is applicable only to Public Limited Companies from the
Financial Year 2012-13.
(ii) Specific disclosure is required of the fundamental accounting assumptions followed in the
financial statements.
(iii) The Whole Time Director of a public company is automatically entitled for remuneration.
(iv) Companies (Auditor's Report) Order, 2003 shall not apply to a Private Limited Company
whose paid up capital and reserves are not more than rupees fifty lakhs.

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 28 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(v) Errors of commission' is where a transaction has been omitted either wholly or partially.
(vi) There is no difference in terms "Audit Procedure" and "Audit Technique".
(vii) Maintenance of internal control system is responsibility of Auditor.
(viii) ABC Ltd. declared dividends without providing depreciation for the current year.
(ix) ABC Ltd., a government company came into existence in year 2012, donated ` 50,000 to
a political party.
(x) The Board of Directors can fill the casual vacancy caused by the resignation of an
auditor, who shall hold office until the conclusion of the next annual general meeting.
(8 x 2 = 16 Marks)
Answer
(i) Incorrect, the Revised Schedule VI is applicable to all the companies (other than
banking companies, electricity companies and insurance companies), registered under
the Companies Act, 1956, from the financial year commencing on or after 1.4.2011.
(ii) Incorrect, as per AS 1, “Disclosure of Accounting Policies”, specific disclosure of the
fundamental accounting assumption is required if they are not followed in the financial
statements.
(iii) Correct, in case of a public company the whole time directors may be paid remuneration
either by way of a monthly payment or at a specified percentage of the net profits of the
company or partly by one way and partly by other, subject to the provisions of the
Companies Act, 1956.
(iv) Companies which are not covered under Companies (Auditor’s Report) Order, 2003
includes a private limited company with a paid-up capital and reserves not more than
rupees fifty lakh and which does not have outstanding loan exceeding rupees twenty five
lakhs from any bank or financial institution and does not have a turnover exceeding
rupees five crores at any point of time during the financial year.
Though question is silent about other information, therefore, both the answers are
possible subject to their assumption. Thus statement is Correct, assuming all other
conditions related to outstanding loan and turnover are satisfied or Incorrect, assuming
failure of fulfillment of any condition.
(v) Incorrect, when a transaction has been omitted either wholly or partially it is known as
“Error of Omission” whereas “Error of Commission” is where a transaction has been mis-
recorded either wholly or partially.
(vi) Incorrect, there is distinction between Audit Procedure and Audit Technique. Audit
Procedure may comprise a number of techniques and represents the broad frame of the
manner of handling the audit work; Audit techniques stand for the methods employed for
carrying out the procedure.

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(vii) Incorrect, it is the responsibility of the management for the maintenance of internal
control system rather than of the Auditor. Because, Internal control is the process
designed, implemented and maintained by those charged with governance, management
to provide reasonable assurance about the achievement of entity’s objectives.
(viii) Incorrect, no dividend shall be declared or paid by a company for any financial year
except out of the profits of the company for that year arrived at after providing for
depreciation or out of the profits of the company for any previous financial year or years
arrived at after providing for depreciation.
Alternatively, Correct, assuming it is approved by Central Government as per section
205 of the Companies Act, 1956.
(ix) Incorrect, no government company is allowed to contribute any amount or amounts
directly or indirectly to any political party or for any political purpose to any person.
(x) Incorrect, in case of a casual vacancy arising on account of resignation, only the
company in general meeting can fill the vacancy by appointing another auditor, who shall
hold office till the conclusion of the next annual general meeting.
Question 3
How will you vouch/verify the following?
(a) Preliminary expenses
(b) Building
(c) Recovery of bad debts written off
(d) Cut-off arrangement/procedures. (4 x 4 = 16 Marks)
Answer
(a) Preliminary Expenses: The auditor takes following steps to vouch/verify preliminary
expenses:
(i) Expenditure incidental to creation and floating of a company includes stamp duties,
registration fees, legal costs, accountant’s fees, cost of printing, etc. All such kind of
expenses should be related to the formation of the enterprise.
(ii) Contracts relating to preliminary expenses should be examined with all preliminary
expenses, relevant supporting documents should be there.
(iii) He should examine company’s minute’s book to determine the pattern of writing off
of the preliminary expenses over the period.
(iv) He must check that if such kinds of expenses are incurred by the promoters or they
have been reimbursed to the promoters, it is as per the instructions of the BOD and
the powers in AOA.

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(v) He should make a cross check of the amount of preliminary expenses with that of
amount mentioned in the prospectus, statutory report and balance sheet. Any
amount in excess should be approved by the shareholders.
(b) Buildings:
(i) Examine the title deeds of buildings to see whether the client holds the title on the
balance sheet date. If the property has been mortgaged, the title deeds will be in
the possession of the mortgagee, from whom a certificate should be obtained to that
effect.
(ii) Verify the original cost of buildings by reference to the deed of conveyance. If the
building is constructed by the client, verify the original cost by reference to the cost
as recorded in the books of account of the year in which the construction was
completed.
(iii) Verify that appropriate depreciation has been provided against the buildings. In
case no depreciation is provided on the buildings, a note to this effect should be
given in the profit and loss account.
(iv) See the appropriate lease deed, if the building is leasehold, to ascertain the cost,
amortisation, etc. Also ensure that all the covenants in the lease deed have been
fulfilled by the client.
(v) See that the buildings have been valued at cost less depreciation. If any
revaluation has taken place, see the basis of revaluation and ensure that the
disclosure of the same has been made. In case of a company, the requirements of
Schedule VI to the Companies Act, 1956, have been complied with.
(vi) See that the relevant particulars of buildings have been entered in the fixed assets
record maintained by the client.
(c) Recovery of Bad Debts written off:
(i) Check all correspondence and proper authorization of bad debts written off earlier
and ensure that the decision of writing off of bad debts was recorded properly.
(ii) Ascertain total bad debts and see whether all recovery of bad debts is recorded
properly in the books of account and deposited into bank.
(iii) Check all notifications from Court or bankruptcy trustee and all correspondence
from debtors and collecting agencies.
(iv) Check Credit Manager’s files for amount recovered and confirm acknowledgement
receipts issued to trustee/debtors.
(v) Vouch acknowledgement receipts issued to debtors or trustees.
(d) Cut-off arrangement: Accounting is a continuous process because the business never
comes to halt. It is, therefore, necessary that transactions of one period would be
separated from those in the ensuing period so that the results of the working of each

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period can be correctly ascertained. The arrangement that is made for this purpose is
technically known as “cut-off arrangement”. It essentially forms part of the internal
control system of the organisation. Accounts, other than sales, purchase and stock are
not usually affected by the continuity of the business and therefore, this arrangement is
generally applied only to sales, purchase and stock. The auditor satisfies by examination
and test-checks that the cut-off procedures are adequately followed and ensure that:
(i) Goods purchased, property in which passed on to the client, have in fact been
included in the inventories and that the liability has been provided for in case credit
purchase.
(ii) Goods sold have been excluded from the inventories and credit has been taken for
the sales. If the value of sales is to be received, the concerned party has been
debited.
The auditor may examine a sample of documents, evidencing the movement of stock into
and out of stores, including documents pertaining to period shortly before and after the
cut-off date and check whether stocks represented by those documents were included or
excluded as appropriate during stock taking for perfect and correct presentation in the
financial statements.
Question 4
Discuss with reference to SAs:
(a) What do you mean by "Written Representations"? As an auditor, how you will deal if
management does not provide requested written representations? (5 Marks)
(b) "Operating Conditions" that may cast doubt about going concern assumption. (5 Marks)
(c) The auditor is responsible for maintaining an attitude of professional skepticism
throughout the audit. Do you agree with the statement? (6 Marks)
Answer
(a) Written Representations: As per SA 580, “Written Representation”, is a written
statement by management provided to the auditor to confirm certain matters or to support
other audit evidence. These representations are an important source of audit evidence. If
management modifies or does not provide the requested written representations, it may
alert the auditor to the possibility that one or more significant issues may exist. Further, a
request for written, rather than oral, representations in many cases may prompt
management to consider such matters more rigorously, thereby enhancing the quality of
the representations.
Requested Written Representations not provided by Management: If management
does not provide one or more of the requested written representations,
(i) the auditor shall discuss the matter with management;

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(ii) re-evaluate the integrity of management and evaluate the effect that this may have
on the reliability of representations (oral or written) and audit evidence in general;
and
(iii) take appropriate actions, including determining the possible effect on the opinion in
the auditor’s report.
The auditor shall disclaim an opinion on the financial statements if management does not
provide the written representations.
(b) Operating Conditions casting doubt about going concern assumption: The following
are examples of operating events or conditions that, may cast significant doubt about the
going concern assumption.
(i) Management intentions to liquidate the entity or to cease operations.
(ii) Loss of key management without replacement.
(iii) Loss of a major market, key customer(s), franchise, license, or principal supplier(s).
(iv) Labour difficulties.
(v) Shortages of important supplies.
(vi) Emergence of a highly successful competitor.
(c) Professional Skepticism: As per SA 200, “Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”,
Professional skepticism is an attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence.
Therefore, professional skepticism is necessary to the critical assessment of audit
evidence. This includes questioning contradictory audit evidence and the reliability of
documents and responses to inquiries and other information obtained from management
and those charged with governance. It also includes consideration of the sufficiency and
appropriateness of audit evidence obtained in the light of the circumstances, for example
in the case where fraud risk factors exist and a single document, of a nature that is
susceptible to fraud, is the sole supporting evidence for a material financial statement
amount.
Maintaining professional skepticism throughout the audit is necessary if the auditor is, for
example, to reduce the risks of overlooking unusual circumstances, over generalising
when drawing conclusions from audit observations or using inappropriate assumptions in
determining the nature, timing, and extent of the audit procedures and evaluating the
results thereof.
Further, while obtaining reasonable assurance, the auditor is responsible for maintaining
professional skepticism throughout the audit, considering the potential for management
override of controls and recognizing the fact that audit procedures that are effective for

