Downloaded from castudyweb.

com

1.48 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. (a) ABC Company files a law suit against Unlucky Company for ` 5 crores. The Attorney of
Unlucky Company feels that the suit is without merit, so Unlucky Company merely
discloses the existence of the law suit in the notes accompanying its financial statements.
As an auditor of Unlucky Company, how will you deal with the situation?
(b) T & Co. wants to issue a prospectus, to provide potential investors with information about
future expectations of the Company. You are hired by T & Co. to examine the projected
financial statements and give report thereon. What things you will consider before
accepting the audit engagement and what audit evidence will be obtained for reporting on
projected financial statements?
(c) In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a special audit
conducted at the instance of the management on a possible suspicion of a fraud and
requested for a copy of the report to enable him to report on the fraud aspects. Despite
many reminders it was not provided. In absence of the special audit report, Mr. 'N' insisted
that he be provided with at least a written representation in respect of fraud on/by the
company. For this request also, the management remained silent. Please guide Mr. 'N'.
(d) During the course of audit of Star Limited the auditor received some of the confirmation
of the balances of trade payables outstanding in the balance sheet through external
confirmation by negative confirmation request. In the list of trade payables, there are
number of trade payables of small balances except one, old outstanding of ` 15 Lacs, of
whom, no confirmation on the credit balance received. Comment with respect to Standard
of Auditing.
2. (a) Mr. Z who is appointed as auditor of Elite Co. Ltd. wants to use confirmation request as
audit evidence during the course of audit. What are the factors to be considered by Mr. Z
when designing a confirmation request? Also state the effects of using positive external
confirmation request by Mr. Z.
(b) R & M Co. wants to be alert on the possibility of non-compliance with Laws and
Regulations during the course of audit of SRS Ltd. R & M Co. seeks your guidance for
identifying the indications of non compliance with Laws and Regulations.
(c) The management of CSITA Ltd. has prepared its summary financial statements for the
year 2015-16 to be provided to its investors. Consequently the company wants to appoint

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.49

you for conducting audit of summary financial statements. What are the procedures that
you will perform and consider necessary as the basis for forming an opinion on the
summary financial statements?
(d) The financial statements of Ace Ltd. have been prepared by the management in
accordance with special purpose frame work to meet the financial reporting provisions of
a regulator. As an auditor, what considerations would be undertaken while planning an d
performing an audit in case of such special purpose frame work?
3. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to
conduct auditing for the financial year 2015-16. For the valuation of gratuity scheme of the
company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due to difference
of opinion, all the joint auditors consulted their respective Actuaries. Subsequently, major
difference was found in the actuary reports. However, Mr. X agreed to Mr. Y’s actuary report,
though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit
report due to majority of votes. Now, Mr. Z is in dilemma.
(a) You are required to briefly explain the responsibilities of auditors when they are jointly
and severally responsible in respect of audit conducted by them and also guide Mr. Z in
such situation.
(b) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on,
found faulty.
4. (a) As an auditor of RST Ltd. Mr. P applied the concept of materiality for the financial
statements as a whole. On the basis of obtaining additional information of significant
contractual arrangements that draw attention to a particular aspect of a company's
business, he wants to re-evaluate the materiality concept. Please, guide him.
(b) The financial statements of TC & Co. have been prepared by management of an entity in
accordance with the financial reporting provisions of a contract (that is, a special purpose
framework) to comply with provisions of the contract. Based on the contract, management
does not have a choice of financial reporting frameworks. As an auditor what
considerations would be undertaken while planning and performing audit?
(c) When a sub-service organization performs services for a service organization, there are
two alternative methods of presenting the description of controls. The service organization
determines which method will be used. As a user auditor what information would you
obtain about controls at a sub-service organization?
(d) In an initial audit engagement the auditor will have to satisfy about the sufficiency and
appropriateness of ‘Opening Balances' to ensure that they free from misstatements, which
may materially affect the current financial statements. Lay down the audit procedure, you
will follow, when financial statements are audited for the first time. If, after performing the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.50 ADVANCED AUDITING AND PROFESSIONAL ETHICS

procedure, you are not satisfied about the correctness of 'Opening Balances', what
approach you will adopt in drafting your audit report?
5. An auditor of Sagar Ltd. was not able to get the confirmation about the existence and value of
certain machineries. However, the management gave him a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the
same without any further procedure and signed the audit report. Is he right in his approach?
Answers to Theoretical Questions
1. (a) Existence of Contingent Liability: As per AS 29 "Provisions, Contingent liabilities and
Contingent Assets", a contingent liability is a possible obligation that arises from past
events and the existence of which will be confirmed only by the occurrence or non -
occurrence of one or more uncertain future events not wholly within the control of the
enterprise.
Further, future events that may affect the amount required to settle an obligation should
be reflected in the amount of a provision where there is sufficient objective evidence that
the event will occur.
As per SA 570 “Going Concern”, there are certain examples of events or conditions that,
individually or collectively, may cast significant doubt about the going concern
assumption. Pending legal or regulatory proceedings against the entity that may, if
successful, result in claims that the entity is unlikely to be able to satisfy is one of the
example of such event.
When the auditor concludes that the use of the going concern assumption is appropriate
in the circumstances but a material uncertainty exists, the auditor shall determine whether
the financial statements adequately describe the principal events or conditions that may
cast significant doubt on the entity’s ability to continue as a going concern and
management’s plans to deal with these events or conditions; and disclose clearly that
there is a material uncertainty related to events or conditions that may cast significant
doubt on the entity’s ability to continue as a going concern and, therefore, that it may be
unable to realize its assets and discharge its liabilities in the normal course of business.
In the instant case, ABC Company has filed a law suit against Unlucky Company for ` 5
crores. Though, the attorney of Unlucky Company feels that the suit is without merit so
the company merely discloses the existence of law suit in the notes accompanying its
financial statements. But the auditor may evaluate the source data on which basis the
opinion is formed. If the auditor finds the uncertainty, he may request the management t o
adjust the sum of ` 5 crore by making provision for expenses as per AS 29. If the
management does not accept the request the auditor should qualify the audit report.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.51

(b) Projected Financial Statements: As per SAE 3400, “The Examination of Prospective
Financial Information”, the answer is divided into two parts i.e. (i) the things to be
considered before accepting the engagement and (ii) audit evidence to be obtained for
reporting on projected financial statements.
(i) Acceptance of Engagement: As per SAE 3400, “The Examination of Prospective
Financial Information”, before accepting an engagement to examine prospective
financial information, the auditor would consider, amongst other things:
(1) the intended use of the information;
(2) whether the information will be for general or limited distribution;
(3) the nature of the assumptions, that is, whether they are best-estimates or
hypothetical assumptions;
(4) the elements to be included in the information; and
(5) the period covered by the information.
Further, the auditor should not accept, or should withdraw from, an engagement
when the assumptions are clearly unrealistic or when the auditor believes that the
prospective financial information will be inappropriate for its intended use.
In accordance with SA 210, “Terms of Audit Engagement”, it is necessary that the
auditor and the client should agree on the terms of the engagement.
(ii) Audit evidence to be obtained for Reporting on Projected Financial
Statements: The auditor should document matters, which are important in providing
evidence to support his report on examination of prospective financial information,
and evidence that such examination was carried out.
The audit evidence in form of working papers will include:
(1) the sources of information,
(2) basis of forecasts,
(3) the assumptions made in arriving the forecasts,
(4) hypothetical assumptions, evidence supporting the assumptions,
(5) management representations regarding the intended use and distribution of the
information, completeness of material assumptions,
(6) management’s acceptance of its responsibility for the information,
(7) audit plan,
(8) the nature, timing and extent of examination procedures performed, and,
(9) in case the auditor expresses a modified opinion or withdraws from the
engagement, the reasons forming the basis of such decision.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.52 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(c) Auditor’s Responsibilities Relating to Fraud: As per SA 240 on “The Auditor’s

Responsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor 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 per SA 580 “Written Representations”, 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.
In the instant case, the auditor observed that there was a special audit conducted at the
instance of the management on a possible suspicion of fraud. Therefore, the auditor
requested for special audit report which was not provided by the management despite of
many reminders. The auditor also insisted for written representation in respect of fraud
on/by the company. For this request also management remained silent.
It may be noted that, if management does not provide one or more of the requested written
representations, the auditor shall discuss the matter with management; 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 take appropriate
actions, including determining the possible effect on the opinion in the auditor’s report.
Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company,
in the course of the performance of his duties as auditor, has reason to believe th at 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 (in case amount of fraud is ` 1 crore or above)or Audit Committee or Board
in other cases (in case the amount of fraud involved is less than ` 1 crore) within such
time and in such manner as may be prescribed.
The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016,
Whether any fraud by the company or any fraud on the company by its officers or
employees has been noticed or reported during the year; If yes, the nature and the amount
involved is to be indicated.
If, as a result of a misstatement resulting from fraud or suspected fraud, the audito r
encounters exceptional circumstances that bring into question the auditor’s ability to
continue performing the audit, the auditor shall:
(i) Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to report to
the person or persons who made the audit appointment or, in some cases, to
regulatory authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.53

withdrawal from the engagement is legally permitted; and

(iii) If the auditor withdraws:
(1) Discuss with the appropriate level of management and those charged with
governance, the auditor’s withdrawal from the engagement and the reasons for
the withdrawal; and
(2) Determine whether there is a professional or legal requirement to report to the
person or persons who made the audit appointment or, in some cases, to
regulatory authorities, the auditor’s withdrawal from the engagement and the
reasons for the withdrawal.
(d) External Confirmation: As per SA 505, “External Confirmation”, Negative Confirmation
is a request that the confirming party respond directly to the auditor only if the confirming
party disagrees with the information provided in the request. Negative confirmations
provide less persuasive audit evidence than positive confirmations.
The failure to receive a response to a negative confirmation request does not explicitly
indicate receipt by the intended confirming party of the confirmation request or verification
of the accuracy of the information contained in the request. Accordingly, a failure of a
confirming party to respond to a negative confirmation request provides significantly less
persuasive audit evidence than does a response to a positive confirmation request.
Confirming parties also may be more likely to respond indicating their disagreement with
a confirmation request when the information in the request is not in their favor, and less
likely to respond otherwise.
In the instant case, the auditor sent the negative confirmation requesting the trade
payables having outstanding balances in the balance sheet while doing audit of Star
Limited. One of the old outstanding of ` 15 lacs has not sent the confirmation on the credit
balance. In case of non response, the auditor may examine subsequent cash
disbursements or correspondence from third parties, and other records, such as goods
received notes. Further non response for negative confirmation request does not means
that there is some misstatement as negative confirmation request itself is to respond to
the auditor only if the confirming party disagrees with the information provided in the
request.
But, if the auditor identifies factors that give rise to doubts about the reliability of the
response to the confirmation request, he shall obtain further audit evidence to resolve
those doubts.
2. (a) As per SA 505, “External Confirmation”, factors to be considered when designing
confirmation requests include:
(i) The assertions being addressed.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.54 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(ii) Specific identified risks of material misstatement, including fraud risks.

(iii) The layout and presentation of the confirmation request.
(iv) Prior experience on the audit or similar engagements.
(v) The method of communication (for example, in paper form, or by electronic or other
medium).
(vi) Management’s authorisation or encouragement to the confirming parties to respond
to the auditor. Confirming parties may only be willing to respond to a confirmation
request containing management’s authorisation.
(vii) The ability of the intended confirming party to confirm or provide the requested
information (for example, individual invoice amount versus total balance).
A positive external confirmation request asks the confirming party to reply to the auditor
in all cases, either by indicating the confirming party’s agreement wi th the given
information, or by asking the confirming party to provide information. A response to a
positive confirmation request ordinarily is expected to provide reliable audit evidence.
There is a risk, however, that a confirming party may reply to the confirmation request
without verifying that the information is correct. The auditor may reduce this risk by using
positive confirmation requests that do not state the amount (or other information) on the
confirmation request, and ask the confirming party to fill in the amount or furnish other
information. On the other hand, use of this type of “blank” confirmation request may result
in lower response rates because additional effort is required of the confirming parties.
(b) As per SA 250, “Consideration of Laws and Regulations, the auditor shall perform the
audit procedures to help identify instances of non-compliance with other laws and
regulations that may have a material effect on the financial statements by inquiring of
management and, where appropriate, those charged with governance, as to whether the
entity is in compliance with such laws and regulations; and Inspecting correspondence, if
any, with the relevant licensing or regulatory authorities.
However, when the auditor becomes aware of the existence of, or information about, the
following matters, it may also be an indication of non-compliance with laws and
regulations:
 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.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.55

 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.
 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.
(c) As per SA 810, “Engagement to Report on Summary Financial Statements”, the auditor
shall perform the following procedures, and any other procedures that the auditor may
consider necessary, as the basis for the auditor’s opinion on the summary financial
statements:
(i) Evaluate whether the summary financial statements adequately disclose their
summarised nature and identify the audited financial statements.
(ii) When summary financial statements are not accompanied by the audited financial
statements, evaluate whether they describe clearly:
(1) From whom or where the audited financial statements are available; or
(2) The law or regulation that specifies that the audited financial statements need
not be made available to the intended users of the summary financial
statements and establishes the criteria for the preparation of the summary
financial statements.
(iii) Evaluate whether the summary financial statements adequately disclose the applied
criteria.
(iv) Compare the summary financial statements with the related information in the
audited financial statements to determine whether the summary financial statements
agree with or can be re-calculated from the related information in the audited
financial statements.
(v) Evaluate whether the summary financial statements are prepared in accordance with
the applied criteria.
(vi) Evaluate, in view of the purpose of the summary financial statements, whether the
summary financial statements contain the information necessary, and are at an
appropriate level of aggregation, so as not to be misleading in the circumstances.
(vii) Evaluate whether the audited financial statements are available to the intended users
of the summary financial statements without undue difficulty, unless law or regulation

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.56 ADVANCED AUDITING AND PROFESSIONAL ETHICS

provides that they need not be made available and establishes the criteria for the
preparation of the summary financial statements.
(d) Considerations for Planning and Performing Audit in case of Special Purpose Framework:
As per SA 800 “Special Considerations-Audits of Financial Statements Prepared in
accordance with Special Purpose Frameworks”, financial statements prepared in
accordance with a special purpose framework may be the only financial statements an
entity prepares. In such circumstances, those financial statements may be used by users
other than those for whom the financial reporting framework is designed.
While planning and performing audit of such special purpose framework based company,
the auditor should consider below mentioned factors:
(i) To obtain an understanding of the entity’s selection and application of accounting
policies. In the case of financial statements prepared in accordance with the
provisions of a contract, the auditor shall obtain an understanding of any significant
interpretations of the contract that management made in the preparation of those
financial statements.
(ii) Compliance of all SAs relevant to audit, the auditor may judge it necessary to depart
from a relevant requirement in an SA by performing alternative audi t procedures to
achieve the aim of that requirement.
(iii) Application of some of the requirements of the SAs in an audit of special purpose
financial statements may require special consideration by the auditor. For example,
in SA 320, judgments about matters that are material to users of the financial
statements are based on a consideration of the common financial information needs
of users as a group. In the case of an audit of special purpose financial statements,
however, those judgments are based on a consideration of the financial information
needs of the intended users.
(iv) In the case of special purpose financial statements, such as those prepared in
accordance with the requirements of a contract, management may agree with the
intended users on a threshold below which misstatements identified during the audit
will not be corrected or otherwise adjusted. The existence of such a threshold does
not relieve the auditor from the requirement to determine materiality in accordance
with SA 320 for purposes of planning and performing the audit of the special purpose
financial statements.
(v) Communication with those charged with governance in accordance with SAs is
based on the relationship between those charged with governance and the financial
statements subject to audit, in particular, whether those charged with governance
are responsible for overseeing the preparation of those financial statements. In the
case of special purpose financial statements, those charged with governance may
not have such a responsibility.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.57

3. (a) Difference of Opinion Among Joint Auditors: SA 299 on, “Responsibility of Joint
Auditors” deals with the professional responsibilities, which the auditors undertake in
accepting such appointments as joint auditors. In respect of the work divided amongst
the joint auditors, each joint auditor is responsible only for the work allocated to him,
whether or not he has made a separate report on the work performed by him. On the
other hand the joint auditors are jointly and severally responsible in respect of the audit
conducted by them as under:
(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.
Normally, the joint auditors are able to arrive at an agreed report. However where the joint
auditors are in disagreement with regard to any matters to be covered by the report, each
one of them should express their own opinion through a separate report. 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.
In the instant case, there are three auditors, namely, Mr. X, Mr. Y and Mr. Z, jointly
appointed as an auditor of KRP Ltd. For the valuation of gratuity scheme of the Company
they referred their own known Actuaries. Mr. Z (one of the joint auditor) is not satisfied
with the report submitted by Mr. Y’s referred actuary. He is not agreed with the matters to
be covered by the report whereas Mr. X agreed with the same.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.58 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a separate
report whereas Mr. X and Mr. Y may provide their joint report for the same.
(b) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s
Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities
associated with insurance contracts or employee benefit plans etc., however, the auditor
has sole responsibility for the audit opinion expressed, and that responsibility is not
reduced by the auditor’s use of the work of an auditor’s expert.
The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s
purposes, including the relevance and reasonableness of that expert’s findings or
conclusions, and their consistency with other audit evidence as per SA 500.
Further, in view of SA 620, if the expert’s work involves use of significant assumptions
and methods, then the relevance and reasonableness of those assumptions and methods
must be ensured by the auditor and if the expert’s work involves the use of source data
that is significant to that expert’s work, the relevance, completeness, and accuracy of that
source data in the circumstances must be verified by the auditor.
In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd.,
referred their own known Actuaries for valuation of gratuity scheme. Actuaries are an
auditor’s expert as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation
report, which later on found faulty. Further, Mr. Z is not agreed with this report therefore
he submitted a separate audit report specifically for such gratuity valuation.
In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation
report of Actuary, to ensure the relevance and reasonableness of assumptions and
methods used. They were also required to examine the relevance, completeness and
accuracy of source data used for such report before expressing their opinion.
Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty
report without examining the adequacy of expert actuary’s work whereas Mr. Z will not be
held liable for the same due to separate opinion expressed by him.
4. (a) Re-evaluation of the Materiality Concept: In the instant case, Mr. P, as an auditor of
RST Ltd. has applied the concept of materiality for the financial statements as a whole.
But he wants to re-evaluate the materiality concept on the basis of additional information
of significant contractual arrangements which draws attention to a particular aspect of the
company’s business.
As per SA 320 “Materiality in Planning and Performing an Audit”, while establishing the
overall audit strategy, the auditor shall determine materiality for the financial statement as
a whole. He should set the benchmark on the basis of which he performs his audit
procedure. If, in the specific circumstances of the entity, there is one or more particular