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detecting error may not be effective in detecting fraud. This requirement is also designed
to assist the auditor in identifying and assessing the risks of material misstatement due to
fraud and in designing procedures to detect such misstatement.
Therefore, we do agree with the statement.
Question 5
(a) You are the auditor of a company. What precautions you will suggest in adopting test
checking technique for audit work? (8 Marks)
(b) State the background of "Local Bodies". Draft an audit programme for audit of local
bodies. (8 Marks)
Answer
(a) Precautions for adopting test checking technique: While adopting test check
technique, an auditor should take following precautions:-
(i) Classification: The transactions of the concern should be classified under
appropriate heads and may be stratified in case of wide variations between the
transactions of the same kind.
(ii) System study in sequential order: Authorisations, documentations, recording of
the transactions should be studied right from the beginning to end.
(iii) Evaluation of internal control: Evaluating the system of internal control for its
efficiency, soundness and capability to produce reliable accounting and financial
data.
(iv) Clarity of test check plan: Preparation of test check plan with clear audit objective
understood by the audit staff.
(v) Scientific sample selection: Un-biased selection of the transactions with reference
to the random number tables or other statistical methods.
(vi) Test check, not applicable prohibited areas: Identification of the areas where test
check may not be done.
(vii) Sample size: Based on degree of reliance and the confidence level required in the
audit, the number of transactions to be selected for each test plan should be pre-
determined.
(viii) Materiality: Setting up criteria to judge what constitute material or immaterial
errors. Further investigation of only material errors be carried out and all immaterial
errors may be avoided.
(b) Background of Local Bodies: A municipality can be defined as a unit of local self-
government in an urban area. By the term ‘local self-government’ is ordinarily
understood the administration of a locality – a village, a town, a city or any other area
smaller than a state – by a body representing the local inhabitants, possessing fairly

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large autonomy, raising at least a part of its revenue through local taxation and spending
its income on services which are regarded as local and, therefore, distinct from state and
central services.
Municipal government in India covers five distinct types of urban local authorities, viz.,
the municipal corporations, the municipal councils, the notified area committees, the town
area committees and the cantonment committees.
Audit Programme for local bodies:
(i) The Local Fund Audit Wing of the State Govt. is generally in charge of the audit of
municipal accounts. Sometimes bigger municipal corporations e.g. Delhi, Mumbai
etc have power to appoint their own auditors for regular external audit. So the
auditor should ensure authenticity of his appointment.
(ii) The auditor while auditing the local bodies should report on the fairness of the
contents and presentation of financial statements, the strengths and weaknesses of
system of financial control, the adherence to legal and/or administrative
requirements; upon whether value is being fully received on money spent. His
objective should be to detect errors and fraud and misuse of resources.
(iii) The auditor should ensure that the expenditure incurred conforms to the relevant
provisions of the law and is in accordance with the financial rules and regulations
framed by the competent authority.
(iv) He should ensure that all types of sanctions, either special or general, accorded by
the competent authority.
(v) He should ensure that there is a provision of funds and the expenditure is incurred
from the provision and the same has been authorized by the competent authority.
(vi) The auditor should check that the different schemes, programmes and projects,
where large financial expenditure has been incurred, are running economically and
getting the expected results.
Question 6
(a) Describe "Analytical Review Procedures" in Audit. Briefly discuss analytical procedures
for verification of debtors. (8 Marks)
(b) Mention any eight important points which an auditor will consider while conducting the
audit of hospital. (8 Marks)
Answer
(a) Analytical Review Procedure: As per SA 520, Analytical Procedure means analysis of
financial information through analysis of relationship among financial and non-financial
data. It includes comparison of the entity’s financial information with comparable
information with prior period, anticipated results of the entity like budgets etc or
expectations of auditor and similar industry information.

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Therefore, an analytical review procedure assists the auditor in planning the nature,
timing and extent of other audit procedures. It is an auditing procedure based on ratios
among accounts and tries to identify significant changes. Analytical review procedures
can be used in the consideration of risks and/or as direct tests of balances. When
deciding whether to incorporate analytical review procedures into the examination
program as substantive tests of balances, the examiner should consider the extent to
which the underlying data should be tested.
Analytical Procedures in case of debtors: Following are the analytical review
procedures which may often be helpful as a means of obtaining audit evidence regarding
the various assertions relating to debtors:
(i) comparison of closing balances of debtors with the corresponding figures for the
previous year;
(ii) comparison of the relationship between current year debtor balances and the
current year sales with the corresponding budgeted figures, if available;
(iii) comparison of actual closing balances of debtors with the corresponding budgeted
figures, if available;
(iv) comparison of current year’s ageing schedule with the corresponding figures for the
previous year;
(v) comparison of significant ratios relating to debtors with similar ratios for other firms
in the same industry, if available;
(vi) comparison of significant ratios relating to debtors with the industry norms, if
available.
(vii) Check whether there is any change in credit policy of the organization.
(viii) Check the percentage of bad debts of previous years and current year.
(ix) Find the reasons of major variations in the estimated values and actual values.
These are only an illustrative list of analytical review procedures which an auditor may
employ in carrying out an audit of debtors. The exact nature of analytical review
procedures to be applied in specific situation is a matter of professional judgment of the
auditor.
(b) Audit of Hospital: The points to be considered by the auditor during the audit of a
Hospital are stated below:-
(i) Income from Services: Vouch the Register of patients with copies of bills issued to
them. Verify bills for a selected period with the patients’ attendance record to see
that the bills have been correctly prepared. Also see that bills have been issued to
all patients from whom an amount was recoverable according to the rules of the
hospital.

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(ii) Collection of cash: Check cash collections as entered in the Cash Book with the
receipts, counterfoils and other evidence for example, copies of patients bills,
counterfoils of dividend and other interest warrants, copies of rent bills.
(iii) Income from Investments: See by reference to the property and Investment Regis-
ter that all income that should have been received by way of rent on properties,
dividends, and interest on securities settled on the hospital, has been collected.
(iv) Legacies and Donations: Ascertain that legacies and donations received for a
specific purpose have been applied in the manner agreed upon.
(v) Reconciliation of Subscriptions: Trace all collections of subscription and
donations from the Cash Book to the respective Registers. Reconcile the total
subscriptions due (as shown by the Subscription Register and the amount collected
and that still outstanding).
(vi) Authorisation and Sanctions: Vouch all purchases and expenses and verify that
the capital expenditure was incurred only with the prior sanction of the Trustees or
the Managing Committee and that appointments and increments to staff have been
duly authorised.
(vii) Grants and TDS: Verify that grants, if any, received from Government or local
authority has been duly accounted for. Also, that refund in respect of taxes
deducted at source has been claimed.
(viii) Budgets: Compare the totals of various items of expenditure and income with the
amount budgeted for them and report to the Trustees or the Managing Committee
significant variations which have taken place.
(ix) Internal Check: Examine the internal check as regards the receipt and issue of
stores; medicines, linen, apparatus, clothing, instruments, etc. so as to ensure that
purchases have been properly recorded in the Stock Register and that issues have
been made only against proper authorisation.
(x) Depreciation: See that depreciation has been written off against all the assets at
the appropriate rates.
(xi) Registers: Inspect the bonds, share scrips, title deeds of properties and compare
their particulars with those entered in the property and Investment Registers.
(xii) Inventories: Obtain inventories, especially of stocks and stores as at the end of the
year and check a percentage of the items physically; also compare their total values
with respective ledger balances.
(xiii) Management Representation and Certificate: Get proper Management
Representation and Certificate with respect to various aspects covered during the
course of audit.

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Question 7
Write short notes on any four of the following:
(a) Indicate expenses which are essentially of a revenue nature, if incurred for creating an
asset, are also regarded as expenditure of a capital nature.
(b) Conditions for issue of shares at a discount.
(c) Advantages of Statistical Sampling in Auditing.
(d) Auditing through the computer.
(e) Introductory Paragraph in the Auditor's Report. (4 x 4 = 16 Marks)
Answer
(a) Expenses which are essentially of a revenue nature, if incurred for creating an asset or
adding to its value for achieving higher productivity, are also regarded as expenditure of
a capital nature.
Examples:
(i) Material and wages: capital expenditure when expended on the construction of a
building or erection of machinery.
(ii) Legal expenses: capital expenditure when incurred in connection with the purchase
of land or building.
(iii) Freight: capital expenditure when incurred in respect of purchase of plant and
machinery.
(iv) Repair: Major repairs of a fixed asset that increases its productivity.
(v) Wages: Wages paid on installation costs incurred in Plant & Machinery.
(vi) Interest: Interest paid for the qualification period as per AS-16 i.e. before the asset
is constructed.
Whenever, therefore, a part of the expenditure, ostensibly of a revenue nature, is
capitalised it is the duty of the auditor not only to examine the precise particulars of the
expenditure but also the considerations on which it has been capitalised.
(b) Conditions for issue of Shares at a Discount: According to Section 79 of the
Companies Act, 1956, a company can issue shares at a discount on the following
conditions:
(i) The issue should be authorised by an ordinary resolution of the company
sanctioned by the Central Government.
(ii) No such issue of shares at discount can be sanctioned by the Central Government in
case the maximum rate of discount should exceed 10% unless the Central Government
is of the opinion that a higher rate for discount is justified by the special circumstances
of the case.