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.59

classes of transactions, account balances or disclosures for which misstatements of

lesser amounts than the materiality for the financial statements as a whole could
reasonably be expected to influence the economic decisions of users taken on the basis
of the financial statements, the auditor shall also determine the materiality level or levels
to be applied to those particular classes of transactions, account balances or disclosures.
The auditor shall revise materiality for the financial statements in the event of becoming
aware of information during the audit that would have caused the auditor to have
determined a different amount (or amounts) initially.
If the auditor concludes a lower materiality for the same, then he should consider the fact
that whether it is necessary to revise performance materiality and whether the nature,
timing and extent of the further audit procedures remain appropriate.
Thus, Mr. P can re-evaluate the materiality concepts after considering the necessity of
such revision.
(b) Considerations for Planning and Performing Audit in case of Special Purpose
Framework: As per SA 800 “Special Considerations-Audits of Financial Statements
Prepared in accordance with Special Purpose Frameworks”, financial statements
prepared in accordance with a special purpose framework may be the only financial
statements an entity prepares. In such circumstances, those financial statements may be
used by users other than those for whom the financial reporting framework is designed.
While planning and performing audit of such special purpose framework based company,
the auditor should consider below mentioned factors:
(i) To obtain an understanding of the entity’s selection and application of accounting
policies. In the case of financial statements prepared in accordance with the
provisions of a contract, the auditor shall obtain an understanding of any significant
interpretations of the contract that management made in the preparation of those
financial statements.
(ii) Compliance of all SAs relevant to audit, the auditor may judge it necessary to depart
from a relevant requirement in an SA by performing alternative audit procedures to
achieve the aim of that requirement.
(iii) Application of some of the requirements of the SAs in an audit of special purpose
financial statements may require special consideration by the auditor. For example, in
SA 320, judgments about matters that are material to users of the financial statements
are based on a consideration of the common financial information needs of users as
a group. In the case of an audit of special purpose financial statements, however,
those judgments are based on a consideration of the financial information needs of the
intended users.
(iv) In the case of special purpose financial statements, such as those prepared in

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.60 ADVANCED AUDITING AND PROFESSIONAL ETHICS

accordance with the requirements of a contract, management may agree with the
intended users on a threshold below which misstatements identified during the audit
will not be corrected or otherwise adjusted. The existence of such a threshold does
not relieve the auditor from the requirement to determine materiality in accordance
with SA 320 for purposes of planning and performing the audit of the special purpose
financial statements.
(v) Communication with those charged with governance in accordance with SAs is based
on the relationship between those charged with governance and the financial
statements subject to audit, in particular, whether those charged with governance are
responsible for overseeing the preparation of those financial statements. In the case
of special purpose financial statements, those charged with governance may not have
such a responsibility.
(c) Controls at a Sub-Service Organisation: In accordance with SA 402 “Audit
Considerations relating to an Entity Using a Service Organisation”, a user entity may use
a service organisation that in turn uses a sub-service organisation to provide some of the
services provided to a user entity that are part of the user entity’s information system
relevant to financial reporting. The sub-service organisation may be a separate entity from
the service organisation or may be related to the service organisation.
A user auditor may need to consider controls at the sub-service organisation. In situations
where one or more sub-service organisations are used, the interaction between the
activities of the user entity and those of the service organisation is expanded to include
the interaction between the user entity, the service organisation and the sub -service
organisations. The degree of this interaction, as well as the nature and materiality of the
transactions processed by the service organisation and the sub-service organisations are
the most important factors for the user auditor to consider in determining the significance
of the service organisation’s and sub-service organisation’s controls to the user entity’s
controls.
Further, the user auditor shall determine whether a sufficient understanding of the nature
and significance of the services provided by the service organisation and their effect on
the user entity's internal control relevant to the audit has been obtained to provide a basis
for the identification and assessment of risks of material misstatement.
If the user auditor is unable to obtain a sufficient understanding from the user entity, the
user auditor shall obtain that understanding by application of the following two methods
of presenting description of internal controls i.e. (i) Type 1 report; or (ii) Type 2 report.
If a service organisation uses a subservice organisation, the service auditor's report may
either include or exclude the subservice organisation's relevant control objectives and
related controls in the service organisation's description of its system and in the scope of

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES- AN OVERVIEW 1.61

the service auditor's engagement. These two methods of reporting are known as the
inclusive method and the carve-out method respectively.
In either method, the service organisation includes in its description of controls a
description of the functions and nature of the processing performed by the sub-service
organisation.
If the Type 1 or Type 2 report excludes the control at a subservice organization and the
services provided by the subservice organization are relevant to the audit of the user
entity’s financial statements, the user auditor is required to apply the requirements of the
SA 402 in respect of the subservice organization.
The nature and extent of work to be performed by the user auditor regarding the services
provided by a subservice organization depend on the nature and significance of those
services to the user entity and relevance of those services to the audit.
(d) Audit Procedure for ensuring correctness of Opening Balances: As per SA 510 “Initial
Audit Engagements-Opening Balances”, 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 -
(i) 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;
(ii) Determining whether the opening balances reflect the application of appropriate
accounting policies; and
(iii) By evaluating whether audit procedures performed in the current period provide
evidence relevant to the opening balances; or 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.
Approach for drafting Audit Report: If the auditor concludes that the opening balances
contain a misstatement that materially affects the current period’s financial statements
and the effect of the misstatement is not properly accounted for or not adequately
presented or disclosed, the auditor shall express a qualified opinion or an adverse opinion,
as appropriate, in accordance with SA 705 and in case where the auditor is unable to

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

1.62 ADVANCED AUDITING AND PROFESSIONAL ETHICS

obtain sufficient appropriate audit evidence regarding the openi ng balances, the auditor
shall express a qualified opinion or a disclaimer of opinion, as appropriate, in accordance
with SA 705.
5. Validity of Written Representation: The physical verification of fixed assets is the primary
responsibility of the management. The auditor, however, is required to examine the verification
programme adopted by the management. He must satisfy himself about the existence,
ownership and valuation of fixed assets. In the case of Sagar Ltd., the auditor has not been
able to verify the existence and value of some machinery despite the verification procedure
followed in routine audit. He accepted the certificate given to him by the management wi thout
making any further enquiry.
As per SA 580 “Written Representations”, when representation relate to matters which are
material to the financial information, then the auditor should seek corroborative audit evidence
from other sources inside or outside the entity.
He should evaluate whether such representations are reasonable and consistent with other
evidences and should consider whether individuals making such representations can be
expected to be well informed on the matter. “Written Representations” cannot be a substitute
for other audit evidence that the auditor could reasonably expect to be available.
If the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be
available regarding a matter which has or may have a material effect on the financial
information, this will constitute a limitation on the scope of his examination even if he has
obtained a representation from management on the matter. Therefore, the approach adopted
by the auditor is not right.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

2.48 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. While auditing Z Ltd., you observe certain material financial statement assertions have been
based on estimates made by the management. As the auditor how do you minimize the risk of
material misstatements?
2. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to
conduct auditing for the financial year 2015-16. For the valuation of gratuity scheme of the
company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due to difference
of opinion, all the joint auditors consulted their respective Actuaries. Subsequently, major
difference was found in the actuary reports. However, Mr. X agreed to Mr. Y’s actuary report,
though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit
report due to majority of votes. Now, Mr. Z is in dilemma. Explain the responsibility of auditors,
in case, report made by Mr. Y’s actuary, later on, found faulty.
3. A & Co. was appointed as auditor of Great Airways Ltd. As the audit partner what factors shall
be considered in the development of overall audit plan?
4. As an auditor of garment manufacturing company for the last five years you have observed that
new venture of online shopping has been added by the company during current year. As an
auditor what factors would be considered by you in formulating the audit strategy of the
company?
Answers to Theoretical Questions
1. As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures”, the auditor shall obtain an understanding of the
following in order to provide a basis for the identification and assessment of the risks of material
misstatements for accounting estimates:
(i) The requirements of the applicable financial reporting framework relevant to the
accounting estimates, including related disclosures.
(ii) How Management identifies those transactions, events and conditions that may give rise
to the need for accounting estimates to be recognised or disclosed, in the financial
statements. In obtaining this understanding, the auditor shall make inquiries of
management about changes in circumstances that may give rise to new, or the need to
revise existing, accounting estimates.
(iii) The estimation making process adopted by the management including -

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT PLANNING, STRATEGY & EXECUTION 2.49

(1) The method, including where applicable the model, used in making the accounting
estimates.
(2) Relevant controls.
(3) Whether management has used an expert?
(4) The assumption underlying the accounting estimates.
(5) Whether there has been or ought to have been a change from the prior period in the
methods for making the accounting estimates, and if so, why; and
(6) Whether and, if so, how the management has assessed the effect of estimation
uncertainty.
2. Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s
Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities
associated with insurance contracts or employee benefit plans etc., however, the auditor has
sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the
auditor’s use of the work of an auditor’s expert.
The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s
purposes, including the relevance and reasonableness of that expert’s findings or conclusions,
and their consistency with other audit evidence as per SA 500.
Further, in view of SA 620, if the expert’s work involves use of significant assumptions and
methods, then the relevance and reasonableness of those assumptions and methods must be
ensured by the auditor and if the expert’s work involves the use of source data that is significant
to that expert’s work, the relevance, completeness, and accuracy of that source data in the
circumstances must be verified by the auditor.
In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referred
their own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert
as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later
on found faulty. Further, Mr. Z is not agreed with this report therefore he submitted a separate
audit report specifically for such gratuity valuation.
In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report
of Actuary, to ensure the relevance and reasonableness of assumptions and methods used.
They were also required to examine the relevance, completeness and accuracy of source data
used for such report before expressing their opinion.
Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty report
without examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liable
for the same due to separate opinion expressed by him.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

2.50 ADVANCED AUDITING AND PROFESSIONAL ETHICS

3. Development of an overall plan - Overall plan is basically intended to provide direction for
audit work programming and includes the determination of timing, manpower development and
co-ordination of work with the client, other auditors and other experts. The auditor should
consider the following matters in developing his overall plan for the expected scope and
conduct of the audit:
(i) Terms of his engagement and any statutory responsibilities.
(ii) Nature and timing of reports or other communications.
(iii) Applicable Legal or Statutory requirements.
(iv) Accounting policies adopted by the clients and changes, if any, in those policies.
(v) The effects of new accounting and auditing pronouncement on the audit.
(vi) Identification of significant audit areas.
(vii) Setting of materiality levels for the audit purpose.
(viii) Conditions requiring special attention such as the possibility of material error or fraud or
involvement of parties in whom directors or persons who are substantial owners of the
entity are interested and with whom transactions are likely.
(ix) Degree of reliance to be placed on the accounting system and internal control.
(x) Possible rotation of emphasis on specific audit areas.
(xi) Nature and extent of audit evidence to be obtained.
(xii) Work of the internal auditors and the extent of reliance on their work, if any in the audit.
(xiii) Involvement of other auditors in the audit of subsidiaries or branches of the client and
involvement of experts.
(xiv) Allocation of works to be undertaken between joint auditors and the procedures for its
control and review.
(xv) Establishing and coordinating staffing requirements.
4. Formulation of Audit Strategy: While formulating the audit strategy for a company, following
factors may be considered -
General Factors: Refer Para 2.1.
Specific Factors for Online Shopping:
The auditor shall also obtain an understanding of the information system including the related
business processes due to new venture of online shopping in the following areas:

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT PLANNING, STRATEGY & EXECUTION 2.51

(i) The classes of transactions in the entity’s operations that are significant to the financial
statements;
(ii) The procedures, within both information technology (IT) and manual systems, by which those
transactions are initiated, recorded, processed, corrected as necessary, transferred to the
general ledger and reported in the financial statements;
(iii) The related accounting records, supporting information and specific accounts in the financial
statements that are used to initiate, record, process and report transactions; this includes the
correction of incorrect information and how information is transferred to the general ledger. The
records may be in either manual or electronic form;
(iv) How the information system captures events and conditions, other than transactions, that are
significant to the financial statements;
(v) Controls surrounding journal entries, including non-standard journal entries used to record non-
recurring, unusual transactions or adjustments.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

3.48 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. Briefly describe the various stages of a Risk Assessment process.
2. What are the components of an internal control framework?
3. During the course of his audit, the auditor noticed material weaknesses in the internal control
system and he wishes to communicate the same to the management. You are required to
elucidate the important points the auditor should keep in the mind while drafting the letter of
weaknesses in internal control system.
4. Explain briefly the Flow Chart technique for evaluation of the Internal Control system.
5. What are the General Steps in the conduct of Risk based audit?
Answers to Theoretical Questions
1. Risk Assessment is one of the most critical components of Enterprise Risk Management. The
risk assessment process involves considerations for qualitative and quantitative factors,
definition of key performance and risk indicators, risk appetite, risk scores, scales and maps,
use of data & metrics and benchmarking. The various stages in a Risk Assessment process
are as follows:
 Define Business Objectives and Goals;
 Identify events that affect achievement of business objectives;
 Assess likelihood and impact;
 Respond and mitigate risks;
 Assess residual risk.
2. There are five components of an internal control framework. They are as follows:
 Control Environment;
 Risk Assessment;
 Information & Communication;
 Monitoring;
 Control Activities.
3. Important Points to be kept in Mind While Drafting Letter of Weakness: As per SA 265,
“Communicating Deficiencies in Internal Control to Those who Charged with Governance and
Management”, the auditor shall include in the written communication of significant deficiencies
in internal control -

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

RISK ASSESSMENT AND INTERNAL CONTROL 3.49

(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 other words, the auditor should communicate material weaknesses to the management or
the audit committee, if any, on a timely basis. This communication should be, preferably, in
writing through a letter of weakness or management letter. Important points with regard to suc h
a letter are as follows-
(1) The letter lists down the area of weaknesses in the system and offers suggestions for
improvement.
(2) It should clearly indicate that it discusses only weaknesses which have come to the
attention of the auditor as a result of his audit and that his examination has not been
designed to determine the adequacy of internal control for management.
(3) This letter serves as a valuable reference document for management for the purpose of
revising the system and insisting on its strict implementation.
(4) The letter may also serve to minimize legal liability in the event of a major defalcation or
other loss resulting from a weakness in internal control.
4. Refer Para 5.3
5. Refer Para 9.2.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

4.20 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. Briefly describe the various stages of a Risk Assessment process.
2. What are the components of an internal control framework?
3. Describe application controls and give three examples of automated application controls.
Answers to Theoretical Questions
1. Risk Assessment is one of the most critical components of Enterprise Risk Management. The risk
assessment process involves considerations for qualitative and quantitative factors, definition of key
performance and risk indicators, risk appetite, risk scores, scales and maps, use of data & metrics
and benchmarking. The various stages in a Risk Assessment process are as follows:
 Define Business Objectives and Goals;
 Identify events that affect achievement of business objectives;
 Assess likelihood and impact;
 Respond and mitigate risks;
 Assess residual risk.
2. There are five components of an internal control framework. They are as follows:
 Control Environment;
 Risk Assessment;
 Information & Communication;
 Monitoring;
 Control Activities.
3. Application Controls are automated or manual controls that operate at a business process level.
Automated Application controls are embedded into IT applications viz., ERPs and help in
ensuring the completeness, accuracy and integrity of data in those systems. Examples of
automated applications include:
 Edit checks and validation of input data;
 Sequence number checks;
 User limit checks;
 Reasonableness checks;
 Mandatory data fields.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT

LEARNING OUTCOMES

After studying this chapter, you will be able to:

 Know the procedures of appointment, reappointment, filling up of the casual
vacancies and removal of auditor.
 Understand qualification, disqualification, powers and duties of an auditor.
 Gain the knowledge of the provisions relating to rotational retirement.
 Analyse the significance of true and fair view, reporting requirements under
the Companies Act, 2013 including reporting under CARO, 2016.
 Learn the salient features of audit of limited liability partnership.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.71

(xiii) whether all transactions with the related parties are in compliance with sections 177 and
188 of Companies Act, 2013 where applicable and the details have been disclosed in the
Financial Statements etc., as required by the applicable accounting standards;
(xiv) whether the company has made any preferential allotment or private placement of shares
or fully or partly convertible debentures during the year under review and if so, as to
whether the requirement of section 42 of the Companies Act, 2013 have been complied
with and the amount raised have been used for the purposes for which the funds were
raised. If not, provide the details in respect of the amount involved and nature of non -
compliance;
(xv) whether the company has entered into any non-cash transactions with directors or
persons connected with him and if so, whether the provisions of section 192 of Companies
Act, 2013 have been complied with;
(xvi) whether the company is required to be registered under section 45-IA of the Reserve Bank
of India Act, 1934 and if so, whether the registration has been obtained.
1. ABC Pvt. Ltd. is a holding company of XYZ ltd. Whether CARO is applicable to
ABC Pvt. Ltd.?
CARO 2016 will be applicable to a private limited company which is holding company
of a public company, which was not there in previous CARO. Therefore, CARO is applicable
on ABC Pvt. Ltd.
2. Physical verification of only 50% (in value) of items of inventory has been conducted by
the company. The balance 50% will be conducted in next year due to lack of time and
resources.
Reporting for Physical Verification of Inventory: clause (ii) of Para 3 of CARO, 2016 requires
the auditor to state in his report whether physical verification of inventory has been conducted
at reasonable interval by the management. Physical verification of inventory is the responsibility
of the management which should verify all material items at least once in a year and more often
in appropriate cases. The auditor in order to satisfy himself about verification at reasonable
intervals should examine the adequacy of evidence and record of verification.
In the given case, the above requirement of CARO, 2016 has not been fulfilled as such and the
auditor should point out the specific areas where he believes the procedure of inventory
verification is not reasonable. He may consider the impact on financial statement and report
accordingly.
3. K Ltd. has taken a term loan from a nationalized bank in 2010 for ` 200 lakhs repayable
in five equal instalments of ` 40 lakhs from 31 st March, 2011 onwards. It had repaid the
loans due in 2011 & 2012, but defaulted in 2013, 2014 & 2015. As the auditor of K Ltd.
what is your responsibility assuming that company has sought reschedulement of loan?

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.72 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Reporting for Default in Repayment of Dues: As per clause (viii) of Para 3 of CARO, 2016, the
auditor of a company has to report whether the Company has defaulted in repayment of its
dues to a financial institution or bank or debentures holders and if yes, the period and amount
of default to be reported.
In this case, K Ltd. has defaulted in repayment of dues for three years. Application for
rescheduling will not change the default position. Hence the auditor has to report in his audit
report that the Company has defaulted in its repayment of dues to the bank to the extent of `
120 lakhs.
4. LM Ltd. had obtained a Term Loan of ` 300 lakhs from a bank for the construction of a
factory. Since there was a delay in the construction activities, the said funds were
temporarily invested in short term deposits.
Term Loan Invested in Short Term Deposits: As per clause (ix) of Para 3 of CARO, 2016, an
auditor need to state in his report that whether the term loans were applied for the purpose for
which the loans were obtained.
In the present case, the term loan obtained by LM Ltd. have not been put to use for construction
activities and temporarily invested the same in short term deposit.
Here, the auditor should report the fact in his report that pending utilization of the term loan for
construction of a factory, the funds were temporarily used for the purpose other than the
purpose for which the loan was sanctioned as per clause (ix) of Para 3 of CARO, 2016.
5. For the purpose of availing exemption from CARO what kind of loan to be considered?
All sorts of loan whether term loan, demand loan, export credit, working credit limits, cash
credits. Overdrafts, bill purchased or discounted, but does not include non-fund based facilities
like LC BG.
6. Whether CARO is Applicable to the auditor of consolidated financial statement?
Order shall not apply to the auditor’s report on consolidated financial statements. In previous
order it was not expressly provided hence CFS auditors used to include CARO in their report.
7. What documents Constitute Title Deed?
Following constitute title deeds of the immovable property:-
(i) Registered sale deed / transfer deed / conveyance deed, etc. of land, land & building
together, etc. purchased, allotted, transferred by any person including any government,
government authority / body / agency/ corporation, etc. to the company.
(ii) In case of leasehold land and land & buildings together, covered under the head fixed
assets, the lease agreement duly registered with the appropriate authority.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.73

8. Should the auditor examine the cost record in detail while reporting under CARO?
CARO does not require a detailed examination of Cost Records. The Auditor should, therefore,
conduct a general review of Cost Records to ensure that the records as prescribed are made
and maintained. The word "made" applies in respect of Cost Accounts, and the word
"maintained" applies in respect of Cost Records relating to Materials, Labour, Overheads, etc.
4. Reasons to be stated for unfavourable or qualified answers-
(a) Where, in the auditor's report, the answer to any of the questions referred to in paragraph 3 is
unfavourable or qualified, the auditor's report shall also state the basis for such unfavourable
or qualified answer, as the case may be.
(b) Where the auditor is unable to express any opinion on any specified matter, his report shall
indicate such fact together with the reasons as to why it is not possible for him to give his
opinion on the same.
***************************************************************************************************************
APPENDIX 1
Comprehensive Case Studies on CARO 2016
1. Whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio
of 1:20 to meet out the liability and whether the Nidhi Company is maintaining ten per cent
unencumbered term deposits as specified in the Nidhi Rules, 2014 to meet out the liability?
[Paragraph 3(xii)]
Ans. Relevant Provisions
(a) This clause requires the auditor to report whether, in the case of a Nidhi Company, net -owned
funds to deposit liability ratio is more than 1:20 and the Nidhi Company is maintaining ten per
cent unencumbered term deposits as specified in the Nidhi Rules 2014 to meet out the liability.
(b) Section 406(1) of the Act defines “Nidhi” to mean a company which has been incorporated as
a Nidhi with the object of cultivating the habit of thrift and savings amongst its members,
receiving deposits from, and lending to, its members only, for their mutual benefit, and which
complies with such rules as are prescribed by the Central Government for regulation of such
class of companies.
(c) It may be noted that Ministry of Corporate Affairs on 31st March 2014, vide its Notification No.
GSR 258(E) notified the ‘Nidhi Rules 2014’, which came into force on the first day of April 2014.
These Rules apply to Nidhi company incorporated as a Nidhi pursuant to the provisions of
Section 406 of the Act and also to the Nidhi companies declared under sub-section (1) of
section 620A of the Companies Act 1956.
Audit Procedures and Reporting
(d) It may be noted that Rule 5(1) prescribes the requirements for minimum number of members,
net owned fund etc. As per Rule 5(1) every Nidhi shall, within a period of one year from the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.74 ADVANCED AUDITING AND PROFESSIONAL ETHICS

commencement of these rules, ensure that it has— (i) not less than two hundred members; (ii)
net owned funds of ten lakh rupees or more; (iii) unencumbered term deposits of not less than
ten per cent of the outstanding deposits as specified in Rule 14; and (iv) ratio of net owned
funds to deposits of not more than 1:20. The auditor should note that as such a Nidhi Company
can accept deposits not exceeding twenty times of its net owned funds as per last audited
balance sheet. Furthermore, as per Rule 14, every Nidhi is to invest and continue to keep
invested, in encumbered term deposits with a Scheduled commercial bank (other than a co -
operative bank or a regional rural bank), or post office deposits in its own name an amount
which shall not be less than ten per cent of the deposits outstanding at the close of business
on the last working day of the second preceding month, which needs to be exa mined.
(e) As per Rule 3(d) Net Owned Funds are defined as the aggregate of paid up equity share capital
and free reserves as reduced by accumulated losses and intangible assets appearing in t he
last audited balance sheet: Provided that, the amount representing the proceeds of issue of
preference shares, shall not be included for calculating Net Owned Funds.
(f) (A Nidhi company can accept fixed deposits, recurring deposits accounts and savings deposits
from its members in accordance with the directions notified by the Central Government. The
aggregate of such deposits is referred to as “deposit liability”.
(g) The auditor should ask the management to provide the computation of the deposit liability and
net owned funds on the basis of the requirements contained herein above. This would enable
him to verify that the ratio of deposit liability to net owned funds is in accordance with the
requirements prescribed in this regard. The auditor should verify the ratio using the figures of
net owned funds and deposit liability computed in accordance with what is stated above. The
comments of the auditor should be based upon such a statement provided by the management
and verification of the same by the auditor.
(h) The auditor may report, incorporating the following as at the balance sheet date:- (i) In case of
shortfall in the ratio of net owned funds to the deposits, report the amount of shortfall and state
the actual ratio of net owned funds to the deposits. (ii) In case of shortfall with regard to the
minimum amount of 10% as unencumbered term deposits, as specified in Nidhi Rules 2014,
report the amount thereof.
2. Whether any fraud by the company or any fraud on the company by its officers or employees
has been noticed or reported during the year; If yes, the nature and the amount involved is to
be indicated? [Paragraph 3(x)]
Ans. Relevant Provisions
(a) This clause requires the auditor to report whether any fraud by the company or any fraud on
the company by its officers or employees has been noticed or reported during the year. If yes,
the auditor is required to state the amount involved and the nature of fraud. The clause does
not require the auditor to discover such frauds. The scope of auditor’s inquiry under this clause

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.75

is restricted to frauds ‘noticed or reported’ during the year. The use of the words “noticed or
reported” indicates that the management of the company should have the knowledge about the
frauds by the company or on the company by its Officer and employees that have occurred
during the period covered by the auditor’s report. It may be noted that this clause of the Order,
by requiring the auditor to report whether any fraud by the company or on the company by its
Officer or employees has been noticed or reported, does not relieve the auditor from his
responsibility to consider fraud and error in an audit of financial statements. In other words,
irrespective of the auditor’s comments under this clause, the auditor is also required to comply
with the requirements of Standard on Auditing (SA) 240, “The Auditor’s Responsibility Relating
to Fraud in an Audit of Financial Statements”. In this context, the auditor should also have
regard to the Guidance Note on Reporting on Fraud under Section 143(12) of the Companies
Act, 2013, issued by ICAI.
(b) The term "fraud" refers to an intentional act by one or more individuals among management,
those charged with governance, employees, involving the use of deception to obtain an unjust
or illegal advantage. Although fraud is a broad legal concept, the auditor is concerned with
fraudulent acts that cause a material misstatement in the financial stateme nts. Misstatement
of the financial statements may not be the objective of some frauds. Auditors do not make
legal determinations of whether fraud has actually occurred. Fraud involving one or more
members of management or those charged with governance is referred to as "management
fraud"; fraud involving only employees including officers of the entity is referred to as "employee
fraud". In either case, there may be collusion with third parties outside the entity. In fact,
generally speaking, the “management fraud” can be construed as “fraud by the company”.
(c) Two types of intentional misstatements are relevant to the auditor's consideration of fraud -
misstatements resulting from fraudulent financial reporting and misstatements resulting from
misappropriation of assets.
(d) Fraudulent financial reporting involves intentional misstatements or omissions of amounts or
disclosures in financial statements to deceive financial statement users. Fraudulent financial
reporting may involve: (i) Deception such as manipulation, falsification, or alteration of
accounting records or supporting documents 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 measurement, recognition, classification, presentation, or disclosure.
(e) Misappropriation of assets involves the theft of an entity's assets. Misapprop riation of assets
can be accomplished in a variety of ways (including embezzling receipts, stealing physical or
intangible assets, or causing an entity to pay for goods and services not received); it is often
accompanied by false or misleading records or documents in order to conceal the fact that the
assets are missing.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.76 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(f) Fraudulent financial reporting may be committed by the company because management is
under pressure, from sources outside or inside the entity, to achieve an expected (and perhaps
unrealistic) earnings target particularly when the consequences to management of failing to
meet financial goals can be significant. The auditor must appreciate that a perceived
opportunity for fraudulent financial reporting or misappropriation of assets may exist when an
individual believes internal control could be circumvented, for example, because the individual
is in a position of trust or has knowledge of specific weaknesses in the internal control system.
Audit Procedures and Reporting
Audit Procedures and Reporting
(g) While planning the audit, the auditor should discuss with other members of the audit team, the
susceptibility of the company to material misstatements in the financial statements resulting
from fraud. While planning, the auditor should also make inquiries of management to determine
whether management is aware of any known fraud or suspected fraud that the company is
investigating.
(h) The auditor should examine the reports of the internal auditor with a view to ascertain whether
any fraud has been reported or noticed by the management. The auditor should examine the
minutes of the audit committee, if available, to ascertain whether any instance of fraud
pertaining to the company has been reported and actions taken thereon. The audit or should
enquire from the management about any frauds on the company that it has noticed or that have
been reported to it. The auditor should also discuss the matter with other employees including
officers of the company. The auditor should also examine the minute book of the board meeting
of the company in this regard.
(i) The auditor should obtain written representations from management that: (i) it acknowledges
its responsibility for the implementation and operation of accounting and internal control
systems that are designed to prevent and detect fraud and error; (ii) it believes the effects of
those uncorrected misstatements in financial statements, aggregated by the auditor during the
audit are immaterial, both individually and in the aggregate, to the financial statements taken
as a whole. A summary of such items should be included in or attached to the written
representation; (iii) it has disclosed to the auditor all significant facts relating to any frauds or
suspected frauds known to management that may have affected the entity; and (iv) it has
disclosed to the auditor the results of its assessment of the risk that the financial statements
may be materially misstated as a result of fraud.
(j) Because management is responsible for adjusting the financial statements to correct material
misstatements, it is important that the auditor obtains written representation from management
that any uncorrected misstatements resulting from fraud are, in management's opinion,
immaterial, both individually and in the aggregate. Such representations are not a substitute
for obtaining sufficient appropriate audit evidence. In some circumstances, management may
not believe that certain of the uncorrected financial statement misstatements aggregated by

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.77

the auditor during the audit are misstatements. For that reason, management may want to add
to their written representation words such as, "We do not agree that items constitute
misstatements because [description of reasons]."
(k) The auditor should consider if any fraud has been reported by them during the year under
section 143(12) of the Act and if so whether that same would be reported under this Clause. It
may be mentioned here that section 143(12) of the Act requires the auditor has reasons to
believe that a fraud is being committed or has been committed by an employee or officer. In
such a case the auditor needs to report to the Central Government or the Audit Committee.
However, this Clause will include only the reported frauds and not suspected fraud.
(l) Where the auditor notices that any fraud by the company or on the company by its officers or
employees has been noticed by or reported during the year, the auditor should, apart from
reporting the existence of fraud, also required to report, the nature of fraud and amount
involved. For reporting under this clause, the auditor may consider the following: (i) This clause
requires all frauds noticed or reported during the year shall be reported indicating the nature
and amount involved. As specified the fraud by the company or on the company by its officers
or employees are only covered. (ii) Of the frauds covered under section 143(12) of the Act, only
noticed frauds shall be included here and not the suspected frauds. (iii) While reporting under
this clause with regard to the nature and the amount involved of the frauds noticed or reported,
the auditor may also consider the principles of materiality outlined in Standards on Auditing.
3. Whether the company has entered into any noncash transactions with directors or persons
connected with him and if so, whether the provisions of section 192 of Companies Act, 2013
have been complied with? [Paragraph 3(xv)]
Ans. Relevant Provisions:
(a) Section 192 of the Act deals with restriction on noncash transactions involving directors or
persons connected with them. The section prohibits the company from entering into following
types of arrangements unless it meets the conditions laid out in the said section:
i. An arrangement by which a director of the company or its holding, subsidiary or associate
company or a person connected with such director acquires or is to acquire assets for
consideration other than cash, from the company.
ii. An arrangement by which the company acquires or is to acquire assets for consideration
other than cash, from such director or person so connected.
(b) Arrangements, as discussed herein above, can only be entered by the company on fulfillment
of the conditions laid out in Section 192 of the Act which are as under:
i. The company should have obtained prior approval for such arrangement through a
resolution of the company in general meeting.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.78 ADVANCED AUDITING AND PROFESSIONAL ETHICS

ii. In case the concerned director or the person connected therewith, is also a director of its
holding company, a similar approval should have been obtained by the holding company
through a resolution at its general meeting.
(c) The reporting requirements under this clause are in two parts. The first part requires the auditor
to report on whether the company has entered into any non-cash transactions with the directors
or any persons connected with such director/s. The second part of the clause requires the
auditor to report whether the provisions of section 192 of the Act have been complied with.
Therefore, the second part of the clause becomes reportable only if the answer to the first part
is in affirmative.
(d) In other words, such transactions involving change in the assets or liabilities of a company but
not involving “cash” or cash equivalents” as defined under Accounting Standard (AS) 3, “Cash
Flow Statement” may be construed as non-cash transactions. At this point, it may be
appropriate to also refer to the definition and discussion on “non-cash transactions” & “cash
and cash equivalents”, as given in AS 3.
(e) There may be a situation where the acquisition of the asset takes place in one year and the
corresponding liability is created in the financial statements, the corresponding settlement in
the following year. The said transaction will not be considered as non-cash transaction. Further,
mergers under Court schemes would be entered into subject to requisite approvals of Cou rt
etc., would not be considered non-cash transactions.
(f) The term “person connected with the director” has not been defined in the Act, or the Rules
thereunder. Instead, the term “to any other person in whom the director is interested” is defined
in the Explanation to sub section
(1) of section 185 of the Act, which is reproduced as under and may be used as the reference
point for reporting under this clause.
“(a) any director of the lending company, or of a company which is its holding company
or any partner or relative of any such director;
(b) any firm in which any such director or relative is a partner;
(c) any private company of which any such director is a director or member;
(d) any body corporate at a general meeting of which not less than twenty-five per cent.
of the total voting power may be exercised or controlled by any such director, or by
two or more such directors, together; or (e) any body corporate, the Board of
directors, managing director or manager, whereof is accustomed to act in
accordance with the directions or instructions of the Board, or of any director or
directors, of the lending company.”

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.79

(g) Section 2(77) of the Companies Act, 2013 read with Rule 4 of the Companies (Specification of
Definition Details) Rules, 2014 defines the term “relative”. As per the aforesaid section 2(77),
“Relative, with reference to any person, means anyone who is related to another, if –
(i) they are members of a Hindu Undivided Family;
(ii) they are husband and wife; or
(iii) one person is related to the other in such manner as may be prescribed” As per Rule 4 of
the Companies (Specification of Definition Details) Rules, 2014, a person shall be deemed
to be the relative of another, if he or she is related to another in the following manner,
namely –
(i) Father, including step father
(ii) Mother, including step mother
(iii) Son, including step son
(iv) Son’s wife
(v) Daughter
(vi) Daughter’s husband
(vii) Brother, including step brother
(viii) Sister, including step sister
(h) The term “acquire” simply means to come into possession of something. A thing that cannot be
sold cannot be acquired. Thus, an acquisition would necessarily involve ex istence of two
parties and a transfer of rights and/or obligations in a thing. In the context of section 192 of the
Act, this transfer is between the company and the director and/or a person connected with a
director. Such “director” is not restricted to being a director of the concerned company, but
extends to director of a holding company, subsidiary or associate of the company under
question.
(i) As provided in section 192, the acquisition by/from the company has to be that of an “asset”.
Further, the term assets should be construed to have the same meaning as described in the
Framework for Preparation and Presentation of Financial Statements, issued by the Institute of
Chartered Accountants of India. The auditor would need to evaluate whether the subject matter
of acquisition by/ from the company satisfies the characteristic of an “asset”.
Audit Procedures and Reporting
(j) For reporting on the first leg of the reporting clause, the starting point of the auditor’s
procedures could be obtaining a management representation as to whether the company has
undertaken any non-cash transactions with the directors or persons connected with the
directors, as envisaged in section 192(1) of the Act. The auditor would need to corroborate the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.80 ADVANCED AUDITING AND PROFESSIONAL ETHICS

management representation with sufficient appropriate audit evidence. A scrutiny of the

following books of account, records and documents could provide source of such audit
evidence to the auditor as to the existence of such non cash transactions as well as persons
connected with the Directors:
Persons connected with Director Acquisition by/ From Company
Form No. MBP 1, Notice of Interest by Form No. MBP 2, Register of Loans,
Director, filed pursuant to the Companies Guarantee, Security and Acquisition Made
(Meetings of Board and Its Powers) Rules, by the Company, filed pursuant to the
2014 [Ref: Sec 184(1) and Rule 9(1)] Companies (Meetings of Board and Its
Powers) Rules, 2014 [Ref: Sec 186(9) and
Rule 12(1)]
Form No. MBP 4, Register of Contracts
with Related Party and Contracts and
Bodies etc. in which Directors are
Interested, filed pursuant to the Companies
(Meetings of Board and Its Powers) Rules,
2014 [Ref: Sec 189(1) and Rule 16(1)]
Movements in the Fixed Asset Register
Minutes book of the General Meeting and
Meetings of Directors
Report on Annual General Meeting
pursuant to Companies (Management and
Administration) Rules, 2014 {Ref Sec
121(1) and Rule 31(2)}
(k) The above documents and records would provide evidence of any such non-cash transactions
that have actually taken place. The language of section 192(1) also uses the term “is to acquire”
in the context of such transactions, indicating the existence of intention to acquire. The
management may be requested to provide details of its intention to enter into transactions
covered under section 192, after the date of the financial statements under audit. The minutes
of the meetings of the Board of Directors and the Audit Committee may provide evidence of
such intention. Besides, a scrutiny of the information for subsequent period as contained in the
aforesaid records and documents may provide corroborative audit evidence of such intention
having existed as at the date of the auditor’s report.
(l) Where the company has entered into/is to enter into any non-cash transactions as discussed
above, the auditor would make a report to that effect under this clause. The second leg of the
clause requires the auditor to report whether the Company has complied with the provisions of
section 192 in this regard. Section 192(1) and (2) envisage the following compliances in respect
of such transactions:

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.81

(i) The company should have obtained a prior approval for such arrangement by a resolution
in the General Meeting.
(ii) If the concerned Director or connected person is a director of the company’s holding
company, the latter too should have obtained a similar prior approval for the arrangement
by a resolution at its General Meeting.
(iii) Notice for approval of the resolution should contain details of the arrangement alo ng with
the value of assets involved duly calculated by a registered valuer. The auditor should
check compliance with Section 192(2) and verify the notice of the General Meeting that it
includes particulars of arrangement along with the value of the assets involved such
arrangements. The said value should be calculated by the register valuer.
(m) In case where the concerned director/connected person is also a director of the holding
company, the auditor would need to check whether the holding company has complied with the
requirements. For this purpose, the auditor would need to obtain a management representation
letter from the holding company through the management of the auditee company.
Suggested paragraph on reporting:
According to the information and explanations given to us, the Company has entered into non-cash
transactions with one of the directors/ person connected with the director during the year, by the
acquisition of assets by assuming directly related liabilities, which in our opinion is c overed under
the provisions of Section 192 of the Act, and for which approval has not yet been obtained in a
general meeting of the Company.
***************************************************************************************************************
APPENDIX 2
Key Aspects discussed in Guidance Note on Reporting of Fraud under section143(12)
of the Companies Act 2013
1. What is Duty to report on frauds under Companies Act?
As per sub-section (12) of section 143 of the Companies Act, 2013,
 if an auditor of a company
 in the course of the performance of his duties as auditor,
 has reason to believe that
 an offence of fraud involving such amount or amounts as may be prescribed,
 is being or has been committed in the company
 by its officers or employees,
 the auditor shall report the matter to the Central Government
 within such time and in such manner as may be prescribed.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.82 ADVANCED AUDITING AND PROFESSIONAL ETHICS

2. What is the monetary threshold prescribed for such reporting?

Case-1 Fraud amounting to 1 crore or more:- If auditor has reason to believe that an offence of
fraud, which involves or is expected to involve individually an amount of ` 1 crore or above, is being
or has been committed against the company by its officers or employees, the auditor shall report th e
matter to the Central Government.
The manner of reporting the matter to the Central Government is as follows:
(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be,
immediately but not later than 2 days of his knowledge of the fraud, seeking their reply or
observations within 45 days;
(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or
observations of the Board or the Audit Committee along with his comments (on such reply or
observations of the Board or the Audit Committee) to the Central Government within 15 days
from the date of receipt of such reply or observations;
(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee
within the stipulated period of 45 days, he shall forward his report to the Central Government
along with a note containing the details of his report that was earlier forwarded to the Board or
the Audit Committee for which he has not received any reply or observations;
(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by
Registered Post with Acknowledgement Due or by Speed Post followed by an e -mail in
confirmation of the same;
(e) the report shall be on the letter-head of the auditor containing postal address, e-mail address
and contact telephone number or mobile number and be signed by the auditor with his seal and
shall indicate his Membership Number; and
(f) the report shall be in the form of a statement as specified in Form ADT-4.
Case 2 Fraud amounting to less than 1 Crore.:- Sub-section (12) of section 143 of the Companies
Act, 2013 further prescribes that in case of a fraud involving lesser than the specified amount [i.e.
less than ` 1 crore], the auditor shall report the matter to the audit committee constituted under
section 177 or to the Board in other cases within such time and in such manner as may be prescribed.
In this regard, sub- rule (3) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 states
that in case of a fraud involving lesser than the amount specified in sub -rule (1) [i.e. less than ` 1
crore], the auditor shall report the matter to Audit Committee constituted under section 177 or to the
Board immediately but not later than 2 days of his knowledge of the fraud and he shall report the
matter specifying the following:
(a) Nature of Fraud with description;
(b) Approximate amount involved; and
(c) Parties involved.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.83

3. What are disclosure requirements of FRAUD in Board’s report?

Sub-section (12) of section 143 of the Companies Act, 2013 further prescribes that the
 companies, whose auditors have reported frauds under this sub-section (12)
 to the audit committee or the Board,
 but not reported to the Central Government,
 shall disclose the details about such frauds in the Board's report
 in such manner as may be prescribed.
In this regard, sub-rule (4) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 states that
the auditor is also required to disclose in the Board’s Report the following details of each of the fraud
reported to the Audit Committee or the Board under sub-rule (3) during the year:
(a) Nature of Fraud with description;
(b) Approximate Amount involved;
(c) Parties involved, if remedial action not taken; and
(d) Remedial actions taken.
***************************************************************************************************************
APPENDIX 3
Key Aspects discussed in Guidance Note on Reporting under Section 143(3) (f) and
(h) of the Companies Act, 2013
1. What are the reporting requirements under section 143(3)(f ) and (h) of the Companies
Act, 2013?
According to Section 143 (3) lays down certain matters required to be reported upon by the auditor
in his report. Sub-section (3) of section 143 of Act provides as follows:
"(3) The auditor's report shall also state -
(a) whether he has sought and obtained all the information and explanations which to the
best of his knowledge and belief were necessary for the purpose of his audit and if not,
the details thereof and the effect of such information on the financial statements;
(b) whether, in his opinion, proper books of account as required by law have been kept by
the company so far as appears from his examination of those books and proper returns
adequate for the purposes of his audit have been received from branches not visited by
him;
(c) whether the report on the accounts of any branch office of the company audited under
sub- section (8) by a person other than the company’s auditor has been sent to him under
the proviso to that sub-section and the manner in which he has dealt with it in preparing

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.84 ADVANCED AUDITING AND PROFESSIONAL ETHICS

his report;
(d) whether the company’s balance sheet and profit and loss account dealt with in the report
are in agreement with the books of account and returns;
(e) whether, in his opinion, the financial statements comply with the accounting standards;
(f) the observations or comments of the auditors on financial transactions or matters which
have any adverse effect on the functioning of the company;
(g) whether any director is disqualified from being appointed as a director under sub-section
(2) of section 164;
(h) any qualification, reservation or adverse remark relating to the maintenance of accounts
and other matters connected therewith;
(i) whether the company has adequate internal financial controls system in place and the
operating effectiveness of such controls;
(j) such other matters as may be prescribed.
2. What should be considered while reporting under clause (f) of subsection 3 of section
143:- “the observations or comments of the auditors on financial transactions or matters
which have any adverse effect on the functioning of the company”?
 According to the Guidance note: - The words “observations” or “comments” as appearing in
clause (f) of section 143(3) are construed to have the same meaning as referring to “emphasis
of matter paragraphs, situations leading to modification in the auditor’s report. Accordingly, the
auditor should have made an “observation” or “comment” in the auditor’s report in order to
determine the need to report under clause (f) of section 143(3). Therefore, only such
"observations" or "comments" of the auditors on financial transactions or matters that have
been made by the auditor in the auditor’s report which have an adverse effect on the functioning
of the company are required to be reported under this clause.
 It should be noted that there is no change in the objective and scope of an audit of financial
statements because of inclusion of clause (f) in sub-section (3) of section 143 of the Act.
3. Whether every qualification, disclaimer, adverse opinion, or emphasis of matter para
required to be included in above reporting?
According to this Guidance Note - The auditor expresses his opinion on the true and fair view
presented by the financial statements through his report which may be modified in certain
circumstances. However, the auditor would now have to evaluate the subject matters leading to
modification of the audit report or emphasis of matter in the auditor’s report to make judgment as to
which of them has an adverse effect on the functioning of the company within the overall context of
audit of financial statements of the company. Only such matters which, in the opinion of the auditor,
have an adverse effect on the functioning of the company should be reported under this clause.
Hence such qualifications or adverse opinions or disclaimer of opinion or emphasis of matters of the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.85

auditor, which do not deal with matters that have adverse effect on the functioning of the company,
need not be reported under this clause.
4. Illustrate which type of modifications in auditor’s report will require to report under 143
2(3)(f) and which are not?
Examples of emphasis of matter which may have an adverse effect on the functioning of the
company include situations where:
• The going concern assumption is appropriate but there are several factors leading to a material
uncertainty that may cast a significant doubt about the Company’s ability to continue as a going
concern; or
• a material uncertainty regarding the outcome of a litigation wherein an unfavourable decision
could result in a significant outflow of resources for the company, etc.
Examples of emphasis of matter which may not have an adverse effect on the functioning of
the company include a situation where there is an emphasis of matter:
• on managerial remuneration which is subject to the approval of the Central Government;
• relating to accrual of a contractually receivable claim based on management estimate where
the ultimate realisation could be different from the amount accrued;
• on frauds that have been dealt with in the financial statements of the company and would not
have any continuing effect on the financial statements
5. What is scope of auditor while reporting under 143(3)(h) “any qualification, reservation
or adverse remark relating to the maintenance of accounts and other matters connected
therewith”?
According to Guidance Note, the words “qualification”, “adverse remark” and “reservation” used in
clause (h) of section 143(3) should be considered to be similar to the terms “qualified opinion”,
“adverse opinion” and “disclaimer of opinion”, respectively, referred to in SA 705 “Modifications to
the Opinion in the Independent Auditor’s Report”. Hence, the auditor would need to report under
clause (h) of section 143(3) any matter that causes a qualification, adverse remark or disclaimer of
opinion on the financial statements since such matters will or possibly will have an effect on the
books of account maintained by the company. It should be noted that the auditor may have made
an observation on maintenance of cost records under clause (b) of section 143(3) and this may not
have had an effect on the financial statements of the company or the auditor ’s opinion on the
financial statements. Further, any material weakness in internal financial controls that is reported by
the auditor under clause (i) of section 143(3) may not have an impact on the maintenance of books
of account if such material weakness did not result in a modification to the opinion on the financial
statements of the company. However, if the material weakness in internal financial controls resulted
in a modification to the audit opinion on the financial statements, then such modification may be
covered for reporting under clause (h) of section 143(3).
************************************************************************************************************

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.86 ADVANCED AUDITING AND PROFESSIONAL ETHICS

APPENDIX 4
Key Aspects discussed in Guidance Note on Internal Financial Control over Financial
Reporting
1. What is Internal Financial Control (IFC)? (Sec 134)
As per Section 134 of the Companies Act 2013, the term Internal Financial Controls means the
policies and procedures adopted by the company for ensuring:
 Orderly and efficient conduct of its business, including adherence to Company’s policies,
 Safeguarding of its assets,
 Prevention and detection of frauds and errors,
 Accuracy and completeness of the accounting records, and
 Timely preparation of reliable financial information.
2. What is Internal Controls over financial Reporting (ICFR)?
As per Guidance Note issued by ICAI on Guidance Note on Audit of Internal Financial Controls Over
Financial Reporting (September, 2015), “Internal Financial Controls Over Financial Reporting (ICFR)
shall mean:
“A Process designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles”. A Company’s internal financial control over financial reporting
includes those policies and procedures:
Pertain to the maintenance of the records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company:
It provides reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statement in accordance with generally accepted accounting principles, and those
receipts and expenditures of the company are being made only in accordance with authorizations of
management and director of the company.
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of the company’s assets that could have a material effects of the financial
statement.
3. Which provision of Companies Act requires such IFC and Reporting? Section 134:
In the case of a listed company, the Directors’ Responsibility states that directors, have laid down
IFC to be followed by the company and that such controls are adequate and operating effectively.
Section 143:
The auditor’s report should also state whether the company has adequate IFC system in place and
the operating effectiveness of such controls

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.87

Section 177:
Audit committee may call for comments of auditors about internal control systems before their
submission to the Board and may also discuss any related issues with the internal and statutory
auditors and the management of the company.
Schedule IV
The independent directors should satisfy themselves on the integrity of fin ancial information and
ensure that financial controls and systems of risk management are robust and defensible.
Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 –
The director’s report should contain details in respect of adequacy of internal financ ial controls with
reference to the financial reporting.
4. To whom does this apply?
The guidance note clarifies that reporting on ICFR by auditors will be applicable to both listed and
unlisted companies, including small and one person companies. This is in line with the requirements
of section 143(3)(i) of the Companies Act, 2013.
Furthermore, it states that auditors will have to report on ICFR in respect of both stand alone and
consolidated financial statements.
5. When does this apply and for financial statements of which period?
The guidance note clarifies that auditors will have to report whether a company has an adequate
ICFR system in place and whether the same was operating effectively as at the balance sheet date
of 31 March 2016. In practice, this will mean that when forming its audit opinion on ICFR, the auditor
will surely test transactions during the financial year ending 31 March 2016 and not just as at the
balance sheet date, though the extent of testing at or near the balance sheet date may b e higher. If
control issues or deficiencies are identified during the interim period and are remediated before the
balance sheet date, then the auditor may still be able to express an unqualified opinion on the ICFR.
This is particularly important for companies for the current year ending 31 March 2016, as it will be
the first year when auditor validation of ICFR will be required.
6. What is extent of reporting?
The auditor needs to obtain reasonable assurance to state whether an adequate internal financia l
controls system was maintained and whether such internal financial controls system operated
effectively in the company in all material respects with respect to financial reporting only. The
auditor’s opinion therefore does not assure, for example, the future viability of the entity nor the
efficiency or effectiveness with which management has conducted the affairs of the entity.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.88 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. (a) The Balance Sheet of G Ltd. as at 31st March 16 is as under. Comment on the presentation
in terms of Schedule III.
Heading Note 31st March, 16 31st March, 15
No.
Equity & Liabilities
Share Capital 1 XXX XXX
Reserves & Surplus 2 0 0
Employee stock option outstanding 3 XXX XXX
Share application money refundable 4 XXX XXX
Non-Current Liabilities XXX XXX
Deferred tax liability (Arising from 5 XXX XXX
Indian Income Tax)
Current Liabilities
Trade Payables 6 XXX XXX
Total XXXX XXXX
Assets
Non-Current Assets
Fixed Assets-Tangible 7 XXX XXX
CWIP (including capital advances) 8 XXX XXX
Current Assets
Trade Receivables 9 XXX XXX
Deferred Tax Asset (Arising from 10 XXX XXX
Indian Income Tax)
Debit balance of Statement of Profit XXX XXX
and Loss
Total XXXX XXXX
(b) Z Ltd changed its employee remuneration policy from 1st of April 2015 to S provide for
12% contribution to provident fund on leave encashment also. As per the leave
encashment policy the employees can either utilize or encash it. As at 31st March 16 the
company obtained an actuarial valuation for leave encashment liability. However, it did

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.89

not provide for 12% PF contribution on it. The auditor of the company wants it to be
provided but the management replied that as and when the employees availed leave
encashment, the provident fund contribution was made. The company further contends
that this is the correct treatment as it is not sure whether the employees will avail leave
encashment or utilize it. Comment.
(c) K Ltd. had 5 subsidiaries as at 31st March 2016 and the investments in-subsidiaries are
considered as long term and valued at cost. Two of the subsidiaries net worth eroded as
at 31st March 16 and the prospects of their recovery are very bleak and the other three
subsidiaries are doing exceptionally well. The company did not provide for the decline in
the value of investments in two subsidiaries because the overall investment portfolio in
subsidiaries did not suffer any decline' as the other three subsidiaries are doing
exceptionally well. Comment.
(d) While adopting the accounts for the year, the Board of Directors of Sunrise Ltd. decided
to consider the Interim Dividend declared @15% as final dividend and did not consider
transfer of Profit to reserves.
2. MG & Co. Ltd. seeks your advice while preparing financial statements the general instructional
to be followed while preparing Balance Sheet under Companies Act, 2013 in respect of current
assets and liabilities.
3. As an auditor, how would you deal with the following situations:
(a) Ram and Hanuman Associates, Chartered Accountants in practice have been appointed
as Statutory Auditor of Krishna Ltd. for the accounting year 2015-2016. Mr. Hanuman, a
partner of the Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd., a
subsidiary company of Krishna Ltd.
(b) Nick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central
Government, 25% by Uttar Pradesh Government and 10% by Madhya Pradesh
Government. Nick Ltd. appointed Mr. Prem as statutory auditor for the year.
(c) Contravene Ltd. appointed CA Innocent as an auditor for the company for the current
financial year. Further the company offered him the services of actuarial, investment
advisory and investment banking which was also approved by the Board of Directors.
(d) Mr. Amar, a Chartered Accountant, bought a car financed at ` 7,00,000 by Chaudhary
Finance Ltd., which is a holding company of Charan Ltd. and Das Ltd. He has been the
statutory auditor of Das Ltd. and continues to be even after taking the loan.
4. (a) Astha Pvt. Ltd. has fully paid capital of ` 140 lakh. During the year, the company had
borrowed ` 15 lakh each from a bank and a financial institution independently. It has the
turnover (Net of excise ` 50 lakh which is credited to a separate account) of ` 475 lakh.
Will Companies (Auditor’s Report) Order, 2016 be applicable to Astha Pvt. Ltd.?
(b) Under CARO, 2016, as a statutory auditor, how would you report on the following:

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.90 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(i) A Term Loan was obtained from a bank for ` 80 lakh for acquiring R&D equipment,
out of which ` 15 lakh was used to buy a car for use of the concerned director who
was overlooking the R&D activities.
(ii) Physical verification of only 50% of items of inventory has been conducted by the
company. The balance 50% will be conducted in next year due to lack of time and
resources.
5. T Pvt. Ltd.’s paid up Capital & Reserves are less than ` 50 lakhs and it has no outstanding
loan exceeding ` 25 lakhs from any bank or financial institution. Its sales are ` 6 crores before
deducting Trade discount ` 10 lakhs and Sales returns ` 95 lakhs. The services rendered by
the company amounted to ` 10 lakhs. The company contends that reporting under Companies
Auditor’s Reports Order (CARO) is not applicable. Discuss.
Answers to Theoretical Questions
1. (a) Following Errors are noticed in presentation as per Schedule III:
(i) Share Capital & Reserve & Surplus are to be reflected under the heading
“Shareholders’ funds”, which is not shown while preparing the balance sheet.
Although it is a part of Equity and Liabilities yet it must be shown under head
“shareholders’ funds”. The heading “Shareholders’ funds” is missing in the balance
sheet given in the question.
(ii) Reserve & Surplus is showing zero balance, which is not correct in the given case.
Debit balance of statement of Profit & Loss should be shown as a negative figure
under the head ‘Surplus’. The balance of ‘Reserves and Surplus’, after adjusting
negative balance of surplus shall be shown under the head ‘Reserves and Surplus’
even if the resulting figure is in the negative.
(iii) Schedule III requires that Employee Stock Option outstanding should be disclosed
under the heading “Reserves and Surplus”
(iv) Share application money refundable shall be shown under the sub-heading “Other
Current Liabilities”. As this is refundable and not pending for allotment, hence it is
not a part of equity.
(v) Deferred Tax Liability has been correctly shown under Non-Current Liabilities. But
Deferred tax assets and deferred tax liabilities, both, cannot be shown in balance
sheet because only the net balance of Deferred Tax Liability or Asset is to be shown.
(vi) Under the main heading of Non-Current Assets, Fixed Assets are further classified
as under:
(a) Tangible assets
(b) Intangible assets
(c) Capital work in Progress
(d) Intangible assets under development.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.91