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(iii) The issue should be made within two months of the sanction by the Central
Government and not earlier than one year after the date of commencement of
business.
(iv) The issue should be a class already issued by the company.
(v) It is the duty of the auditor to confirm that the conditions given above have been
complied with by the company at the time the allotment was made.
(c) Advantages of statistical sampling in Auditing: The advantages of using statistical
sampling technique in auditing are:
(i) Sample size does not increase in proportion to the increase in the size of
population.
(ii) Sample selection is more objective and based on law of probability.
(iii) This provides a means of estimating the minimum sample size associated with a
specified risk and precision level.
(iv) It also provides a means for deriving a calculated risk and corresponding precision.
(v) It may provide a better description of a large mass of data than a complete
examination of all the data, since non-sampling errors such as processing and
clerical mistake are not large.
(d) ‘Auditing through the computer approach’: Following are several circumstances
where auditing through the computer approach must be used:
(i) The application system processes large volumes of input and produces large
volumes of output that make extensive direct examination of the validity of input and
output difficult.
(ii) Significant parts of the internal control system are embodied in the computer
system. For example, in an online banking system a computer program may batch
transactions for individual tellers to provide control totals for reconciliation at the
end of the day’s processing.
(iii) The logic of the system is complex and there are large portions that facilitate use of
the system for efficient processing.
(iv) Because of cost-benefit considerations, there are substantial gaps in the visible
audit trail.
The primary advantage is that the auditor has increased power to effectively test a
computer system. The range and capability of tests that can be performed increases and
the auditor acquires greater confidence that data processing is correct. By examining the
system’s processing the auditor also can assess the system’s ability to cope with
environment change.

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 PAPER- 6 : AUDITING AND ASSURANCE 39

The primary disadvantage of the approach are the high costs sometimes involved and
the need for extensive technical expertise when system are complex. However, these
disadvantages are really spurious if auditing through computer is the only viable method
of carrying out the audit.
(e) Introductory Paragraph: As per SA 700, “Forming an Opinion and Reporting on
Financial Statements”, the introductory paragraph in the auditor’s report shall:
(i) Identify the entity whose financial statements have been audited;
(ii) State that the financial statements have been audited;
(iii) Identify the title of each statement that comprises the financial statements;
(iv) Refer to the summary of significant accounting policies and other explanatory
information; and
(v) Specify the date or period covered by each financial statement comprising the
financial statements.

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 DISCLAIMER
The Suggested Answers hosted in the website do not constitute the basis for evaluation of the
students’ answers in the examination. The answers are prepared by the Faculty of the Board
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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
Discuss the following:
(a) Despite of several disadvantages, audit programme is required to start an audit. (5 Marks)
(b) The discipline of behavioural science is closely linked with the subject of auditing. (5 Marks)
(c) The reliability of audit evidence is influenced by its source, nature and circumstances
under which it is obtained. (5 Marks)
(d) As per SA 530, meaning of audit sampling, sample design, sample size and selection of
items for testing. (5 Marks)
Answer
(a) Despite several disadvantages, audit programme is required to start an audit.
Despite of several disadvantages, the audit programme is required to start an audit due
to the following considerations:
(i) The audit programme lists down areas of audit before commencement.
(ii) The audit timing is built therein; thereby it becomes a schedule of audit plan
(iii) The staff who are entrusted with the audit assignment is also specified. It is a plan
of resource allocation of the firm.
(iv) It specifies the procedures to be checked during the audit.
(v) As the audit work is split into various elements of procedures to be performed, the
audit programme acts as a guiding chart or check list during the performance of
audit.
(vi) Since the staff in charge of each work is specified and they sign the programme, it
extracts the responsibility from the audit assistants.
(vii) The working papers of the audit staff can be reviewed against the audit programme
which helps a base of reference for evaluation of the performance before reporting
on the financial statements.
(viii) It also helps in preparing a diary of the performance and plan and also base for
billing the clients for the time and manpower involved in the audit.
(b) The discipline of behavioural science is closely linked with the subject of auditing:
The field of auditing as a discipline involves review of various assertions; both in financial
as well as in non-financial terms, with a view to prove the veracity of such assertions and
expression of opinion by auditor on the same. Thus, it is quite logical and natural that the

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function of audit can be performed if and only if the person also possesses a good
knowledge about the fields in respect of which he is conducting such a review.
The discipline of behavioural science is closely linked with the subject of auditing. While
it may be said that an auditor, particularly the financial auditor, deals basically with the
figures contained in the financial statements but he shall be required to interact with a lot
of people in the organisation. As against the financial auditor, the internal auditor or a
management auditor is expected to deal with human beings rather than financial figures.
One of the basic elements in designing the internal control system is personnel.
Howsoever, if a sound internal control structure is designed, it cannot work until and
unless the people who are working in the organisation are competent and honest. The
knowledge of human behaviour is indeed very essential for an auditor so as to effectively
discharge his duties.
(c) The reliability of audit evidence is influenced by its source, nature and circumstances
under which it is obtained. The reliability of information to be used as audit evidence, and
therefore of the audit evidence itself, is influenced by its source and its nature, and the
circumstances under which it is obtained, including the controls over its preparation and
maintenance where relevant. Therefore, generalisations about the reliability of various
kinds of audit evidence are subject to important exceptions. Even when information to be
used as audit evidence is obtained from sources external to the entity, circumstances
may exist that could affect its reliability. For example, information obtained from an
independent external source may not be reliable if the source is not knowledgeable, or a
management’s expert may lack objectivity. While recognising that exceptions may exist,
the following generalisations about the reliability of audit evidence may be useful:
♦ The reliability of audit evidence is increased when it is obtained from independent
sources outside the entity.
♦ The reliability of audit evidence that is generated internally is increased when the
related controls, including those over its preparation and maintenance, imposed by
the entity are effective.
♦ Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or
by inference (for example, inquiry about the application of a control).
♦ Audit evidence in documentary form, whether paper, electronic, or other medium, is
more reliable than evidence obtained orally (for example, a contemporaneously
written record of a meeting is more reliable than a subsequent oral representation of
the matters discussed).
♦ Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles, or documents that have been filmed,
digitised or otherwise transformed into electronic form, the reliability of which may
depend on the controls over their preparation and maintenance.

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 30 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

(d) As per SA 530 on “Audit Sampling”, the meaning of the term Audit Sampling is the
application of audit procedures to less than 100% of items within a population of audit
relevance such that all sampling units have a chance of selection in order to provide the
auditor with a reasonable basis on which to draw conclusions about the entire population.
As per SA 530, Requirements relating to Sample design, sample size and selection
of items for testing are explained below-
Sample design - When designing an audit sample, the auditor shall consider the
purpose of the audit procedure and the characteristics of the population from which the
sample will be drawn.
Sample Size- The auditor shall determine a sample size sufficient to reduce sampling
risk to an acceptably low level.
Selection of Items for Testing- The auditor shall select items for the sample in such a
way that each sampling unit in the population has a chance of selection.
Question 2
State with reason (in short) whether the following statements are correct or incorrect. (any
Eight)
(a) Rajat, an auditor recovers his fees on progressive basis is said to be indebted to
company.
(b) “Examination in depth” implies that the auditor vouches almost all transactions in a
manner that the chances of not checking any transaction are left at minimum.
(c) Branch auditor of a company should give photocopies of his working papers on demand
by Company Auditor.
(d) The first auditor of PQR Ltd., a Government company was appointed by the board of
directors of company.
(e) Mr. ‘R’, a practicing Chartered Accountant, is appointed as a “Tax Consultant” of MN
Ltd., in which his father Mr. ‘C’ is the managing director.
(f) Inherent and control risk, and detection risk have same meaning.
(g) Deviation in accounting policies are to be reported in auditor’s report.
(h) Financial Statements should show “True and correct” view of the affairs of the entity.
(i) Events occurring after the balance sheet date must be disclosed in the financial
statements.
(j) Audit of Private Limited Companies are to be excluded while calculating ceiling on
number of audits. (8 x 2 = 16 Marks)

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Answer
(a) Incorrect. According to the Research Committee of the Institute, a question often arises
as to whether indebtedness arises in cases where in accordance with the terms of his
engagement by a client (e.g. resolution passed by the general meeting) the auditor
recovers his fees on a progressive basis as and when a part of work is done without
waiting for the completion of the whole job. Where in accordance with such terms, the
auditor recovers his fees on a progressive basis, he cannot be said to be indebted to the
company at any stage.
In view of the above, Rajat cannot be said to be indebted to the company.
(b) Incorrect. Examination in depth implies examination of a few selected transactions from
the beginning to the end through the entire flow of the transaction. This examination
consists of studying the recording of transactions at the various stages through which
they have passed. At each stage, relevant records and authorities are examined; it is
also judged whether the person who has exercised the authority in relation to the
transactions is fit to do so in terms of the prescribed procedure.
(c) Incorrect. As per SA 230 on “Audit Documentation”, audit documentation is the property
of the auditor. He may at his discretion, make portions of, or extracts from, audit
documentation available to clients, provided such disclosure does not undermine the
validity of the work performed, or, in the case of assurance engagements, the
independence of the auditor or of his personnel.
Main auditor does not have right of access to the working papers of the branch auditor. In
the case of a company, the main auditor has to consider the report of the branch auditor
and has a right to seek clarification and to visit the branch but cannot ask for the copy of
working papers and therefore, the branch auditor is under no compulsion to give
photocopies of his working papers to the principal auditor of the Company.
(d) Incorrect. Section 224(5) of the Companies Act, 1956 (the Act) lays down that “the first
auditor or auditors of a company shall be appointed by the Board of directors within one
month of the date of registration of the company”. Thus, the first auditor of a company
can be appointed by the Board of Directors within one month from the date of registration
of the company. However, in the case of a Government Company, the appointment or
re-appointment of auditor is governed by the provisions of Section 619 of the Companies
Act, 1956. Hence in the case of PQR Ltd., being a government company, the first
auditors shall be appointed by the Comptroller and Auditor General of India.
Thus, the appointment of first auditors made by the Board of Directors of PQR Ltd., is
null and void.
(e) Correct. A chartered accountant appointed as an auditor of a company, should disclose
his interest while making the audit report. If this disclosure is not made, it would amount
to “misconduct” under the Chartered Accountants Act, 1949.

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In this case, Mr R is a “Tax Consultant” and not a “Statutory Auditor” of MN Ltd., hence
he is not liable to disclose his relationship with Managing Director of the company except
as required by Section 349 of the Companies Act, 1956.
(f) Incorrect. Inherent and control risks differ from detection risk in that they exist
independently of an audit of financial information. Inherent and control risks are functions
of the entity’s business and its environment and the nature of the account balances or
classes of transactions, regardless of whether an audit is conducted. Even though
inherent and control risks cannot be controlled by the auditor, the auditor can assess
them and design his substantive procedures to produce an acceptable level of detection
risk, thereby reducing audit risk to an acceptably low level.
(g) Incorrect. It is not that all deviations in accounting policies be reported in the auditor’s
report. Only those deviations in accounting policies are to be reported in the auditor’s
report in respect of which proper disclosure regarding such deviations in the accounting
policies have not been made.
(h) Incorrect. Financial statements are frequently described as showing a true and fair view
of the financial position, performance and cash flows of an enterprise. The application of
the principal qualitative characteristics and of appropriate accounting standards normally
results in financial statements that convey what is generally understood as a true and fair
view of such information.
There has been a shift of emphasis from arithmetical accuracy to the question of
reliability to the financial statements. A statement may be reliable even though there are
some errors or even frauds, provided they are not so big as to vitiate the picture. The
word “correct” was somewhat misplaced as the accounting largely consists of estimates.
(i) Incorrect. As per AS-4 on “Contingencies and Events Occurring After the Balance
Sheet Date”, Events occurring after the balance sheet date which do not affect the
figures stated in the financial statements would not normally require disclosure in the
financial statements although they may be of such significance that they may require a
disclosure in the report of the approving authority to enable users of financial statements
to make proper evaluations and decisions.
(j) Incorrect. The Companies (Amendment) Act, 2000 has amended Section 224(1B) by
adding a proviso that audit of private companies are not to be counted in computation of
ceiling limit. An auditor can accept audit of any number of private companies. This,
however, is subject to guidelines of the Institute which provide restriction in respect of
private companies as well. The Council of ICAI has specified a ceiling of 30 audit
assignments per person, whether in respect of private companies or other companies.
Question 3
(a) Explain inherent limitations of internal control systems. (8 Marks)
(b) With reference of SA 250 give some examples or matters indicating to the auditor about
non compliance of laws & regulations by management. (8 Marks)

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Answer
(a) Internal control can provide only reasonable but not absolute assurance that its objective
relating to prevention and detection of errors/frauds, safeguarding of assets etc., are
achieved. This is because it suffers from some inherent limitations, such as:-
(i) Management’s consideration that cost of an internal control does not exceed the
expected benefits.
(ii) Most controls do not tend to be directed at unusual transactions.
(iii) The potential of human error due to carelessness, misjudgment and
misunderstanding of instructions.
(iv) The possibility that control may be circumvented through collusion with employees
or outsiders.
(v) The possibility that a person responsible for exercising control may abuse that
authority.
(vi) Compliance with procedures may deteriorate because the procedures becoming
inadequate due to change in condition.
(vii) Manipulation by management with respect to transactions or estimates and
judgements required in the preparation of financial statements.
(viii) Inherent limitations of Audit.
(b) As per SA 250 on “Consideration of Laws and Regulation in an Audit of Financial
Statements”, the following are examples or matters indicating to the auditor about non-
compliance with laws and regulations by management :
♦ Investigations by regulatory organisations and government departments or payment
of fines or penalties.
♦ Payments for unspecified services or loans to consultants, related parties,
employees or government employees.
♦ Sales commissions or agent’s fees that appear excessive in relation to those
ordinarily paid by the entity or in its industry or to the services actually received.
♦ Purchasing at prices significantly above or below market price.
♦ Unusual payments in cash, purchases in the form of cashiers’ cheques payable to
bearer or transfers to numbered bank accounts.
♦ Unusual payments towards legal and retainership fees.
♦ Unusual transactions with companies registered in tax havens.
♦ Payments for goods or services made other than to the country from which the
goods or services originated.
♦ Payments without proper exchange control documentation.

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♦ Existence of an information system which fails, whether by design or by accident, to

provide an adequate audit trail or sufficient evidence.
♦ Unauthorised transactions or improperly recorded transactions.
♦ Adverse media comment.
Question 4
How will you vouch and verify the following?
(a) Remuneration paid to directors.
(b) Assets acquired on hire purchase.
(c) Profit or loss arising on sale of plots held by real estate dealer.
(d) Advertisement expenses. (4 x 4 = 16 Marks)
Answer
(a) Remuneration paid to Directors
(i) Refer to General Meeting or Board meeting resolution for the appointment and
terms of appointment of the director.
(ii) Examine Articles of Association and general meeting resolution to determine the
mode of payment-monthly, quarterly, or by way of commission.
(iii) Check agreement with the director.
(iv) Verify director’s attendance in the board meetings.
(v) Ensure compliance with the provisions of Sections 198, 309, 349 and 350 and
Schedule XIII of the Companies Act, 1956, where appropriate.
(vi) Check computation of the net profits and the commission payable to directors in
terms of Revised Schedule VI to the Companies Act, 1956.
(vii) Computation of net profit under section 349 with details of the commission payable
as percentage of profits to the directors including Managing Directors/Manager (if
any) should be stated by way of note.
(b) Assets acquired on Hire purchase
(i) Examine the Board’s minutes book approving the purchase on Hire Purchase terms
(ii) Examine the Hire Purchase Agreement carefully & note the description of the
machinery and cost of machinery, Hire Purchase charges, terms of payment and
rate of purchase
(iii) Assets acquired under Hire Purchase system should be recorded at full cash value
with corresponding liability of the same amount. In case cash value is not readily
available, it should be calculated presuming an appropriate rate of interest

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(iv) Hire Purchased assets are shown in Balance Sheet with appropriate narration to
indicate that the enterprise does not have full ownership thereof. The interest
payable along with each installment, whether separately or included therein, should
be debited to the interest account, and not to the asset account.
(c) Profit or loss arising on sale of plots held by real estate dealer.
The land holding in the case of real estate dealer will be a current asset and not a fixed asset.
The same should, therefore, be valued at cost or market value whichever is less.
Profit or loss arising on sale of plots of land by Real Estate Dealer should be verified as
follows:
(i) Each property account should be examined from the beginning of the development
with special reference to the nature of charges so as to find out that only the
appropriate cost and charges have been debited to the account and the total cost of
the property has been set off against the price realised for it.
(ii) This basis of distribution of the common charges between different plots of land
developed during the period, and basis for allocation of cost to individual properties
comprised in a particular piece of land should be scrutinised.
(iii) If land price lists are available, these should be compared with actual selling prices
obtained. And it should be verified that contracts entered into in respect of sale
have been duly sanctioned by appropriate authorities.
(iv) Where part of the sale price is intended to reimburse taxes or expenses, suitable
provisions should be maintained for the purpose.
(v) The prices obtained for various plots of land sold should be checked with the plan
map of the entire tract and any discrepancy or unreasonable price variations should
be inquired into. The sale price of different plots of land should be verified on a
reference to certified copies of sale deeds executed.
(vi) Out of the sale proceeds, provision should be made for the expenditure incurred on
improvement of land, which so far has been accounted for.
(d) Advertisement Expenses: The following steps may be taken by the auditor to
vouch/verify the different items:
(i) Ascertaining the value of advertisement expenses to ensure that the said expense
has been properly allocated.
(ii) Examining that such expenses relate to the client’s business.
(iii) Review and examination of the complete list of media of advertisement indicating the
dates, location, timing, etc., along with the amounts paid in respect of each category.
(iv) Examination of the receipts for amounts paid.