Keeping in view the above, the CWIP shall be shown under Fixed Assets as
Capital Work in Progress. The amount of Capital advances included in CWIP
shall be disclosed under the sub-heading “Long term loans and advances”
under the heading Non-Current Assets.
(e) Deferred Tax Asset shall be shown under Non-Current Asset. It should be the
net balance of Deferred Tax Asset after adjusting the balance of deferred tax
liability.
(b) As per Para 11 of AS-15 on “Employee Benefits”, issued by the Institute of Chartered
Accountants of India, an enterprise should recognize the expected cost of short -term
employee benefits in the form of compensated absences in the case of accumulating
compensated absences, when the employees render service that increases their
entitlement to future compensated absences.
Since the company obtained actuarial valuation for leave encashment, it is obvious that
the compensated absences are accumulating in nature. An enterprise should measure
the expected cost of accumulating compensated absences as the additional amount that
the enterprise expects to pay as a result of the unused entitlement that has accumulated
at the balance sheet date.
Here, Z Ltd will accumulate the amount of leave encashment benefits as it is the liability
of the company to provide 12% PF on amount of leave encashment. Hence the contention
of the auditor is correct that full provision should be provided by the company.
(c) As per AS-13 “Accounting for Investments” issued by the Institute of Chartered
Accountants of India, long-term investments are usually of individual importance to the
investing enterprise. The carrying amount of long-term investments is therefore
determined on an individual investment basis. Investments classified as long term
investments should be carried in the financial statements at cost. However, provision for
diminution shall be made to recognize a decline, other than temporary, in the value of the
investments, such reduction being determined and made for each investment individually.
Keeping in view the above, K Ltd should provide for the decline in the value of investments
in two subsidiaries despite the fact that the overall investment portfolio in subsidiaries did
not suffer any decline.
(d) Declaration of Interim Dividend: Section 123(3) of the Companies Act, 2013 provides
that the Board of Directors of a company may declare interim dividend during any financial
year out of the surplus in the Statement of Profit and Loss and out of profits of the financial
year in which such interim dividend is sought to be declared. The amount of dividend
including interim dividend should be deposited in a separate bank account within five days
from the declaration of such dividend for the compliance of Section 123(4) of the said Act.
Based on Section 2(35) of the said Act, it can be said that since interim dividend is also a
dividend, companies should provide for depreciation as required by Section 123 before
declaration of interim dividend. However, the first proviso to Section 123(1) provides that

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.92 ADVANCED AUDITING AND PROFESSIONAL ETHICS

a company may, before the declaration of any dividend in any financial year, transfer such
percentage of its profit for that financial year as it may consider appropriate to the reserves
of the company irrespective of the size of the declared dividend i.e. the com pany is not
mandatorily required to transfer the profit to the reserves, it is an option available to the
company to transfer such percentage.
In the instant case, the Board has decided to pay interim dividend @15% of the paid -up
capital. Assuming that the company has complied with the depreciation requirement, the
interim dividend can be declared without transferring such percentage of its profits as it
may consider appropriate to the reserves of the company.
2. General Instructions for Preparation of Balance Sheet:
(i) General Instruction in respect of Current Assets: An asset shall be classified as
current when it satisfies any of the following criteria-
(1) it is expected to be realized in, or is intended for sale or consumption in, the
company’s normal operating cycle;
(2) it is held primarily for the purpose of being traded;
(3) it is expected to be realized within twelve months after the reporting date; or
(4) it is cash or cash equivalent unless it is restricted from being exchanged or used to
settle a liability for at least twelve months after the reporting date.
(ii) General Instruction in respect of Current Liabilities: A liability shall be classified as
current when it satisfies any of the following criteria-
(1) it is expected to be settled in the company’s normal operating cycle;
(2) it is held primarily for the purpose of being traded;
(3) it is due to be settled within twelve months after the reporting date; or
(4) the company does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting date. Terms of a liability that could, at
the option of the counterparty, result in its settlement by the issue of equity
instruments do not affect its classification.
3. (a) Auditor Holding Securities of a Company: As per sub-section (3)(d)(i) of Section 141
of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors)
Rule, 2014, a person shall not be eligible for appointment as an auditor of a company,
who, or his relative or partner is holding any security of or interest in the company or its
subsidiary, or of its holding or associate company or a subsidiary of such holding
company. Provided that the relative may hold security or interest in the company of face
value not exceeding rupees one lakh.
Also, as per sub-section (4) of Section 141 of the Companies Act, 2013, where a person
appointed as an auditor of a company incurs any of the disqualifications mentioned in sub -

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.93

section (3) after his appointment, he shall vacate his office as such auditor and such
vacation shall be deemed to be a casual vacancy in the office of the auditor.
In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and
Hanuman Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of
Krishna Ltd. Therefore, the firm, M/s Ram and Hanuman Associates would be disqualified
to be appointed as statutory auditor of Krishna Ltd. as per section 141(3)(d)(i), which is
the holding company of Shiva Ltd., because Mr. Hanuman one of the partner is holding
equity shares of its subsidiary.
(b) According to Section 139(7) of the Companies Act, 2013, the auditors of a government
company shall be appointed or re-appointed by the Comptroller and Auditor General of
India. As per section 2(45), a Government company is defined as any company in which
not less than 51% of the paid-up share capital is held by the Central Government or by
any State Government or Governments or partly by the Central Government and partly by
one or more State Governments and includes a company which is a subsidiary of a
Government Company as thus defined”.
In the given case Ajanta Ltd is a government company as its 20% shares have been held
by Central Government, 25% by U.P. State Government and 10% by M.P. State
Government. Total 55% shares have been held by Central and State governments.
Therefore, it is a Government company.
Nick Ltd. is a subsidiary company of Ajanta Ltd. Hence Nick Ltd. is covered in the definition
of a government company. Therefore, the Auditor of Nick Ltd. can be appointed only by C
& AG.
Consequently, appointment of Mr. Prem is invalid and he should not give acceptance to
the Directors of Nick Ltd.
(c) Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013
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

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

5.94 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(ix) any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualify a person for
appointment as an auditor of a company who is engaged as on the date of
appointment in consulting and specialized services as provided in section 144.
In the given case, CA Innocent was appointed as an auditor of Contravene Ltd. He
was offered additional services of actuarial, investment advisory and investment
banking which was also approved by the Board of Directors. The auditor is advised
not to accept the services as these services are specifically notified in the services
not to be rendered by him as an auditor as per section 144 of the Act.
(d) According to section 141(3)(d)(ii) of the Companies Act, 2013, a person is not eligible
for appointment as auditor of any company, If he is indebted to the company, or its
subsidiary, or its holding or associate company or a subsidiary of such holding company,
in excess of rupees five lakh.
In the given case Mr. Amar is disqualified to act as an auditor under section 141(3)(d)(ii)
as he is indebted to M/s Chaudhary Finance Ltd. for more than ` 5,00,000. Also,
according to section 141(3)(d)(ii) he cannot act as an auditor of any subsidiary of
Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd.
Therefore he has to vacate his office in Das Ltd. Even though it is a subsidiary of
Chaudhary Finance Ltd.
Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his
office immediately and Das Ltd should appoint another auditor for the company.
4. (a) Applicability of CARO, 2016: The CARO, 2016 specifically exempts a private limited
company, not being a subsidiary or holding company of a public company, having a paid up
capital and reserves and surplus not more than rupees one crore as on the balance sheet date
and which does not have total borrowings exceeding rupees one crore from any bank or
financial institution at any point of time during the financial year and which does not have a
total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue
from discontinuing operations) exceeding rupees ten crore during the financial year as per the
financial statements.
In the case of Astha Pvt. Ltd., it has outstanding loan of ` 30 lakh (` 15 lakh + ` 15
lakh) collectively from bank and financial institution which is less than ` 1 crore rupees
and turnover is ` 4.75 crore i.e. also less than ` 10 crore and not exceeding the limit.
However, it has paid capital of ` 140 lakh i.e. more than ` 1 crore.
Thus, in view of rupees 140 lakh paid up capital which is exceeding the prescribed limit
for exemption, CARO, 2016 will be applicable to Astha Pvt. Ltd.
(b) Reporting under CARO, 2016
(i) Utilisation of Term Loans: According to clause (ix) of Para 3 of CARO, 2016, the
auditor is required to report “whether moneys raised by way of initial public offer or
further public offer (including debt instruments) and term loans were applied for the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

COMPANY AUDIT 5.95

purposes for which those are raised. If not, the details together with delays or default
and subsequent rectification, if any, as may be applicable”.
The auditor should examine the terms and conditions of the term loan with the actual
utilisation of the loans. If the auditor finds that the fund has not been utilized for the
purpose for which they were obtained, the report should state the fact.
In the instant case, term loan taken for the purpose of R&D equipment has been
utilized for the purchase of car which has no relation with R&D equipment.
Therefore, car though used for R&D Director cannot be considered as R&D
equipment. The auditor should state the fact in his report as per Paragraph 3 clause
ix of the CARO 2016, that out of the term loan taken for R&D equipment, ` 15 lakh
was not utilised for the purpose of acquiring R&D equipment.
(ii) Physical Verification of Inventory: Clause (ii) of Para 3 of CARO, 2016 requires
the auditor to report on whether physical verification of inventory has been conducted
at reasonable intervals by the management. Physical verification of inventory is the
responsibility of the management which should verify all material items at least once
in a year and more often in appropriate cases. The auditor in order to satisfy himself
about verification at reasonable intervals should examine the adequacy of evidence
and record of verification.
In the given case, the above requirement of CARO, 2016 has not been fulfilled as
such and the auditor should point out the specific areas where he believes th e
procedure of inventory verification is not reasonable. He may consider the impact
on financial statement and report accordingly.
5. Applicability of CARO, 2016: The CARO, 2016 specifically exempts a private limited company,
not being a subsidiary or holding company of a public company, having a paid up capital and
reserves and surplus not more than rupees one crore as on the balance sheet date and which
does not have total borrowings exceeding rupees one crore from any bank or financial
institution at any point of time during the financial year and which does not have a total revenue
as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from discontinuing
operations) exceeding rupees ten crore during the financial year as per the fi nancial
statements.
In the given case, paid up capital and reserves of T Pvt. Ltd. is less than ` 1 crore and has no
loan outstanding exceeding ` one crore from any bank or financial institution. Further, its total
revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from
discontinuing operations) is not exceeding rupees ten crore during the financial year as per the
financial statements.
Thus CARO 2016 will not be applicable to T Pvt. Ltd.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

6.50 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. Under the applicable Standards on Auditing, in what circumstances does the report of the statutory
auditor require modifications? What are the types of modifications possible to the said report?
2. Write a short note on Emphasis of matter paragraph in Audit Reports.
3. Write a short note on Certificate for Special Purpose vs. Audit Report.
4. Compare and explain the following:
(i) Reporting to Shareholders vs. Reporting to those Charged with Governance
(ii) Audit Qualification vs. Emphasis of Matter.
Answers to Theoretical Questions
1. Refer Para 5.
2. Refer Para 6.
3. Certificate for Special Purpose vs. Audit Report: A certificate is a written confirmation of the
accuracy of the facts stated therein and does not involve any estimate or opinion. The term
‘certificate’ is, therefore, used where the auditor verifies the accuracy of facts. An auditor may
thus, certify the circulation figures of a newspaper or the value of imports or exports of a
company. An auditor’s certificate represents that he has verified certain figures and is in a
position to vouch safe their accuracy as per his examination of documents and books of
account. A report, on the other hand, is a formal statement usually made after an enquiry,
examination or review of specified matters under report and includes the reporting auditor’s
opinion thereon. Thus, when a reporting auditor issues a certificate, he is responsible for the
factual accuracy of what is stated therein. On the other hand, when a reporting auditor gives a
report, he is responsible for ensuring that the report is based on factual data, that his opinion
is in due accordance with facts, and that it is arrived at by the application of due care and skill.
The ‘report’ involves expression of opinion which may differ from one professional to another.
There is no question of exactitude in case of a report since the information contained therein
is based on estimates and involves judgement element.
4. (i) Reporting to Shareholders vs. Reporting to those Charged with Governance:
REPORT
Reporting to Shareholders Reporting to those Charged with Governance
 Section 143 of the Companies  Standard on Auditing 260 deals with the
Act, 2013 deals with the provisions relating to reporting to those Charged
provisions relating to reporting with Governance.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT REPORTS 6.51

to Shareholders. Thus, it is a
Statutory Audit Report which is
addressed to the members.
 Statutory Audit Report is on true  It is a reporting on matters those charged with
and fair view and as per governance like scope of audit, audit
prescribed Format. procedures, audit modifications, etc.
 Statutory Audit Reports are in  Reporting to those Charged with Governance is
public domain. an internal document i.e. private report.
(ii) Audit Qualification vs. Emphasis of Matter:
REPORT
Audit Qualification Emphasis of Matter
 Standard on Auditing 705  Standard on Auditing 706 “Emphasis of
“Modifications to the Opinion in Matter Paragraphs and Other Matter
the Independent Auditor’s Paragraphs in the Independent Auditor’s
Report”, deals with the provisions Report” deals with the provisions relating
relating to Audit Qualification. to Emphasis of Matter.
 Audit Qualifications are also  Emphasis of Matter is a paragraph
known as “subject to report” or which is included in auditor’s report to
“except that report”. draw users’ attention to important
matter(s) which are already disclosed in
Financial Statements and are
fundamental to users’ for understanding
of Financial Statements.
 Audit Qualifications are given  Emphasis of Matter is a paragraph
when auditor is having which is issued when there is a
reservations on some of the uncertainty relating to future outcome of
items out of the financial exceptional litigation, regulatory action,
statements as a whole i.e. etc.; or there is early application (where
Auditor’s Judgment about the permitted) of a new accounting standard
Pervasiveness of the Effects or that has a pervasive effect on the
Possible Effects on the Financial financial statements in advance of its
Statements relating to if the effective date.
impact of material misstatements
is not pervasive on the financial
statements but is present at
some levels of the financial
statements, qualified report is
issued.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT REPORTS AND CERTIFICATES FOR SPECIAL PUROSE ENGAGEMENT 7.61

Theoretical Questions
1. List down the format of a report required to be issued under the framework of Guidance note
on Reports or certificates for special purpose.
2. Explain the key differences between limited and reasonable assurance?
3. Describe briefly the procedures required to be performed while carrying out work on certificate
to be issued to regulatory authority.
4. What is an agreed upon procedure engagement under SRS 4400?
5. What are the standard procedures required to be performed in a agreed upon procedures?
6. Draft a Practitioner’s report regarding payment of statutory dues, pursuant to request by
lenders.
Answers to Theoretical Questions
1. Refer Para 2.9
2. Refer Para 2.1
3. Refer Para 2
4. Refer Para 6
5. Refer Para 6.2
6. Illustrative case given in Para 2.12

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT COMMITTEE AND CORPORATE GOVERNANCE 8.31

Theoretical Questions
1. State the main features of the Qualified and Independent Audit Committee set up SEBI
(Listing Obligations and Disclosure Requirements) Regulations, 2015.
2. Write short notes on the following:
(a) Content of Management Discussion and Analysis.
(b) Corporate Governance
3. Dishonest Limited, a company incorporated in India has six members in its Audit Committee.
Due to recessionary conditions in India the revenue of the company is going down and there
is slow down in other activities of the company. Therefore, it was expected that there would
not be significant work for members of the Audit Committee. Considering the overall
recession in the company and the economy, the members of the Committee decided
unanimously to meet once in a year only on March 31, 2017. They reviewed monthly
information system of the Company and found no errors. As an auditor of Dishonest Limited
would you consider the decision taken by the Audit Committee is in line with the SEBI ( Listing
Obligations and Disclosure Requirements) Regulations, 2015?