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(v) Reviewing the contracts with the different agencies and ensuring that the billing
conforms to the term and conditions specified therein.
(vi) Ensuring that all such outstanding expenses have been properly accounted for.
Question 5
(a) What are the general considerations about the duties of an auditor that can be
summarized on the basis of legal decisions taken by court so far? (5 Marks)
(b) Under what circumstances the retiring auditor can not be reappointed? (6 Marks)
(c) LMN Ltd., forefeited 1,000 equity shares because of non payment of final call money. On
1st November, 2013 directors reissued all these forfeited shares. As an auditor how will
you verify the transaction? (5 Marks)
Answer
(a) General considerations: The statutory duties of the auditor cannot be limited in any
way either by the Articles or by the directors or members but a company may extend
them by passing a resolution at the general meeting or making a provision in the articles.
[Newton v. Birmingham Small Arms Co. Ltd.]
An auditor is expected to determine the scope of his duties on a consideration of the
nature of business carried on by the concern, provisions of the law that govern the
organisation and the system of internal control in operation. Under the Companies Act,
sub-sections (1A), (2), (3) (4) and (4A) lay down scope of auditor’s duties. However, on
taking into account the legal decisions in the cases which so far have been taken to
courts, his duties and responsibilities can be summarised as follows :
(i) To verify that the statements of account are drawn up on the basis of the books of
the business : The auditor is not responsible for failure to disclose the affairs of the
company kept out of the books and concealed from him which could not be known
in the ordinary course of exercise of reasonable care and diligence. However, it is
his duty to check the books for finding out that the position, as shown by the books
of account, is true and substantially correct.
(ii) To verify that the statements of account drawn up on the basis of the books exhibit
a true and fair state of affairs of the business : The duty of the auditor is not limited
to mere verification of the arithmetical accuracy of the statements of account. He
must find out that these are substantially correct, having regard to provisions in the
Articles and the statute governing the business of the organisation under which it is
being carried on.
(iii) To confirm that the management has not exceeded the financial administrative
powers vested in it by the Articles or by any specific resolution of the shareholders
recorded at a general meeting

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(iv) To investigate matters in regard to which his suspicion is aroused as to the result of
a certain action on the part of the servants of the company - He is, however, not
required to start an audit with a suspicion or to prove in the manner of trying to
detect a fraud or an irregularity unless some information has reached him which
excites his suspicion or should arouse suspicion in a professional man of
reasonable competence. This is because his duty is verification and not primarily
detection of fraud.
(v) To perform his duties by exercising reasonable skill and care - For the verification of
matters which are not capable of direct verification, he can rely on what he believes
to be honest statements of the management. He must, however, review the
verification of assets by the company and not rely merely on the statement made by
the persons appointed by the company.
(b) In the following circumstances, the retiring auditor cannot be reappointed:
(i) A specific resolution has not been passed to reappoint the retiring auditor.
(ii) The auditor proposed to be reappointed does not possess the qualification
prescribed under section 226.
(iii) The proposed auditor suffers from the disqualifications under section 226(3) and 226(4).
(iv) He has given to the company notice in writing of his unwillingness to be reappointed.
(v) A resolution has been passed in AGM appointing somebody else or providing
expressly that the retiring auditor shall not be reappointed.
(vi) A written certificate has not been obtained from the proposed auditor to the effect
that the appointment or reappointment, if made, will be in accordance within the
limits specified under section 224(1B).
(c) Re-issue of Forfeited Shares: The auditor should:
(i) ascertain that the Board of Directors has the authority under the Articles to re-issue
forfeited shares;
(ii) refer to the resolution of the Board of Directors, reallotting forfeited shares;
(iii) vouch the amounts collected from person to whom the shares have been allotted
and verify the entries recorded from reallotment and see that the total amount
received on the share, including that received prior to forfeiture, is not less than the
par value; and
(iv) verify that computation of the amount of surplus resulting on the reissue of shares
credited to the Capital Reserve Account; and
(v) where partly paid shares are forfeited for non-payment of call, and are re-issued as
fully paid, the re-issue is treated as an allotment at a discount (Biochemical and
Synthetic Products Ltd. v. Registrar of Companies) . In such a case the provisions
of Section 79 would require compliance.

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Question 6
(a) What procedure may be adopted by an auditor, while auditing leasing transactions
entered into by the leasing company? (8 Marks)
(b) Mention any eight important points which an auditor will consider while conducting audit
of club? (8 Marks)
Answer
(a) In respect of leasing transaction entered into by the leasing company, the
following procedures may be adopted by the auditor.
(i) The object clause of leasing company to see that the goods like capital goods,
consumer durables etc. in respect of which the company can undertake such
activities. Further, to ensure that whether company can undertake financing
activities or not.
(ii) Whether there exists a procedure to ascertain the credit analysis of lessee like
lessee’s ability to meet the commitment under lease, past credit record, capital
strength, availability of collateral security, etc.
(iii) The lease agreement should be examined and the following points may be noted:
(1) the description of the lessor, the lessee, the equipment and the location where
the equipment is to be installed. (The stipulation that the equipment shall not
be removed from the described location except for repairs. For the sake of
identification, the lessor may also require plates or markings to be attached to
the equipment).
(2) the amount of tenure of lease, dates of payment, late charges, deposits or
advances etc. should be noted.
(3) whether the equipment shall be returned to the lessor on termination of the
agreement and the cost shall be borne by the lessee.
(4) whether the agreement prohibits the lessee from assigning the subletting the
equipment and authorises the lessor to do so.
(iv) Examine the lease proposal form submitted by the lessee requesting the lessor to
provide him the equipment on lease.
(v) Ensure that the invoice is retained safely as the lease is a long-term contract.
(vi) Examine the acceptance letter obtained from the lessee indicating that the
equipment has been received in order and is acceptable to the lessee.
(vii) See the Board resolution authorising a particular director to execute the lease
agreement has been passed by the lessee.
(viii) See that the copies of the insurance policies have been obtained by the lessor for
his records.

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(b) Audit of Club: A club is usually constituted as a company limited by guarantee.

Therefore, various provisions of the Companies Act, 1956 relating to the audit of
accounts of companies are also applicable to its audit. The special steps involved in such
an audit are stated below:
(i) Vouch the receipt on account of entrance fees with members’ applications,
counterfoils issued to them, as well as on a reference to minutes of the Managing
Committee.
(ii) Vouch members’ subscriptions with the counterfoils of receipt issued to them, trace
receipts for a selected period to the Register of Members; also reconcile the amount
of total subscriptions due with the amount collected and that outstanding.
(iii) Ensure that arrears of subscriptions for the previous year have been correctly
brought over and arrears for the year under audit and subscriptions received in
advance have been correctly adjusted.
(iv) Check totals of various columns of the Register of members and tally them across.
(v) See the Register of Members to ascertain the Member’s dues which are in arrear
and enquire whether necessary steps have been taken for their recovery; the
amount considered irrecoverable should be mentioned in the Audit Report.
(vi) Verify the internal check as regards members being charged with the price of
foodstuffs and drinks provided to them and their guests, as well as, with the fees
chargeable for the special services rendered, such as billiards, tennis, etc.
(vii) Trace debits for a selected period from subsidiary registers maintained in respect of
supplies and services to members to confirm that the account of every member has
been debited with amounts recoverable from him.
(viii) Vouch purchase of sports items, furniture, crockery, etc. and trace their entries into
the respective stock registers.
(ix) Vouch purchases of foodstuffs, cigars, wines, etc., and test their sale price so as to
confirm that the normal rates of gross profit have been earned on their sales. The
stock of unsold provisions and stores, at the end of year, should be verified
physically and its valuation checked.
(x) Check the stock of furniture, sports material and other assets physically with the
respective stock registers or inventories prepared at the end of the year.
(xi) Inspect the share scrips and bonds in respect of investments, check their current
values for disclosure in final accounts; also ascertain that the arrangements for their
safe custody are satisfactory.
(xii) Examine the financial powers of the secretary and, if these have been exceeded,
report specific case for confirmation by the Managing Committee.

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Question 7
Write short notes on any four of the following:
(a) Basic standards set for audit of Government expenditure.
(b) Use of flow charts in evaluation of internal control.
(c) Importance of audit working papers.
(d) Identification of significant related party transaction outside business.
(e) Verification of issue of sweat equity shares. (4 x 4 = 16 Marks)
Answer
(a) Basic standards set for audit of Government Expenditure: The audit of government
expenditure is one of the major components of government audit. The basic standards
set for audit of expenditure are to ensure that there is provision funds authorised by
competent authority fixing the limits within which expenditure can be incurred. These
standards are :—
(i) that the expenditure incurred conforms to the relevant provisions of the statutory
enactment and in accordance with the Financial Rules and Regulations framed by
the competent authority. Such an audit is called as the audit against ‘rules and
orders’.
(ii) that there is sanction, either special or general, accorded by competent authority
authorising the expenditure. Such an audit is called as the audit of sanctions.
(iii) that there is a provision of funds out of which expenditure can be incurred and the
same has been authorised by competent authority. Such an audit is called as audit
against provision of funds.
(iv) that the expenditure is incurred with due regard to broad and general principles of
financial propriety. Such an audit is also called as propriety audit.
(v) that the various programmes, schemes and projects where large financial
expenditure has been incurred are being run economically and are yielding results
expected of them. Such an audit is termed as the performance audit.
(b) Use of Flow Charts in evaluation of internal control: It is a graphic presentation of
each part of the company’s system of internal control. A flow chart is considered to be
the most concise way of recording the auditor’s review of the system. It minimises the
amount of narrative explanation and thereby achieves a consideration or presentation not
possible in any other form. It gives bird’s eye view of the system and the flow of
transactions and integration and in documentation, can be easily spotted and
improvements can be suggested.
It is also necessary for the auditor to study the significant features of the business carried
on by the concern; the nature of its activities and various channels of goods and

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materials as well as cash, both inward and outward; and also a comprehensive study of
the entire process of manufacturing, trading and administration. This will help him to
understand and evaluate the internal controls in the correct perspective.
(c) Importance of Audit Working Papers
(i) It provides guidance to the audit staff with regard to the manner of checking the
schedules.
(ii) The auditor is able to fix responsibility on the staff member who signs each
schedule checked by him.
(iii) It acts as evidence in the court of law when a charge of negligence is brought
against the auditor.
(iv) It acts as the process of planning for the auditor so that he can estimate the time
that may be required for checking the schedules.
The auditor should adopt reasonable procedures for custody and confidentiality of his
working papers and should retain them for a period of time sufficient to meet the needs of
his practice and satisfy any pertinent legal or professional requirements of record
retention.
(d) Identification of significant related party transaction outside business: As per SA
550 on “Related Parties”, for identified significant related party transactions outside the
entity’s normal course of business, the auditor shall:
(i) Inspect the underlying contracts or agreements, if any, and evaluate whether:
(1) The business rationale (or lack thereof) of the transactions suggests that they
may have been entered into to engage in fraudulent financial reporting or to
conceal misappropriation of assets;
(2) The terms of the transactions are consistent with management’s explanations;
and
(3) The transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework; and
(ii) Obtain audit evidence that the transactions have been appropriately authorised and
approved.
(e) Verification of Issue of Sweat Equity Shares: As per explanation to section 79A, the
expression “sweat equity shares” means equity shares issued by the company to
employees or directors at a discount or for consideration other than cash for providing
know-how or making available right in the nature of intellectual property rights or value
additions, by whatever name called. The auditor may see that the sweat equity shares
issued by the company are of a class of shares already issued and following conditions
are fulfilled:

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(i) The issue of sweat equity shares is authorised by a special resolution passed by the
company in the general meeting;
(ii) The resolution specifies the number of shares, current market price, consideration,
if any, and the class or classes of directors or employees to whom such equity
shares are to be issued;
(iii) Not less than one year has, at the date of the issue elapsed since the date on which
the company was entitled to commence business;
(iv) The sweat equity shares of a company whose equity shares are listed on a
recognised stock exchange are issued in accordance with the regulations made by
the Securities Exchange Board of India in this behalf:
Provided that in the case of a company whose equity shares are not listed on any
recognised stock exchange, the sweat equity shares are issued in accordance with the
guidelines as may be prescribed.
For the purposes of this sub-section, the expression “a company” means the company
incorporated, formed and registered under this Act and includes its subsidiary company
incorporated in a country outside India.

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 DISCLAIMER
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 PAPER – 6 : AUDITING AND ASSURANCE
Question No.1 is compulsory.
Attempt any five questions from the remaining six questions.
Question 1
(a) Discuss with reference to SAs :
(i) The auditor shall communicate all significant findings with those charged with
Governance. (5 Marks)
(ii) Factors effecting form, contents and extent of audit. (5 Marks)
(b) Discuss the following :
(i) Is surprised checks desirable in audit, if so give important recommendations. (5 Marks)
(ii) Inquiry is one of the audit procedure to obtain audit evidence. (5 Marks)
Answer
(a) (i) As per SA-260 “Communication with Those Charged with Governance”, the auditor shall
communicate the following significant findings from the audit, with those charged with
governance:
(a) The auditor’s views about significant qualitative aspects of the entity’s
accounting practices, including accounting policies, accounting estimates and
financial statement disclosures. When applicable, the auditor shall explain to
those charged with governance why the auditor considers a significant
accounting practice, that is acceptable under the applicable financial reporting
framework, not to be most appropriate to the particular circumstances of the
entity;
(b) Significant difficulties, if any, encountered during the audit;
(c) Unless all of those charged with governance are involved in managing the
entity:
(i) Significant matters, if any, arising from the audit that were discussed, or
subject to correspondence with management; and
(ii) Written representations the auditor is requesting; and
(d) Other matters, if any, arising from the audit that, in the auditor’s professional
judgment, are significant to the oversight of the financial reporting process.
(ii) As per SA-230 on “Audit Documentation”, the form, content and extent of audit
documentation depend on the following factors :
1. The size and complexity of the entity.
2. The nature of the audit procedures to be performed.

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3. The identified risks of material misstatement.

4. The significance of the audit evidence obtained.
5. The nature and extent of exceptions identified.
6. The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained.
7. The audit methodology and tools used.
(b) (i) The need for and frequency of surprise checks is obviously a matter to be decided
having regard to the circumstances of each audit. It would depend upon the extent to
which the auditor considers the internal control system as adequate, the nature of the
clients’ transaction, the locations from which he operates and the relative importance of
items like cash, investments, stores etc. However, wherever feasible a surprise check
should be made at least once in the course of an audit.
The following are the important recommendations:
(1) Surprise checks should be considered as a desirable part of each audit.
(2) The areas over which surprise checks should be employed would depend upon
the circumstances of each audit but should normally include:
(a) Verification of cash and investments.
(b) Test-verification of stores and stocks and the records relating thereto.
(c) Verification of books of prime entry and statutory registers normally
required to be examined for the purposes of audit.
(3) The frequency of surprise checks may be determined by the auditor in the
circumstances of each audit but should normally be at least once in the course
of an audit.
(4) The results of the surprise checks should be communicated to the
management if they reveal any weakness in the system of internal control or
any fraud or error or deficiency in the maintenance of records.
(5) The auditor should satisfy himself that adequate action is taken by the
management on the matters communicated by him.
(6) It is not necessary in all cases for the results of the surprise checks to be
included in the auditors’ report on the accounts. They should, however, be
included if in the opinion of the auditor they are material and affect a true and
fair view of the accounts on which he is reporting.
(ii) Inquiry consists of seeking information of knowledgeable persons, both financial and
non- financial, within the entity or outside the entity. Inquiry is used extensively
throughout the audit in addition to other audit procedures. Inquiries may range from

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formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is

an integral part of the inquiry process.
Responses to inquiries may provide the auditor with information not previously
possessed or with corroborative audit evidence. Alternatively, responses might
provide information that differs significantly from other information that the auditor
has obtained, for example, information regarding the possibility of management
override of controls. In some cases, responses to inquiries provide a basis for the
auditor to modify or perform additional audit procedures.
Although corroboration of evidence obtained through inquiry is often of particular
importance, in the case of inquiries about management intent, the information
available to support management’s intent may be limited. In these cases,
understanding management’s past history of carrying out its stated intentions,
management’s stated reasons for choosing a particular course of action, and
management’s ability to pursue a specific course of action may provide relevant
information to corroborate the evidence obtained through inquiry.In respect of some
matters, the auditor may consider it necessary to obtain written representations
from management and, where appropriate, those charged with governance to
confirm responses to oral inquiries.
Question 2
Comment on any eight of the following: (8 x 2 = 16 Marks)
(i) PQR Ltd. Include underwriting commission and stamp duty as preliminary expenses.
(ii) AGM is not held in time, auditor automatically vacates his office.
(iii) Selling and distribution cost included in the cost of inventories.
(iv) Internal check is part of internal control system.
(v) Company can provide lower rate of depreciation than prescribed by Schedule XIV of
the Companies Act; 1956.
(vi) Compliance procedures are tests designed to obtain audit evidence as to completeness,
accuracy and validity of data produced by accounting system.
(vii) ABC Ltd. having turnover of ` 100 crores during financial year 2011-12, need not get its
branch audited whose turnover is ` 1.5 crores during the same year.
(viii) Computer software which is the integral part of the related hardware can be treated as
intangible assets or fixed assets?
(ix) CARO, 2004 does not apply to a foreign company.
(x) Define shortly arm's length transaction.