Answers to Theoretical Questions

1. The main features of a qualified and independent audit committee to be set up under SEBI
(Listing Obligations and Disclosure Requirements) Regulations, 2015 are as follows:
(i) The audit committee shall have minimum three directors as members. Two-thirds of the
members of audit committee shall be independent directors;
(ii) All members of audit committee shall be financially literate and at least one member shall
have accounting or related financial management expertise;
Explanation (i): The term “financially literate” means the ability to read and understand basic
financial statements i.e. balance sheet, profit and loss account, and statement of cash
flows.
Explanation (ii): A member will be considered to have accounting or related financial
management expertise if he or she possesses experience in finance or accounting, or
requisite professional certification in accounting, or any other comparable experience or
background which results in the individual’s financial sophistication, including being or
having been a chief executive officer, chief financial officer or other senior officer with
financial oversight responsibilities.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

8.32 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(iii) The Chairperson of the Audit Committee shall be an independent director;

(iv) The Chairperson of the Audit Committee shall be present at Annual General Meeting to
answer shareholder queries;
(v) The Audit Committee at its discretion shall invite the finance director or the head of the
finance function, head of internal audit and a representative of the statutory auditor and
any other such executives to be present at the meetings of the committee; provided that
occasionally, the Audit Committee may meet without the presence of any executives of
the listed entity;
(vi) The Company Secretary shall act as the secretary to the committee.
2. (a) Content of Management Discussion and Analysis: As part of the directors’ report or
as an addition thereto, a Management Discussion and Analysis report should form part of
the Annual Report to the shareholders. This Management Discussion & Analysis should
include discussion on the following matters within the limits set by the company’s
competitive position:
(i) Industry structure and developments.
(ii) Opportunities and Threats.
(iii) Segment–wise or product-wise performance.
(iv) Outlook.
(v) Risks and concerns.
(vi) Internal control systems and their adequacy.
(vii) Discussion on financial performance with respect to operational performance.
(viii) Material developments in Human Resources/Industrial Relations front, including
number of people employed.
(b) Corporate Governance: Corporate governance is the system by which companies are
directed and controlled by the management in the best interest of the shareholders and
others ensuring greater transparency and better and timely financial reporting. The Board
of Directors are responsible for governance of their companies. A number of reports and
codes of corporate governance have been published internationally.
The Securities and Exchange Board of India (SEBI) issued a circular dated April 17, 2014
to all recognised stock exchanges, making amendments to Clauses 35B and Clause 49
of the Equity Listing Agreement, with the intent to align the Listing Agreement with the
provisions of the Companies Act, 2013, to make the corporate governance framework
more effective and to adopt best practices on corporate governance. Further amendments
were made to Clause 49 of the Listing Agreement vide circular dated September 15, 2014.
Since a listing agreement is a statutorily mandated contract between the listed entity and
the stock exchange where it is listed, it does not have the authority of law behind it. Hence,
on September 2, 2015, SEBI issued the Securities and Exchange Board of India (Listing

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT COMMITTEE AND CORPORATE GOVERNANCE 8.33

Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”), with

the objective of streamlining and consolidating the provisions of various listing
agreements in operation for different segments of the capital markets, such as equity
shares, preference shares, debt instruments, units of mutual funds, Indian depository
receipts, securitised debt instruments and any other securities that the SEBI may specify.
The LODR Regulations are divided into two parts - the substantive provisions are
incorporated in the main body while the procedural requirements are incorporated in the
form of schedules. The LODR Regulations also capture the corporate governance
principles found in Clause 49 of SEBI’s Model Listing Agreement. It may be noted that the
LODR Regulations deal with only post-listing requirements and exclude all pre-listing
requirements. Needless to add, the above-mentioned circulars stand rescinded.
3. One of the following additional requirement as stipulated under SEBI (Listing Obligations and
Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) on which Section 177 of the
Companies Act, 2013 (relating to audit committee) is silent is – The Audit Committee should
meet at least four times in a year and not more than one hundred and twenty days shall elapse
between two meetings. The quorum shall be either two members or one third of the members
of the audit committee whichever is greater, but there should be a minimum of two independent
directors present.
Besides, there is a mandatory review requirement and to review only monthly information
system is not sufficient. Here the audit committee members reviewed only monthly information
system of the company and the same is not sufficient as per LODR Regulations.
The Audit Committee shall mandatorily review the following information as per LODR
Regulations:
(i) Management discussion and analysis of financial condition and results of operations;
(ii) Statement of significant related party transactions (as defined by the Audit Committee),
submitted by management;
(iii) Management letters / letters of internal control weaknesses issued by the statutory
auditors;
(iv) Internal audit reports relating to internal control weaknesses;
(v) The appointment, removal and terms of remuneration of the Chief internal auditor shall
be subject to review by the Audit Committee; and
(vi) Statement of deviations: (a) quarterly statement of deviations including report of monitoring
agency if applicable and (b) annual statement of funds utilized for purposes other than those
stated in the offer document/ prospectus/ notice.
Applying the above, the decision taken by the audit committee is not in line with the LODR
Regulations.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF CONSOLIDATED FINANCIAL STATEMEMTS 9.25

Theoretical Questions
1. While doing the audit of Consolidated Financial Statements, which current period consolidation
adjustments are to be taken into account?
2. Write a short note on:
(a) Responsibility of holding company for preparation of Consolidated Financial
Statements.
(b) Permanent Consolidated Adjustments.
3. R Ltd. owns 51% voting power in S Ltd. It however, holds and discloses all the shares as
"Stock-in-trade" in its accounts. The shares are held exclusively with a view to their subsequent
disposal in the near future. R Ltd. represents that while preparing Consolidated Financial
Statements, S Ltd. can be excluded from the consolidation. As a Statutory Auditor, how would
you deal?
4. A Ltd. holds the ownership of 10% of voting power and control over the composition of Board
of Directors of B Ltd. While planning the statutory audit of A Ltd., what factors wo uld be
considered by you for audit of financial statements?
Answers to Theoretical Questions
1. Refer Para 7.2
2. (a) Refer Para 2
(b) Refer Para 7.1
3. Consolidation of Financial Statement: AS 21 “Consolidated Financial Statements”, states
that a subsidiary should be excluded from consolidation when:
(i) Control is intended to be temporary because the shares are acquired and held
exclusively with a view to its subsequent disposal in the near future or
(ii) Subsidiary operates under severe long- term restrictions which significantly impair its
ability to transfer funds to the parent.
Where an enterprise owns majority of voting power by virtue of ownership of the shares of
another enterprise and all the shares held as ‘stock-in-trade’ are acquired and held exclusively
with a view to their subsequent disposal in the near future, the control by the first mentioned
enterprise would be considered temporary and the investments in such subsidiarie s should be
accounted for in accordance with AS 13 “Accounting for Investments”.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

9.26 ADVANCED AUDITING AND PROFESSIONAL ETHICS

As per Ind AS 110, there is no such exemption for ‘temporary control’, or “for operation under
severe long-term funds transfer restrictions” and consolidation is mandatory for Ind AS
compliant financial statement in this case.
However, as per Section 129(3) of the Companies Act, 2013 read with rule 6 of the Companies
(Accounts) Rules, 2014, where a company having subsidiary, which is not required to prepare
consolidated financial statements under the Accounting standards, it shall be sufficient if the
company complies with the provisions on consolidated financial statements provided in
Schedule III to the Act.
In this case, R Ltd’s intention is to dispose off the shares in the near future as shares are being
held as stock in trade and it is quite clear that the control is temporary, Therefore, R Ltd. is not
required to prepare consolidated financial statement as per AS 21, however, for the compliance
of provisions related to consolidation of financial statements given under section 129(3) of the
Companies Act, 2013 read with Companies (Accounts) Rules, 2014, R Ltd. is required to make
disclosures in the financial statements as per the provisions provided in Schedule III to the
Companies Act, 2013.
However, if R Ltd. is required to prepare its financial statements under Ind AS, it shall have to
prepare Consolidated Financial Statements in accordance with Ind AS 110 as exemption for
‘temporary control’, or “for operation under severe long-term funds transfer restrictions” is not
available under Ind AS 110. Paragraph 20 of Ind AS 110 states that “Consolidation of an
investee shall begin from the date the investor obtains control of the investee and cease when
the investor loses control of the investee”.
4. Voting Power and Control over the composition of Board of Directors: In this case, A Ltd.
holds only 10 percent of the voting power and control over the composition of the Board of
Directors of B Ltd. In such a case, A Ltd. would be considered as a parent of B Ltd. and,
therefore, it would consolidate B Ltd. in the consolidated financial statements as subsidiary.
The auditor should verify whether the parent controls the composition of the Board of Directors
or corresponding governing body of any entity. There would be various means by which such
kind of control can be obtained.
In this regard, the auditor may verify the Board’s minutes, shareholder agreements entered into
by the parent, agreements with the entities to which the parent might have provided any
technology or know how, enforcement of statute, as the case may be, etc.
The auditor should verify that the adjustments warranted by the relevant accounting standards
have been made wherever required and have been properly authorised by the management of
the parent. The preparation of consolidated financial statements gives rise to permanent
consolidation adjustments and current period consolidation adjustments. The auditor should
make plans, among other things, for the understanding of accounting policies of the parent,
subsidiaries, associates and joint ventures and determining and programming the nature,
timing, and extent of the audit procedures to be performed etc.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF CONSOLIDATED FINANCIAL STATEMEMTS 9.27

Further, the duties of an auditor with regard to reporting of transactions with related parties as
required by Accounting Standard 18 are given in SA 550 on Related Parties. As per SA 550
on, “Related Parties”, the auditor should review information provided by the management of
the entity identifying the names of all known related parties. A person or other entity that has
control or significant influence, directly or indirectly through one or more intermediaries, over
the reporting entity are considered as Related Party.
In forming an opinion on the financial statements, the auditor shall evaluate whether the
identified related party relationships and transactions have been appropriately accounted for
and disclosed in accordance with the applicable financial reporting framework and whether the
effects of the related party relationships and transactions prevent the financial statements from
achieving true and fair presentation (for fair presentation frameworks); or cause the financial
statements to be misleading (for compliance frameworks).

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF BANKS 10.51

Theoretical Questions
1. Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The Bank
follows financial year as accounting year. State your views on the following issues which were
brought to your notice by your Audit Manager:
(a) The bank has recognised on accrual basis income from dividends on securities and Units
of Mutual Funds held by it as at the end of financial year. The dividends on securities and
Units of Mutual Funds were declared after the end of financial year.
(b) The bank is a consortium member of Cash Credit Facilities of ` 50 crores to X Ltd. Bank's
own share is ` 10 crores only. During the last two quarters against a debit of
` 1.75 crores towards interest the credits in X Ltd's account are to the tune of
` 1.25 crores only. Based on the certificate of lead bank, the bank has class ified the
account of X Ltd as performing.
2. As statutory central auditors of a Nationalized bank, what special points are to be borne in mind
in the audit of compliance with "Statutory Liquidity Ratio" (SLR) requirements?
3. Explain the scope of concurrent audit of a bank with reference to Reserve Bank of India
guidelines.
4. In course of audit of Good Samaritan Bank as at 31st March, 16 you observed the following:
(a) In a particular account there was no recovery in the past 18 months. The bank has not
applied the NPA norms as well as income recognition norms to this particular account.
When queried the bank management replied that this account was guaranteed by the
central government and hence these norms were not applicable. The bank has not
invoked the guarantee. Please respond. Would your answer be different if the advance
is guaranteed by a State Government?
(b) The bank’s advance portfolio comprised of significant loans against Life Insurance
Policies. Write suitable audit program to verify these advances.
Answers to Theoretical Questions
1. (a) It is not a prudent practice to treat dividend on shares of corporate bodies and units of
mutual funds as income unless these are actually received. Accordingly, income from
dividend on shares of corporate bodies and units of mutual funds should be booked on
cash basis. In respect of income from government securities and bonds and debentures
of corporate bodies, where interest rates on these instruments are pre -determined,
income could be booked on accrual basis, provided interest is serviced regularly and as
such is not in arrears. It was further, however, clarified that banks may book income on
accrual basis on securities of corporate bodies/public sector undertakings in respect of
which the payment of interest and repayment of principal have been guaranteed by the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

10.52 ADVANCED AUDITING AND PROFESSIONAL ETHICS

central government or a State government. Banks may book income from dividend on
shares of corporate bodies on accrual basis, provided dividend on the shares has been
declared by the corporate body in its annual general meeting and the owner's right to
receive payment is established. This is also in accordance with AS 9 as well. In the instant
case, therefore, the recognition of income by the bank on accrual basis is not in order.
(b) The bank is a consortium member of cash credit facilities of ` 50 crores to X Ltd. Bank's
own share is ` 10 crores only. During the last two quarters against a debit of
` 1.75 crores towards interest, the credits in X Ltd's account are to the tune of
` 1.25 crores only. Sometimes, several banks form a group (the 'consortium') under the
leadership of a 'lead bank' to make advance to a large customer on same conditions and
security with proportionate rights. In such cases, each bank may classify the advance
given by it according to its own experience of recovery and other factors. Since in the last
two quarters, the amount remains outstanding and, thus, interest amount should be
reversed. This is despite the certificate of lead bank to classify that the acco unt as
performing. Accordingly, the amount should be shown as non-performing asset.
2. Refer Para no 6.2.
3. Refer Para no. 9.1
4. (a) Government Guaranteed Advance: If a government guaranteed advance becomes NPA,
then for the purpose of income recognition, interest on such advance should not to be taken
to income unless interest is realized. However, for purpose of asset classification, credit facility
backed by Central Government Guarantee, though overdue, can be treated as NPA only when
the Central Government repudiates its guarantee, when invoked.
Since the bank has not revoked the guarantee, the question of repudiation does not arise.
Hence the bank is correct to the extent of not applying the NPA norms for provisioning
purpose. But this exemption is not available in respect of income recognition norms.
Hence the income to the extent not recovered should be reversed.
The situation would be different if the advance is guaranteed by State Government
because this exception is not applicable for State Government Guaranteed advances,
where advance is to be considered NPA if it remains overdue for more than 90 days.
In case the bank has not invoked the Central Government Guarantee though the amount is
overdue for long, the reasoning for the same should be taken and duly reported in LFAR.
(b) The Audit Programme to Verify Advances against Life Insurance Policies is as
under-
(i) The auditor should inspect the policies and see whether they are assigned to the
bank and whether such assignment has been registered with the insurer.
(ii) The auditor should also examine whether premium has been paid on the policies
and whether they are in force.
(iii) Certificate regarding surrender value obtained from the insurer should be examined.
(iv) The auditor should particularly see that if such surrender value is subject to payment
of certain premium, the amount of such premium has been deducted from the
surrender value.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF INSURANCE COMPANIES 11.61

Theoretical Questions
1. What are the steps to be taken while verifying the Premium of (a) General Insurance Company;
and (b) Life Insurance Company?
2. Enumerate the steps to be taken by an auditor for the verification of Re-insurance outward by
a General Insurance Company.
3. State the procedure for verification of Agents’ Balances in the course of audit of a General
Insurance Company.
4. As at 31st March 2017 while auditing Safe Insurance Ltd, you observed that a policy has been
issued on 25th March 2017 for fire risk favouring one of the leading corporate houses in the
country without the actual receipt of premium and it was reflected as premium receivable. The
company maintained that it is a usual practice in respect of big customers and the money was
collected on 5th April, 2017. You further noticed that there was a fire accident in the premises
of the insured on 31st March 2017 and a claim was lodged for the same. The insurance
company also made a provision for claim. Please respond.
5. ABC & Co., Chartered Accountants are the Auditors of Just Care Life Insurance Company
Limited. Enumerate the steps to be taken by the auditor while verifying the "Investment".
6. Briefly explain the term policy lapse and revival in case of Life Insurance Company and role of
auditor in verifying the same.
Answers to Theoretical Questions
1. (a) Refer Point no. 1 of Para 9.2.
(b) Refer Point no 7 of Para 8.2.
2. Refer Point no. 16 of Para 9.2.
3. Refer Point no. 13 of Para 9.2.
4. Provision for Claim: No risk can be assumed by the insurer unless the premium is received.
According to section 64VB of the Insurance Act, 1938, no insurer should assume any risk in
India in respect of any insurance business on which premium is ordinarily payable in India
unless and until the premium payable is received or is guaranteed to be paid by such person
in such manner and within such time, as may be prescribed, or unless and until deposit of such

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

11.62 ADVANCED AUDITING AND PROFESSIONAL ETHICS

amount, as may be prescribed, is made in advance in the prescribed m anner. The premium
receipt of insurance companies carrying on general insurance business normally arise out of
three sources, viz., premium received from direct business, premium received from reinsurance
business and the share of co-insurance premium.
In view of the above, the insurance company is not liable to pay the claim and hence no
provision for claim is required.
5. Refer Point no 9 of Para 8.2.
6. Refer Point no 5 of Para 8.2.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF NON-BANKING FINANCIAL COMPANIES 12.29

(e) The auditor may report, incorporating the following as at the balance sheet date:
(i) In case of shortfall in the ratio of net owned funds to the deposits, report the
amount of shortfall and state the actual ratio of net owned funds to the deposits.
(ii) In case of shortfall with regard to the minimum amount of 10% as
unencumbered term deposits, as specified in Nidhi Rules 2014, report the
amount thereof.
(Note: Students are required to refer Guidance Note on CARO, 2016 for more details).

Theoretical Questions
1. Enumerate the verification procedures in relation to audit of a Hire-Purchase Finance
Company.
2. You are appointed as the auditor of a NBFC which is an Investment company registered with
RBI. What shall be the special points to be covered for the audit of NBFC in case of Investment
companies?

Answers to Theoretical Questions

1. Refer Para 6

2. Refer Para 6

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT UNDER FISCAL LAWS 13.99

Theoretical Questions
1. Mr. A engaged in business as a sole proprietor presented the following information to you for
the FY 2017-18. Turnover made during the year ` 124 lacs. Goods returned in respect of
sales made during FY 2016-17 is ` 20 lacs not included in the above. Cash discount allowed
to his customers ` 1 lac for prompt payment. Special rebate allowed to customer in the
nature of trade discount ` 5 lacs. Kindly advise him whether he has to get his accounts
audited u/s 44AB of the Income Tax Act, 1961.
2. Comment with respect to computation of total sales, turnover or gross receipts in business
exceeding the prescribed limit under Section 44 AB of Income Tax Act, 1961.
(i) Discount allowed in the sales invoice
(ii) Cash discount
(iii) Price of goods returned related to earlier year
(iv) Sale proceeds of fixed assets.
3. Write a short note on - Method of accounting in Form No. 3CD of Tax Audit.
4. ABC Pvt. Ltd. and XYZ Pvt. Ltd. are the companies in which public are not substantially
interested. During the previous year 2017-18, ABC Pvt. Ltd. received some property, being
shares of XYZ Pvt. Ltd., the details of which are provided below:
No. of Shares: 1,000
Aggregate fair market value of shares: ` 75,000
Consideration value: Nil
The management of the company contends that the shares need not to be furnished in Form
No. 3CD. As the tax auditor of ABC Pvt. Ltd., how would you deal with the m atter?
5. ABC Printing Press, a proprietary concern, made a turnover of above ` 1.03 crore for the
year ended 31.03.2018. The Management explained its auditor Mr. Z, that it undertakes
different job work orders from customers. The raw materials required fo r every job are
dissimilar. It purchases the raw materials as per specification/ requirements of each
customer, and there is hardly any balance of raw materials remaining in the stock, except
pending work-in-progress at the year end. Because of variety and complexity of materials, it
is rather impossible to maintain a stock-register. Give your comments.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

13.100 ADVANCED AUDITING AND PROFESSIONAL ETHICS

6. A Co-operative Society having receipts above ` 1 crore gets its accounts audited by a person
eligible to do audit under Co-operative Societies Act, 1912, who is not a Chartered
Accountant. State with reasons whether such audit report can be furnished as tax audit report
under Section 44AB of the Income-tax Act, 1961?
7. Draft an Audit programme for conducting the audit of a Public Trust registered under section
12A of the Income-tax Act, 1961.
8. State whether a Tax audit report can be revised and if so state those circumstances.
9. Briefly discuss the provisions given under section 66 regarding Special Audit required under
CGST Act.
Answers to Theoretical Questions
1. Turnover limit for the purpose of Tax Audit: The following points merit consideration as stated in
the Guidance note on Tax Audit issued by the Institute of Chartered Accountants of India-
(i) Price of goods returned should be deducted from the figure of turnover even if the
return are from the sales made in the earlier years.
(ii) Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nat ure
of a financing charge and is not related to turnover. The same should not be deducted
from the figure of turnover.
(iii) Special rebate allowed to a customer can be deducted from the sales if it is in the
nature of trade discount.
Applying the above stated points to the given problem,
1. Total Turnover 124 Lacs
2. Less – (i) Goods Returned 20 Lacs
(ii) Special rebate allowed to customer in the nature of trade
discount would be deducted 5 Lacs
Balance 99 Lacs
As the limit for tax audit is ` one crore, he would not be required to get his accounts audited
under section 44AB of the Income Tax Act, 1961.
2. Computation of Sales, Turnover or Gross Receipts:
In the context of section 44AB of the Income Tax Act, 1961: Following considerations are
required with regard to computation of sales, turnover or gross receipts in business
exceeding the prescribed limit under section 44AB of the Income Tax Act, 1961 -
(i) Discount allowed in the sales invoice will reduce the sale price and, therefore, the same
can be deducted from the turnover.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT UNDER FISCAL LAWS 13.101

(ii) Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature
of a financing charge and is not related to turnover. Therefore, should not be deducted
from the turnover.
(iii) Price of goods returned should be deducted from the turnover even if the returns are
from the sales made in the earlier year/s.
(iv) Sale proceeds of fixed assets would not form part of turnover since these are not held
for resale.
3. Method of accounting in Form No. 3CD of Tax Audit: Clause 13 of Form No. 3CD of the
tax audit requires to state method of accounting employed in the previous year. It also
requires to state the change in method of accounting vis-à-vis the preceding year. If so,
details of change and the effect on the profit or loss are to be stated. Also details of
deviation thereof if any, from accounting standards prescribed under section 145 and the
effect there of on the profit or loss are stated. Section 145 provide that method of
accounting be either cash or mercantile. Hybrid system is not permitted.
4. Reporting for Receipt of Shares, the Aggregate Fair Market Value of Which Exceeds
` 50,000 : In this case, ABC Pvt. Ltd. is a company, other than a company in which the public
are substantially interested. During the previous year 2017-18, the company received
property, being shares, for no consideration, the aggregate fair market value of which i s
` 75,000.
Provisions and Explanations: A tax auditor has to furnish the details of shares received
during the previous year, under clause 28 of Form 3CD, in case, the assessee has received
any property, being share of a company not being a company in which public are
substantially interested, without consideration or for inadequate consideration as referred to
in section 56(2)(viia) of the Income Tax Act, 1961.
Section 56(2)(viia) provides that where a firm or a company not being a company in which th e
public are substantially interested, receives, in any previous year any property being shares
of a company not being a company in which the public is substantially interested,
(i) without consideration, the aggregate fair market value of which exceeds ` 50,000, the
whole of the aggregate fair market value of such property;
(ii) for a consideration which is less than the aggregate fair market value of the property by
an amount exceeding ` 50,000, the aggregate fair market value of such property as
exceeds such consideration,
shall be chargeable to income-tax under the head “Income from other sources”.
The fair market value of shares means the value as determined in accordance with the
method prescribed in Income Tax Rules, 1962.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

13.102 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Conclusion: As per the facts of the case, provisions and explanations given above, the
income generated by ABC Pvt. Ltd., being whole of the aggregate fair market value of shares
received (i.e. ` 75,000), is chargeable to income-tax under the head “Income from other
sources” as per section 56(2)(viia) of the Income Tax Act, 1961.
Therefore, the tax auditor of ABC Pvt. Ltd. is required to furnish the details of such shares
received under clause 28 of Form 3CD. The contention of the management of the company,
for not reporting such receipt of shares, is not acceptable.
5. Non-maintenance of stock register: The explanation of the entity for the use of varieties of raw
materials for different jobs undertaken may be valid. But the auditor needs to verify the specified
job-orders received and the different raw materials purchased for each job separately. The use of
different papers (quality, quantity and size)ink, colour etc. may be examined. If possible, the
auditor may also enquire with the other similar printers in the locality to ensure the prevailing
custom. At the same time, he has to report and certify under the clause 35(b) and clause 11(b) of
Form 3CD read with the Rule 6G(2) of the Income-tax Act, 1961, about the details of stock and
account books (including stock register) maintained. He (or his deputy) must verify the closing
stock of raw materials, work-in-progress and finished goods of the concern, at least on the date of
its balance sheet. In case the said details are not properly maintained, he has to specifically
mention the same with reasons for non-maintenance of stock register by the entity.
6. Furnishing Audit Report of a Co-operative Society: As per Section 44AB read with
Explanation to Section 288(2) of the Income Tax Act, 1961, “accountant” means a chartered
accountant within the meaning of the Chartered Accountants Act, 1949, and includes, in
relation to any State, any person who by virtue of the provisions of section 141 of the
Companies Act, 2013, is entitled to be appointed to act as an auditor of companies regis tered
in that State.
Accordingly, the person who is not a Chartered Accountant as mentioned in the question,
though is eligible to act as auditor of Cooperative Society under the Cooperative Society Act,
1912, but is not eligible to carry out tax audit under Section 44AB of the Income Tax Act,
1961.
Hence, such audit report cannot be furnished as tax audit report under Section 44AB of the
Income-tax Act, 1961.
7. An auditor should conduct routine checking during the course of audit of a public
trust, in the following manner:
(i) Check the books of account and other records having regard to the system of
accounting and internal control;
(ii) Vouch the transactions of the trust to satisfy that:

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT UNDER FISCAL LAWS 13.103

 the transaction falls within the ambit of the trust the transaction is properly
authorized by the trustees or other delegated authority as may be permissible in
law;
 all incomes due to the trust have been properly accounted for on the basis of the
system of accounting followed by the trust;
 all expenses and outgoings appertaining to the trust have been recorded on the
basis of the system of accounting followed by the trust;
 amounts shown as applied towards the object of the trust are covered by the
objects of trust as specified in the document governing the trust.
(iii) Obtain trial balance on the closing date duly certified by the trustee;
(iv) Obtain Balance Sheet and Profit & Loss Account of the trust authenticated by the
trustees and check the same with the trial balance with which they should agree.
8. Revision of Tax Audit Report:
(a) Normally, the report of the tax auditor cannot be revised later.
(b) However, when the accounts are revised in the following circumstances, the tax Auditor may
have to revise his Tax audit report also.
(i) Revision of accounts of a company after its adoption in the annual general
meeting.
(ii) Change in law with retrospective effect.
(iii) Change in interpretation of law (e.g.) CBDT Circular, Notifications, Judgments, etc.
The Tax Auditor should state it is a revised Report, clearly specifying the reasons for such
revision with a reference to the earlier report.
9. Refer Para 7.1.3

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

14.72 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. Enumerate the key features of environment audit of an industrial unit.
2. State the items contained in the SEBI’s check list for auditors in respect of contract notes issued
by a Stock Broker.
3. Write short notes on the following:
(a) Rolling Settlements.
(b) Sauda Book.
(c) Margins (Under Stock Exchange Trading Regulations).
(d) Types of market under NEAT (National Exchange Automated Trading).
4. Explain the audit of Depositories under the SEBI (Depositories and Participants) Regulations,
1996 and the records and documents which are required to be maintained by the Depositories.
Answers to Theoretical Questions
1. Refer Para 4 of Unit I.
2. Refer Para 7.4 of Unit 5.
3. (a) Refer Para 3 of Unit 5.
(b) Refer Para 7.3 of Unit 5.
(c) Refer Para 2.6 of Unit 5.
(d) Refer Para 2.9 of Unit 5.
4. Refer Para 1 of Unit 7.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

15.34 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. What are the principles involved regarding “Propriety audit’ in the case of Public Sector
Undertaking?
2. Write a short explanatory note on –
(a) Areas of propriety audit under Section 143(1) of the Companies Act, 2013.
(b) Role of C&AG in the Audit of a Government company.
3. ABG & Co., a Chartered Accountant firm has been appointed by C & AG for performance audit
of a Sugar Industry. What factors should be considered by ABG & Co., while planning a
performance audit of Sugar Industry?

Answers to Theoretical Questions

1. Companies Act, lays down special provisions regarding audit of accounts of public sector
undertakings registered as Government Companies. Section 143 of the Companies Act, 2013
empowers C&AG to conduct supplementary or test audit. Audit of public enterprises in India is
not restricted to financial and compliance audit; it extends also to efficiency, economy and
effectiveness with which these operate and fulfill their objectives and goals. Another aspect of
audit relates to questions of propriety; this audit is directed towards an examination of
management decisions in sales, purchases, contracts, etc. to see whether these have been
taken in the best interests of the undertaking and conform to accepted principles of financial
propriety. Propriety audit stands for verification of transactions on the tests of public interest,
commonly accepted customs and standards of conduct. On an analysis, these tests boil down
to tests of economy, efficiency and faithfulness. Instead of too much dependence o n
documents, vouchers and evidence, it shifts the emphasis to the substance of transactions and
looks into the appropriateness thereof on a consideration of financial prudence, public interest
and prevention of wasteful expenditure. Thus, propriety audit is concerned with scrutiny of
executive actions and decisions bearing on financial and profit and loss situation of the
company, with special regard to public interest and commonly accepted customs and standards
of conduct. It is also seen whether every officer has exercised the same vigilance in respect of
expenditure incurred from public money, as a person of ordinary prudence would exercise in
respect of expenditure of his own money under similar circumstances. Some general principles
have been laid down in the Audit Code, which have for long been recognised as standards of

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF PUBLIC SECTOR UNDERTAKINGS 15.35

financial propriety. Audit against propriety seeks to ensure that expenditure conforms to these
principles which have been stated as follows:
(i) 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.
(ii) No authority should exercise its powers of sanctioning expenditure to pass an order which
will be directly or indirectly to its own advantage.
(iii) Public moneys should not be utilised for the benefit of a particular person or section of the
community.
(iv) Apart from the agreed remuneration or reward, no other avenue is kept open to indirectly
benefit the management personnel, employees and others.
It may be stated that it is the responsibility of the executive departments to enforce economy
in public expenditure. The aim of propriety audit is to bring to the notice of the proper authorities
of wastefulness in public administration and cases of improper; avoidable and in fructuous
expenditure.
2. (a) Areas of propriety audit under Section 143(1): Section 143(1) of the Companies Act,
2013 requires the auditor to make an enquiry into certain specific areas. In some of the
areas, the auditor has to examine the same from propriety angle as to -
(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; Again, considering the propriety element,
rationalizing the proper disclosure of loans and advance given by company is made;
(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.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

15.36 ADVANCED AUDITING AND PROFESSIONAL ETHICS

A control has been set up to verify the receipt of cash in case of allotment of shares for cash.
Further, if cash is not received, the books of accounts and statement of affairs shows the true
picture.
(b) Role of C&AG in the Audit of a Government company: Role of C&AG is prescribed
under sub section (5), (6) and (7) of section 143 of the Companies Act, 2013.
In the case of a Government company, the comptroller and Auditor-General of India shall
appoint the auditor under sub-section (5) or sub-section (7) of section 139 i.e. appointment
of First Auditor or Subsequent Auditor and direct such auditor the manner in which the
accounts of the Government company are required to be audited and thereupon the
auditor so appointed shall submit a copy of the audit report to the Comptroller and Auditor -
General of India which, among other things, include the directions, if any, issued by the
Comptroller and Auditor-General of India, the action taken thereon and its impact on the
accounts and financial statement of the company.
The Comptroller and Auditor-General of India shall within sixty days from the date of
receipt of the audit report have a right to:
(i) conduct a supplementary audit of the financial statement of the company by such
person or persons as he may authorize in this behalf; and for the purposes of such
audit, require information or additional information to be furnished to any person or
persons, so authorised, on such matters, by such person or persons, and in such
form, as the Comptroller and Auditor-General of India may direct; and
(ii) comment upon or supplement such audit report.
It may be noted that any comments given by the Comptroller and Auditor-General of India
upon, or supplement to, the audit report shall be sent by the company to every person
entitled to copies of audited financial statements under sub-section (1) of section 136 i.e.
every member of the company, to every trustee for the debenture-holder of any
debentures issued by the company, and to all persons other than such member or trustee,
being the person so entitled and also be placed before the annual general meeting of the
company at the same time and in the same manner as the audit report.
Test Audit: Further, without prejudice to the provisions relating to audit and auditor, the
Comptroller and Auditor- General of India may, in case of any company covered under
sub-section (5) or sub-section (7) of section 139, if he considers necessary, by an order,
cause test audit to be conducted of the accounts of such company and the provisions of
section 19A of the Comptroller and Auditor-General's (Duties, Powers and Conditions of
Service) Act, 1971, shall apply to the report of such test audit.
3. Factors to be considered while planning the Performance Audit: While planning a
performance audit of Sugar Industry, the auditors should take care of certain factors which are
listed below:
(i) to consider significance and the needs of potential users of the audit report.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

AUDIT OF PUBLIC SECTOR UNDERTAKINGS 15.37

(ii) to obtain an understanding of the program to be audited.

(iii) to consider legal and regulatory requirements.
(iv) to consider management controls.
(v) to identify criteria needed to evaluate matters subject to audit.
(vi) to identify significant findings and recommendations from previous audits that could affect
the current audit objectives. Auditors should determine if management has corrected the
conditions causing those findings and implemented those recommendations.
(vii) to identify potential sources of data that could be used as audit evidence and consider the
validity and reliability of these data, including data collected by the audited entity, data
generated by the auditors, or data provided by third parties.
(viii) to consider whether the work of other auditors and experts may be used to satisfy some
of the auditors' objectives.
(ix) to provide sufficient staff and other resources to do the audit.
(x) to prepare a written audit plan.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

16.32 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. Indicate the precise nature of auditor's liability in the following situations and support your views
with authority, if any:
(i) A misstatement had occurred in the prospectus issued by the company.
(ii) Certain weaknesses in the internal control procedure in the payment of wages in a large
construction company were noticed by the statutory auditor who in turn brought the same
to the knowledge of the Managing Director of the company. In the subsequent year huge
defalcation came to the notice of the management. The origin of the same was traced to
the earlier year. The management wants to sue the auditor for negligence and also p lans
to file a complaint with the Institute.
(iii) Based upon the legal opinion of a leading advocate, X Ltd. made a provision of
` 5 crores towards Income Tax liability. The assessing authority has worked out the
liability at ` 5 crores. It is observed that the opinion of the advocate was inconsistent with
legal position with regard to certain revenue items.
2. Write a short note on - Auditor’s liability in case of unlawful acts or defaults by clients.
3. Explain briefly duties and responsibilities of an auditor in case of material misstatement
resulting from Management Fraud.
4. In assessment procedure of M/s Cloud Ltd., Income Tax Officer observed some irregularities.
Therefore, he started investigation of Books of Accounts audited and signed by Mr. O ld, a
practicing Chartered Accountant. While going through books he found that M/s Cloud Ltd. used
to maintain two sets of Books of Accounts, one is the official set and other is covering all the
transactions. Income Tax Department filed a complaint with the Institute of Chartered
Accountants of India saying Mr. Old had negligently performed his duties. Comment.

5. Mr. Fresh, a newly qualified chartered accountant, wants to start practice and he requires your
advice, among other things, on criminal liabilities of an auditor under the Companies Act, 2013.
Kindly guide him.
Answers to Theoretical Questions
1. (i) Refer para 4.
(ii) In the given case, certain weaknesses in the internal control procedure in the payment of
wages in a large construction company were noticed by the statutory auditor and brought

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

LIABILITIES OF AUDITOR 16.33

the same to the knowledge of the Managing Director of the company. In the subsequent
year, a huge defalcation took place, the ramification of which stretched to the earlier year.
The management of the company desires to sue the statutory auditor for negligence. The
precise nature of auditor's liability in the case can be ascertained on the basis of the under
noted considerations:
(a) Whether the defalcation emanated from the weaknesses noticed by the statutory auditor,
the information regarding which was passed on to the management; and
(b) Whether the statutory auditor properly and adequately extended the audit programme of
the previous year having regard to the weaknesses noticed.
SA 265 on “Communicating Deficiencies in Internal Control to Those Charged with
Governance and Management” clearly mentions that, “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. 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 ”.
The fact, however, remains that, weaknesses in the design of the internal control system
and non-compliance with identified control procedures increase the risk of fraud or error.
If circumstances indicate the possible existence of fraud or error, the auditor should
consider the potential effect of the suspected fraud or error on the financial information. If
the auditor believes the suspected fraud or error could have a material effect on the
financial information, he should perform such modified or additional procedures as he
determines to be appropriate. Thus, normally speaking, as long as the auditor took due
care in performing the audit work, he cannot be held liable.
The fact that the matter was brought to the notice of the managing director may be a good
defence for the auditor as well. According to the judgement of the classic case in re
Kingston Cotton Mills Ltd., (1896) it is the duty of the auditor to probe into the depth only
when his suspicion is aroused. The statutory auditor, by bringing the weakness to the
notice of the managing director had alerted the management which is judicially held to be
primarily responsible for protection of the assets of the company and can put forth this as
defence against any claim arising subsequent to passing of the information to the
management. In a similar case S.P. Catterson & Sons Ltd. (81 Acct. L. R.68), the auditor
was acquitted of the charge.
(iii) SA 620 on "Using the Work of an Auditor’s Expert" discusses the auditor's
responsibility in relation to and the procedures the auditor should consider in, using the
work of an expert as audit evidence. During the audit, the auditor may seek to obtain, in
conjunction with the client or independently, audit evidence in the form of reports,

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

16.34 ADVANCED AUDITING AND PROFESSIONAL ETHICS

opinions, valuations and statements of an expert, e.g., legal opinions concerning

interpretations of agreements, statutes, regulations, notifications, circulars, etc. Before
relying on advocate's opinion, the auditor should have seen that opinion given by the
expert is prima facie dependable. The question states very clearly that the opinion of the
advocate was inconsistent with legal position with regard to certain items. It is, perhaps,
quite possible that auditor did not seek reasonable assurance as to the appropriateness
of the source data, assumptions and methods used by the expert properly.
In fact, SA 620 makes it incumbent upon the part of the auditor to resolve the
inconsistency by discussion with the management and the expert. In case, the expert's '
work does not support the related representation in the financial information the
inconsistency in legal opinions could have been detected by the auditor if he had gone
through the same. This seems apparent having regard to wide difference in the liabili ty
worked out by the assessing authority. Under the circumstance, the auditor should have
rejected the opinion and insisted upon making proper provision.
2. Auditor's liability in case of unlawful Acts or defaults by clients: The auditor's basic
responsibility is to report whether in his opinion the accounts show a true and fair view and in
discharging his responsibility he has to see as to how the particular situations affected his
position. The general thinking with regard to unlawful acts or defaults by clients appears to be
that the auditor should not 'aid or abet' but he is apparently not under any legal obligation to
disclose the offence. A professional accountant would himself be guilty of a criminal offence if
he advises his client to commit any criminal offence or helps or encourages in planning or
execution of the same or conceals or destroys evidence to obstruct the course of public justice
or positively assists his client in evading prosecution. A professional accountant in his capacity
as auditor, accountant, or tax representative has access to a variety of information concerning
his clients. On some occasions, he may acquire knowledge that his client has been guilty of
some unlawful act, default, fraud, or other criminal offence. The duty of the professional
accountant in such a case would depend upon the actual circumstances of the situation. Due
consideration should be given to the exact nature of services that a professional accountant is
rendering to his client, i.e. is he representing the client in income-tax proceedings or is he
acting in the capacity of an auditor or an accountant or a consultant.
The Institute of Chartered Accountants of India has considered the role of chartered
accountants in relation to taxation frauds by an assessee and has made the following major
recommendations:
(i) A professional accountant should keep in mind the provisions of Section 126 of the Evidence
Act whereby a barrister, an attorney, a pleader or a Vakil is barred from disclosing any
communication made to him in the course of and for the purpose of his employment.
(ii) If the fraud relates to past years when the accountant did not represent the client, the client
should be advised to make a disclosure. The accountant should also be careful that the past
fraud does not in any way affect the current tax matters.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