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Answer
(i) The expenditure incidental to the creation and floating of a company includes stamp
duties, registration fees, legal costs, accountant’s fees, cost of printing, etc. Underwriting
commission and brokerage paid for shares and debentures should not be included under
the head preliminary expenses. Therefore, PQR Ltd should include stamp duty as
preliminary expense but exclude underwriting commission.
(ii) Section 224(1) provides that an auditor is appointed for a particular period, i.e., from
conclusion of one annual general meeting until conclusion of the next annual general
meeting. In case the annual general meeting is not held within the period prescribed, the
auditor will continue in office till the annual general meeting is actually held and
concluded. Therefore, auditor shall continue to hold office till the conclusion of the
annual general meeting. Auditor’s office is not vacated automatically if AGM is not held in
time.
(iii) As per AS-2 on Valuation of Inventories, in determining the cost of inventories, it is
appropriate to exclude selling and distribution costs and recognise them as expenses in
the period in which they are incurred. Therefore, it is not appropriate to include selling
and distribution cost in the cost of inventories.
(iv) Internal check has been defined as “checks on day-to-day transactions which operate
continuously as part of the routine system whereby the work of one person is proved
independently or is complementary to the work of another, the object being the
prevention or early detection of errors or fraud”. Internal check is a part of the overall
internal control system and operates as a built-in device as far as the staff organisation
and job allocation aspects of the control system are concerned.
(v) It is permissible for the entity to charge deprecation on its assets at rate different from
schedule XIV rates provided those rates are higher than the schedule rates based on
technical estimation or otherwise allowed under Section 205 of the Act. The rates as
contained in Schedule XIV are minimum rates and therefore a company cannot provide
lower rate of depreciation than prescribed by Schedule XIV of the Companies Act, 1956.
(vi) Compliance procedures are tests designed to obtain reasonable assurance that those
internal controls on which audit reliance is to be placed are in effect. Here auditor is
concerned with assertions that the control exists and is operating effectively.
(vii) As per rules to section 228 (4) of the companies (Branch Audit exemption) Rules 1961,
where the aggregate value of goods sold by a branch office does not exceed ` 2 lakhs or
2% of the average of the total turnover of the company, whichever is higher, the branch
shall be exempted from audit. Hence the branch in question is not required to be
audited.
(viii) As per AS-26 on Intangible Assets, computer software for a computer controlled machine
tool that cannot operate without that specific software is an integral part of the related

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hardware and it is treated as a fixed asset. Therefore, computer software which is the
integral part of the related hardware should be treated as fixed asset.
(ix) CARO, 2003 applies to all companies including foreign companies except Banking,
Insurance, Sec. 25 Companies and Private Ltd. Companies subject to certain conditions.
(x) Arm’s length transaction - A transaction conducted on such terms and conditions as
between a willing buyer and a willing seller who are unrelated and are acting
independently of each other and pursuing their own best interests.
Question 3
(a) What is continuous audit and what are the precautions which should be taken to
avoid the disadvantages of continuous audit ? (8 Marks)
(b) Explain the basic principles governing audit. (8 Marks)
Answer
(a) Continuous audit : A continuous audit is one in which the auditor’s staff is engaged
continuously in checking the accounts of the client the whole year round or when for this
purpose the staff attends at intervals, fixed or otherwise, during the currency of the
financial period.
The disadvantages of a continuous audit can be avoided if the following precautions are
taken:
(1) During the course of each visit, work should be completed upto a definite stage so
as to avoid loose ends.
(2) At the end of each visit, important balances should be noted down and the same
should be compared at the time of the next visit.
(3) The visits should be at irregular intervals of time so that the client’s staff may not in
advance know the exact date when the audit would be resumed and thus may be
able to prepare themselves in advance for the same.
(4) The nominal accounts should be checked only at the time of final closing.
(5) The client’s staff should be instructed not to alter or correct audited figures. The
auditor should also device a special form of ticks for being placed against figures
which have been altered and neither its purpose nor significance should be dis-
closed to the client’s staff.
(b) Basic Principles Governing an Audit
The basic principles which govern the auditor’s professional responsibilities and which
should be complied with wherever an audit is carried are described below:
(i) Integrity, objectivity and independence: The auditor should be straight forward,
honest and sincere in his approach to his professional work. He should maintain an
impartial attitude and both be and appear to be free of any interest which might be

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regarded, whatever is actual effect, as being incompatible with integrity and

objectivity.
(ii) Confidentiality: The auditor should respect the confidentiality of information
acquired in the course of his work and should not disclose any such information to a
third party without specific authority or unless there is a legal or professional duty to
disclose.
(iii) Skills and Competence: The audit should be performed and the report prepared
with due professional care by persons who have adequate training, experience and
competence in auditing. The auditor requires specialised skills and competence
along with a continuing awareness of developments including pronouncements of
the ICAI on accounting and auditing matters, and relevant regulations and statutory
requirements.
(iv) Work performed by others: When the auditor delegates work to assistants or uses
work performed by other auditors and experts, he continues to be responsible for
forming and expressing his opinion on the financial information. However, he will be
entitled to rely on work performed by others, provided he exercises adequate skill
and care and is not aware of any reason to believe that he should not have so
relied.
(v) Documentation: The auditor should document matters which are important in
providing evidence that the audit was carried out in accordance with the basic
principles.
(vi) Planning: The auditor should plan his work to enable him to conduct an effective
audit in an efficient and timely manner. Plans should be based on knowledge of the
client’s business.
(vii) Audit evidence: 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.
(viii) Accounting system and Internal Control: The auditor should gain an
understanding of the accounting system and related controls and should study and
evaluate the operation of those internal controls upon which he wishes to rely in
determining the nature, timing and extent of other audit procedures.
(ix) Audit Conclusions and Reporting: The auditor should review and assess the
conclusions drawn from the audit evidence obtained and from his knowledge of
business of the entity as the basis for the expression of his opinion on the financial
information.
The audit report should contain a clear written opinion on the financial information and
should comply the legal requirements. When a qualified opinion, adverse opinion or a

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disclaimer of opinion is to be given or reservation of opinion on any matter is to be made,

the audit report should state the reasons therefore.
Question 4
(a) To prepare an audit plan in CIS environment an auditor should gather information.
Mention any four·such important information which he has to collect. (4 Marks)
(b) How will you vouch/verify the followings?
(i) Purchase with invoice
(ii) Patterns, dies, loose tools etc.
(iii) Work-in-Progress (3 x 4 = 12 Marks)

Answer
(a) The auditor should gather information about the CIS environment that is relevant to the
audit plan, including information as to:
1. How the CIS function is organized and the extent of concentration or distribution of
computer processing throughout the entity.
2. The computer hardware and software used by the entity.
3. Each significant application processed by the computer, the nature of the
processing (e.g. batch, on-line), and data retention policies.
4. Planned implementation of new applications or revisions to existing applications.
5. When considering his overall plan the auditor should consider matters, such as:
(i). Determining the degree of reliance, if any, he expects to be able to place on
the CIS controls in his overall evaluation of internal control.
(ii). Planning how, where and when the CIS function will be reviewed including
scheduling the works of CIS experts, as applicable.
(iii) Planning auditing procedures using computer-assisted audit techniques.
(b) (i) Purchase with invoice: While vouching entries for purchases with the invoices, the
following points should be specially observed:
(a) that the date of invoice falls within the accounting period;
(b) that the invoice is made out in the name of the client;
(c) that the supplier’s account has been credited with the full amount of the invoice
and that the deduction in the amount of the invoice, if any, has been made on
a proper basis;
(d) that the goods purchased are those that are regularly dealt in by the concern
or required for the process of manufacture carried on by it and that the price
payable has been correctly arrived at;

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(e) that the cost of purchases has been debited to an appropriate nominal account
or accounts;
(f) that the invoice is signed by the accountant to show that he has verified it as
well as the store-keeper to indicate that the delivery of goods have been taken
by him. If the invoice relates to the purchase of a technical store or a chemical,
the price whereof is dependent on its quality, a copy of the report of a technical
person showing that the article purchased is of the specification for which the
order has been placed; and
(g) that the manager or some other official, competent to sanction payment, has
authorised its payment.
(ii) Patterns, Dies, Loose Tools, etc.: Several entities have large investments in such assets
which have a relatively short useful life and low unit cost. Evidently, it is a difficult matter,
under the circumstances, to prepare a separate account for each such asset although a
careful control over such property is necessary.
On these considerations, some entities charge off small tools and other similar
items to Production Account as and when they are purchased and do not place any
value on the unused stock on the Balance Sheet. Nevertheless, a record of issues
and receipts of tools to workmen is kept, as a check on the same being pilfered and
a memorandum stock account of dies and patterns is also maintained. In other
concerns, the cost of tools, dies, etc. purchased is debited to appropriate assets
account, and an inventory of the unused items at the end of the year is prepared
and valued; the sum total of opening balance and purchase reduced by the value of
closing stock, as disclosed by the inventory, is charged off to Production Account in
respect of such assets. On the other hand, some concerns carry such assets at
their book values at the end of the first year and charge off the cost of all the
purchases in the subsequent year to the Production Account on the plea that they
represent cost of replacement.
The most satisfactory method, however, is that of preparing an inventory of
serviceable articles, at the close of each year, and revaluing the assets on this
basis, the various articles included in the inventory being valued at cost. It should
be seen that the inventory does not include any worn out or defective articles the
life of which has already run out.
(iii) Work-in-Progress: The audit procedures regarding work-in-progress are similar to
those used for raw materials and finished goods. However, the auditor has to
carefully assess the stage of completion of the work-in-progress for assessing the
appropriateness of its valuation. For this purpose, the auditor may examine the
production/costing records (i.e., cost sheets), hold discussions with the personnel
concerned, and obtain expert opinion, where necessary. The auditor may advise his
client that where possible the work-in-progress should be reduced to the minimum

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before the closing date. Cost sheets of work-in-progress should be verified as

follows:
(i) Ascertain that the cost sheets are duly attested by the works engineer and
works manager.
(ii) Test the correctness of the cost as disclosed by the cost records by verification
of quantities and cost of materials, wages and other charges included in the
cost sheets by reference to the records maintained in respect thereof.
(iii) Compare the unit cost or job cost as shown by the cost sheet with the standard
cost or the estimated cost expected.
(iv) Ensure that the allocation of overhead expenses had been made on a rational
basis.
Compare the cost sheet in detail with that of the previous year. If they vary
materially, investigate the cause thereof.
(v) Ensure that the Work-in-Progress as at Balance Sheet date has been
appropriately disclosed in Balance Sheet as per the requirements of Part I of
Revised Schedule VI (applicable w.e.f. 1.4.2011) to the Companies Act, 1956

Question 5
(a) State the circumstances which could lead to any of the following in an Auditors Report:
(i) A modification of opinion
(ii) Disclaimer of opinion
(iii) Adverse opinion
(iv) Qualified opinion (4 x 2 = 8 Marks)
(b) What are the cases in which special audit may be called by Central Government? (4 Marks)
(c) Anandbhai & Co. Ltd. issued shares to the equity shareholders in the proportion of one
bonus share for every three existing shares. As an auditor of the Company how would
you verify this issue? (4 Marks)
Answer
(a) (i) The auditor shall modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatement; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence to
conclude that the financial statements as a whole are free from material
misstatement.

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(ii) The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes
that the possible effects on the financial statements of undetected misstatements, if
any, could be both material and pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances
involving multiple uncertainties, the auditor concludes that, notwithstanding having
obtained sufficient appropriate audit evidence regarding each of the individual
uncertainties, it is not possible to form an opinion on the financial statements due to
the potential interaction of the uncertainties and their possible cumulative effect on
the financial statements.
(iii) The auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually or
in the aggregate, are both material and pervasive to the financial statements.
(iv) The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes
that misstatements, individually or in the aggregate, are material, but not
pervasive, to the financial statements; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which
to base the opinion, but the auditor concludes that the possible effects on the
financial statements of undetected misstatements, if any, could be material but
not pervasive.
(b) Section 233 A empowers the Central Government, in certain cases, to call for a ‘special
audit’. Such an audit may be required where the Central Government has reasons to
believe:
(i) that the affairs of the company are not being managed on sound business
principles or according to prudent commercial practices; or
(ii) that the company is being managed in a manner likely to cause serious injury or
damage to the interests of the trade, industry or business to which it pertains; or
(iii) that the financial position of the company is such as might endanger its solvency.
(c) Verification of Issue of Bonus Shares: Primarily, it should be ascertained whether the
Articles permit capitalisation of profits; also whether the company had a sufficient number
of unissued shares for allotment as bonus shares. In addition, the following steps should
be taken:
(i) Inspect the Minute book of Shareholders for the resolution authorising declaration of
the Bonus and Director’s Minute for the resolution appropriating profits for being
applied in payment of shares to be allotted to shareholders as bonus shares;

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(ii) Trace the allotment of shares as per particulars contained in the Allotment Book or
sheets into the Register of Members; and
(iii) Confirm that all statutory requirements relevant to the issue of shares have been
complied with, viz., the filing of the particulars of the bonus shares allotted with the
Registrar together with a copy of the resolution pursuant to which allotment has
been made.
(iv) Confirm that the issue of fully paid up bonus shares in pursuance of sub-section (3)
of Section 205 has been kept in abeyance in respect of shares where any
instrument of transfer of such shares has been delivered to the company for
registration and the transfer of such shares has not been registered by the company
as required by the provisions of section 206A of the Companies (Amendment) Act,
1988.
(v) Ensure that SEBI Guidelines relating to issue of bonus shares have been complied
with.
Question 6
(a) Mention important points which auditors will consider while conducting audit of
accounts of a partnership firm. (8 Marks)
(b) What are the points on which an auditor should concentrate while planning audit of an
N.G.O. ? (8 Marks)
Answer
(a) Important points which auditors will consider while conducting audit of accounts of a
partnership firm are:
(i) Confirming that the letter of appointment, signed by a partner, duly authorised,
clearly states the nature and scope of audit contemplated by the partners, specially
the limitation, if any, under which the auditor shall have to function.
(ii) Studying the minute book, if any, maintained to record the policy decision taken by
partners specially the minutes relating to authorisation of extraordinary and capital
expenditure, raising of loans; purchase of assets extraordinary contracts entered
into and other such matters as are not of a routine nature.
(iii) Verifying that the business in which the partnership is engaged is authorised by the
partnership agreement; or by any extension or modification thereof agreed to
subsequently.
(iv) Examining whether books of account appear to be reasonable and are considered
adequate in relation to the nature of the business of the partnership.
(v) Verifying generally that the interest of no partner has suffered prejudicially by an
activity engaged in by the partnership which, it was not authorised to do under the
partnership deed or by any violation of a provision in the partnership agreements.

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(vi) Confirming that a provision for the firm’s tax payable by the partnership has been
made in the accounts before arriving at the amount of profit divisible among the
partners.
(vii) Verifying that the profits and losses have been divided among the partners in their
agreed profit-sharing ratio.
(b) While planning the audit of an N.G.O, the auditor should concentrate on the following:
(i) Knowledge of the NGO's work, its mission and vision, areas of operations and
environment in which it operates.
(ii) Updating knowledge of relevant statutes especially with regard to recent
amendments, circulars, judicial decisions viz. Foreign Contribution (Regulation) Act
1976, Societies Registration Act, 1860, Income Tax Act 1961 etc. and the Rules
related to the statutes.
(iii) Reviewing the legal form of the Organisation and its Memorandum of Association,
Articles of Association, Rules and Regulations.
(iv) Reviewing the NGO's Organisation chart, Financial and Administrative Manuals,
Project and Programme Guidelines, Funding Agencies Requirements and formats,
budgetary policies if any.
(v) Examination of minutes of the Board/Managing Committee/Governing
Body/Management and Committees thereof to ascertain the impact of any decisions
on the financial records.
(vi) Study the accounting system, procedures, internal controls and internal checks
existing for the NGO and verify their applicability.
(vii) Setting of materiality levels for audit purposes.
(viii) The nature and timing of reports or other communications.
(ix) The involvement of experts and their reports.
(x) Review the previous year's Audit Report.
Question 7
Write short notes on any four of the following:
(i) Audit Planning & Materiality
(ii) Impairment of Assets
(iii) Internal Control Questionnaire
(iv) Letter of Weakness
(v) Assertion about balance at the end of the reporting period. (4x4 = 16 Marks)

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Answer
(i) Audit Planning and Materiality: Materiality is an important consideration for an auditor
to evaluate whether the financial statements reflect a true or fair view or not. SA 320 on
“Materiality in Planning and Performing an Audit” requires that an auditor should consider
materiality and its relationship with audit risk while conducting an audit. When planning
the audit, the auditor considers what would make the financial information materially
misstated. The auditor’s preliminary assessment of materiality related to specific account
balances and classes of transactions helps the auditor decide such questions as what
items to examine and whether to use sampling and analytical procedures. This enables
the auditor to select audit procedures that, in combination, can be expected to support
the audit opinion at an acceptably low degree of audit risk. It may be noted that the
auditor’s assessment of materiality and audit risk may be different at the time of initially
planning of the audit as against at the time of evaluating the results of audit procedures.
(ii) Impairment of assets: Besides charging annual depreciation on assets by the reason of
normal wear and tear, effluxion of time and obsolescence to reinstate the correct value of
the assets considering the future cash flows that the assets can generate, impairment
loss needs to be provided. The difference between the carrying amount of an asset and
recoverable amount is termed as impairment loss. The treatment of impairment loss is
similar to depreciation except the fact that it can be reinstated in future, if the recoverable
amount of the asset exceeds the carrying amount.
The auditor must ensure that provisions of AS 28 “Impairment of assets” are followed.
(iii) Internal Control Questionnaire: This is a comprehensive series of questions
concerning internal control. This is the most widely used form for collecting information
about the existence, operation and efficiency of internal control in an organisation.
An important advantage of the questionnaire approach is that oversight or omission of
significant internal control review procedures is less likely to occur with this method. With
a proper questionnaire, all internal control evaluation can be completed at one time or in
sections. The review can more easily be made on an interim basis. The questionnaire
form also provides an orderly means of disclosing control defects. It is the general
practice to review the internal control system annually and record the review in detail. In
the questionnaire, generally questions are so framed that a ‘Yes’ answer denotes
satisfactory position and a ‘No’ answer suggests weakness. Provision is made for an
explanation or further details of ‘No’ answers. In respect of questions not relevant to the
business, ‘Not Applicable’ reply is given.
The questionnaire is usually issued to the client and the client is requested to get it filled
by the concerned executives and employees. If on a perusal of the answers,
inconsistencies or apparent incongruities are noticed, the matter is further discussed by
auditor’s staff with the client’s employees for a clear picture. The concerned auditor then
prepares a report of deficiencies and recommendations for improvement.

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(iv) Letter of Weakness

(1) The auditor does compliance procedure to ascertain that the internal control system
exist in the entity, it works effectively; it work continuously in the entity during review
period.
(2) When he comes across any weakness in the control points, he issues letter of
weakness.
(3) Letter of weakness is a report issued by auditor stating the weakness in internal
control mechanism. It also suggests measures by which the weakness in the
system be corrected and the control system be made better protected.
(4) Lapses in operation of internal control too are reported in the communication of
weakness.
(5) The communication of weakness is reporting to management of such weakness in
design and operation of internal control as have come to notice of auditor during his
auditing and it should not be taken to be a review and comment on adequacy of the
control mechanism for management purpose.
(v) Assertions about account balances at the end of the reporting period:
Assertions about account balances at the period end are :
(i) Existence—assets, liabilities, and equity interests exist.
(ii) Rights and obligations—the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
(iii) Completeness—all assets, liabilities and equity interests that should have been
recorded have been recorded.
(iv) Valuation and allocation—assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.

© The Institute of Chartered Accountants of India