LIABILITIES OF AUDITOR 16.35

(iii) In case of fraud relating to accounts examined and reported upon by the professional
accountant himself, he should advise the client to make a complete disclosure. In case the
client refuses to do so, the accountant should inform him that he is entitled to dissociate himself
from the case and that he would make a report to the authorities that the accounts prepared or
examined by him are unreliable on account of certain information obtained later. In making
such a report, the contents of the information as such should not be communicated unless the
client consents in writing.
(iv) In case of suppression in current accounts, the client should be asked to make a full disclosure.
If he refuses to do so, the accountant should make a complete reservation in his report and
should not associate himself with the return.
However, it can be argued that the auditor has a professional obligation to ensure that the client is
fully aware of the seriousness of the offence and to seriously consider full disclosure of the matter.
It has been clearly established in various case laws that the auditor is expected to know the contents
of documents and records and ascertain whether the affairs of the client are being c onducted in an
unlawful manner. It is in the course of the work, he comes across any unlawful acts, it is his duty to
bring it to the notice of the client as also to make a disclosure in his report in appropriate cases. In
this regard, one has to bear in mind the consequence of the act in relation to the professional code
to which an auditor is subjected. Under the code, an auditor cannot disclose confidential information
unless permitted by the client or unless required by law. Each case has to be judged o n its
circumstances. However, in every case he has to assess the implications of the unlawful act or
default on the true and fair character of the accounting statements.
The question of liability of an auditor for unlawful acts or defaults by clients shoul d be considered in
the light of the broad parameters given above. However, it appears that if an auditor was aware of
any unlawful act having been committed by client in respect of accounts audited by him and the
unlawfulness was not rectified by proper disclosure or any other appropriate means, the auditor
owes a duty to make a suitable report. If he does not, he may be held liable, if the true and fair
character of the accounts has been vitiated.
3. Duties & Responsibilities of an Auditor in case of Material Misstatement resulting from
Management Fraud: Misstatement in the financial statements can arise from fraud or error.
The term fraud refers to an ‘Intentional Act’ by one or more individuals among management,
those charged with governance. The auditor is concerned with fraudulent acts that cause a
material misstatement in the financial statements.
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements”, fraud can be committed by management overriding controls using
such techniques as engaging in complex transactions that are structured to misrepresent the
financial position or financial performance of the entity.
Fraud involving one or more members of management or those charged with the governance
is referred to as “management fraud”. The primary responsibility for the prevention and

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

16.36 ADVANCED AUDITING AND PROFESSIONAL ETHICS

detection of fraud rests with those charged with the governance and the management of the
entity.
Further, 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. Owing to the inherent limitations of an audit,
there is an unavoidable risk that some material misstatements of the financial statements may
not be detected, even though the audit is properly planned and performed in accordance with
the SAs.
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
Auditor’s opinion on the financial statements is based on the concept of obtaining reasonable
assurance, hence in an audit, the auditor does not guarantee that material misstatements will
be detected.
Further, as per section 143(12) of the Companies Act, 2013, 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 (in case
amount of fraud is ` 1 crore or above)or Audit Committee or Board in other cases (in case the
amount of fraud involved is less than ` 1 crore) within such time and in such manner as may
be prescribed.
The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016,
Whether any fraud by the company or any fraud on the company by its officers or employees
has been noticed or reported during the year; If yes, the nature and the amount involve d is to
be indicated.
If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters
exceptional circumstances that bring into question the auditor’s ability to continue performing
the audit, the auditor shall:
(i) Determine the professional and legal responsibilities applicable in the circumstances,
including whether there is a requirement for the auditor to report to the person or persons
who made the audit appointment or, in some cases, to regulatory authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where withdrawal
from the engagement is legally permitted; and
(iii) If the auditor withdraws:

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

LIABILITIES OF AUDITOR 16.37

(1) Discuss with the appropriate level of management and those charged with governance,
the auditor’s withdrawal from the engagement and the reasons for the withdrawal; and
(2) Determine whether there is a professional or legal requirement to report to the person or
persons who made the audit appointment or, in some cases, to regulatory authorities,
the auditor’s withdrawal from the engagement and the reasons for the withdrawal.
4. Liability of Auditor: “It is the auditor’s responsibility to audit the statement of accounts and
prepare tax returns on the basis of books of accounts produced before him. Also if he is
satisfied with the books and documents produced to him, he can give his opinion on the basi s
of those documents only by exercising requisite skill and care and observing the laid down
audit procedure.
In the instant case, Income tax Officer observed some irregularities during the assessment
proceeding of M/s Cloud Ltd. Therefore, he started investigation of books of accounts audited
and signed by Mr. Old, a practicing Chartered Accountant. While going through the books, he
found that M/s Cloud Ltd. Used to maintain two sets of Books of Accounts, one is the official
set and other is covering all the transactions. Income Tax Department filed a complaint with
the ICAI saying Mr. Old had negligently performed his duties.
Mr. Old, the auditor was not under a duty to prepare books of accounts of assessee and he
should, of course, neither suggest nor assist in the preparations of false accounts. He is
responsible for the books produced before him for audit. He completed his audit work with
official set of books only.
In this situation, as Mr. Old, performed the auditing with due skill and diligence; and, therefore,
no question of negligence arises. It is the duty of the Department to himself investigate the
truth and correctness of the accounts of the assessee.
5. Refer Para 5.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

INTERNAL AUDIT, MANAGEMENT AND OPERATIONAL AUDIT 17.43

SIA 11 : Consideration of Fraud in an Internal Audit.

SIA 12 : Internal Control Evaluation
SIA 13 : Enterprise Risk Management
SIA 14 : Internal Audit in an Information Technology Environment
SIA 15 : Knowledge of the Entity and its Environment.
SIA 16 : Using the Work of an Expert.
SIA 17 : Consideration of Laws and Regulations in an Internal Audit.
SIA 18 : Related Parties.

Theoretical Questions
1. Write a short note on-Summary Written Report.
2. State the important aspects to be considered by the External auditor in the evaluation of Internal
Audit Function.
3. AB Pvt. Ltd. company having outstanding loans or borrowings from banks exceeding one
hundred crore rupees wants to appoint internal auditor. Please guide him for applicability of the
same and who can be appointed as internal auditor and what work would be reviewed by him.

Answers to Theoretical Questions

1. Refer Para 7.7.
2. Evaluation of Internal Audit Functions by External Auditor: The external auditor’s general
evaluation of the internal audit function will assist him in determining the extent to which he can
place reliance upon the work of the internal auditor. The external auditor should document his
evaluation and conclusions in this respect. The important aspects to be consid ered in this
context are:
(a) Organisational Status - Whether internal audit is undertaken by an outside agency or by
an internal audit department within the entity itself, the internal auditor reports to the
management. In an ideal situation his reports to the highest level of management and is
free of any other operating responsibility. Any constraints or restrictions placed upon his
work by management should be carefully evaluated. In particular, the internal auditor
should be free to communicate fully with the external auditor.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

17.44 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(b) Scope of Function - The external auditor should ascertain the nature and depth of
coverage of the assignment which the internal auditor discharges for management. He
should also ascertain to what extent the management considers, and where appropriate,
acts upon internal audit recommendations.

(c) Technical Competence - The external auditor should ascertain that internal audit work
is performed by persons having adequate technical training and proficiency. This may be
accomplished by reviewing the experience and professional qualifications of the persons
undertaking the internal audit work.
(d) Due Professional Care - The external auditor should ascertain whether internal audit
work appears to be properly planned, supervised, reviewed and documented. An example
of the exercise of due professional care by the internal auditor is the existence of adequate
audit manuals, audit programmes and working papers.
3. Applicability of Internal Audit: Section 138 of the Companies Act, 2013 states that every
private limited company is required to conduct internal audit if its outstanding loans or
borrowings from banks or public financial institutions exceeding one hundred crore rupees or
more at any point of time during the preceding financial year.
In view of above provisions, AB Pvt. Ltd. is under compulsion to conduct internal audit as its
loans or borrowings are falling under the prescribed limit.
Who can be appointed as Internal Auditor- The internal auditor shall either be a chartered
accountant or a cost accountant, whether engaged in practice or not, or such other professional
as may be decided by the Board to conduct internal audit of the functions and activities of the
companies.
The internal auditor may or may not be an employee of the company.
Work to be reviewed by Internal Auditor- Refer Para 2.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

18.68 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. Sri Rajan is above 80 years old and wishes to sell his proprietary business of manufacture of
specialty chemicals. Ceta Ltd. wants to buy the business and appoints you to carry out a due
diligence audit to decide whether it would be worthwhile to acquire the business.
What procedures you would adopt before you could render any advice to Ceta Ltd.?
2. An American Company engaged in the business of manufacturing and distribution of industrial
gases, is interested in acquiring a listed Indian Company having a market share of more than
65% of the industrial gas business in India, request you to conduct a “Due Diligence” of this
Indian Company and submit your Report. List out the contents of your Due Diligence Review
Report that you will submit to your USA based Client.
3. A nationalised bank received an application from an export company seeking sanction of a term
loan to expand the existing sea food processing plant. In this connection, the General Manager,
who is in charge of Advances, approaches you to conduct a thorough investigation of this
limited company and submit a confidential report based on which he will decide whether to
sanction this loan or not.
List out the points you will cover in your investigation before submitting your report to the
General Manager.
4. What are the important steps involved while conducting Investigation on behalf of an Incoming
Partner?
5. Mr. Clean who proposes to buy the proprietary business of Mr. Perfect, engages you as
investigating accountant. Specify the areas which you will cover in your investigation.
6. In a Company, it is suspected that there has been embezzlement in cash receipts. As an
investigator, what are the areas that you would verify?
7. J Ltd. is interested in acquiring S Ltd. The valuation of S Ltd. is dependent on future
maintainable sales. As the person entrusted to value S Ltd. what factors would you consider
in assessing the future maintainable turnover?
8. Briefly mentioned the forensic audit techniques name.
9. Forensic audit is unlike other audits. Explain
10. Enumerate the steps to be undertaken in case of forensic audit process.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

DUE DILIGENCE, INVESTIGATION & FORENSIC AUDIT 18.69

Answers to Theoretical Questions

1. Refer Financial Due Diligence given in Para 4 of Unit 1.
2. Refer Para 7 of Unit 1.
3. Refer Para 6.4 of Unit 2.
4. Refer Para 6.2 of Unit 2.
5. Refer Para 5 of Unit 2.
6. Refer Para 5.5.1 of Unit 2.
7. In assessing the turnover which the business would be able to maintain in the future,
the following factors should be taken into account:
(i) Trend: Whether in the past, sales have been increasing consistently or they have been
fluctuating. A proper study of this phenomenon should be made.
(ii) Marketability: Is it possible to extend the sales into new markets or that these have been fully
exploited? Product wise estimation should be made.
(iii) Political and economic considerations: Are the policies pursued by the Government likely
to promote the extension of the market for goods to other countries? Whether the sales in the
home market are likely to increase or decrease as a result of various emerging economic
trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the
same field or if products which would sell in competition are placed on the market at
cheaper price? Is the demand for competing products increasing? Is the company’s
share in the total trade constant or has it been fluctuating?
8. Refer Para 5 of Unit 3.
9. Refer Para 2 of Unit 3.
10. Refer Para 4 of Unit 3.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

PEER REVIEW AND QUALITY REVIEW 19.37

Theoretical Questions
1. A, a practicing Chartered Accountant is appointed to conduct the peer review of another
practicing unit. What areas A should review in the assessment of independence of the
practicing unit?
2. What are the areas excluded from the scope of peer reviewer?
3. Write short notes on the following:
(a) Scope of peer review.
(b) Technical, ethical and professional standards as per statement on peer review.
4. What are the objectives of the Quality review?
5. What are the reporting responsibilities of the technical reviewer while carrying out a Quality
review assignment?
6. Give examples of areas on which the reviewer may qualify the report?
7. What are the consequences if the Quality review board notices major non -compliances with
the requirements of the Standards on quality control or standards on auditing or accounting
standards?
Answers to Theoretical Questions
1. Review in the Assessment of Independence of the Practicing Unit – The reviewer should
carry out the compliance review of the five general controls, i.e., independence, maintenance
of professional skills and standards, outside consultation, staff supervision and development
and office administration and evaluate the degree of reliance to be placed upon them. The
degree of reliance will, ultimately, affect the attestation service engagements to be reviewed.
A, a practicing Chartered Accountant should review following controls in respect of assessment
of independence of the practicing unit:
(i) Does the practice unit have a policy to ensure independence, objectivity and integrity, on
the part of partners and staff? Who is responsible for this policy?
(ii) Does the practice unit communicate these policies and the expected standards of
professional behaviour to all staff?

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

19.38 ADVANCED AUDITING AND PROFESSIONAL ETHICS

(iii) Does the practice unit monitor compliance with policies and procedures relating to
independence?
(iv) Does the practice unit periodically review the practice unit's association with clients to
ensure objectivity and independence?
2. Refer Para 3 of Peer Review.
3. (a) Refer Para 3 of Peer Review.
(b) Refer Para 3 of Peer Review.
4. Refer Para 2 of Quality Review.
5. The Technical Reviewers expresses an opinion on whether the system of quality control for the
attestation services of the firm under review has been designed so as to carry out professional
attestation services assignments in a manner that ensures compliance with the applicable
Technical standards and maintenance of the quality of attestation service work they perform.
The Technical Reviewer’s review would not necessarily disclose all weaknesses in the quality
of attestation work or all instances of lack of compliance with applicable Technical Standards.
As there are inherent limitations in the effectiveness of any system of quality control, departure
from the system may occur and not be detected. Also, projection of any evaluation of system
of quality control to future periods is subject to the risk that the system of quality controls may
become inadequate because of changes in conditions, or that the degree of compliance with
the policies and procedures may deteriorate. In the process, the Technical Reviewers also
identified what they considered to be deficiencies and any defects in, or criticisms of the firm’s
quality control system.
6. Refer Para 7 of Quality Review.
7. Refer Para 8 of Quality Review.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

20.126 ADVANCED AUDITING AND PROFESSIONAL ETHICS

Theoretical Questions
1. P, a Chartered Accountant in practice provides management consultancy and other services
to his clients. During 2017, looking to the growing needs of his clients to invest in the stock
markets, he also advised them on Portfolio Management Services whereby he managed
portfolios of some of his clients.
2. Mr. G, a Chartered Accountant in practice as a sole proprietor has an office in Mumbai near
Church Gate. Due to increase in professional work, he opens another office in a suburb of
Mumbai which is approximately 80 kilometers away from the municipal limits of the city. For
running the new office, he employs three retired Income-tax Officers.
3. Write a short note on Other Misconduct.
4. Mr. K, a practicing Chartered Accountant gave 50% of the audit fees received by him to a
non-Chartered Accountant, Mr. L, under the nomenclature of office allowance and such an
arrangement continued for a number of years.
5. Mr. X who passed his CA examination of ICAI on 18th July, 2017 and started his practice
from August 15, 2017. On 16th August 2017, one female candidate approached him for
articleship. In addition to monthly stipend, Mr. X also offered her 1 % profits of his CA firm.
She agreed to take both 1 % profits of the CA firm and stipend as per the rate prescribed by
the ICAI. The Institute of Chartered Accountants of India sent a letter to Mr. X objecting the
payment of 1 % profits. Mr. X replies to the ICAI stating that he is paying 1 % profits of his
firm over and above the stipend to help the articled clerk as the financial position of the
articled clerk is very weak. Is Mr. X Liable to professional misconduct?
6. M/s XYZ, a firm in practice, develops a website “xyz.com”. The colour chosen for the website
was a very bright green and the web-site was to run on a “push” technology where the names
of the partners of the firm and the major clients were to be displayed on the web-site without
any disclosure obligation from any regulator.
7. A partner of a firm of chartered accountants during a T.V. interview handed over a bio -data of
his firm to the chairperson. Such bio-data detailed the standing of the international firm with
which the firm was associated. It also detailed the achievements of the concerned partner
and his recognition as an expert in the field of taxation in the country. The chairperson rea d
out the said bio-data during the interview. Discuss whether this action by the Chartered
Accountant would amount to misconduct or not.
8. (a) An advertisement was published in a Newspaper containing the photograph of Mr. X, a
member of the institute wherein he was congratulated on the occasion of the opening

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

PROFESSIONAL ETHICS 20.127

ceremony of his office.

(b) Mr. X, a Chartered Accountant and the proprietor of X & Co., wrote several letters to the
Assistant Registrar of Co-operative Societies stating that though his firm was on the
panel of auditors, no audit work was allotted to the firm and further requested him to
look into the matter.
9. A practising Chartered Accountant uses a visiting card in which he designates himself,
besides as Chartered Accountant, Cost Accountant.
10. Mr. Nigal, a Chartered Accountant in practice, delivered a speech in the national conference
organized by the Ministry of Textiles. While delivering the speech, he told to the audience that
he is a management expert and his firm provides services of taxation and audit at reasonable
rates. He also requested the audience to approach his firm of chartered accountants for these
services and at the request of audience he also distributed his business cards and telephone
number of his firm to those in the audience. Comment.
11. Mr. 'A' is a practicing Chartered Accountant working as proprietor of M/s A & Co. He went
abroad for 3 months. He delegated the authority to Mr. 'Y' a Chartered Accountant his
employee for taking care of routine matters of his office. During his absence Mr. 'Y' has
conducted the under mentioned jobs in the name of M/s A & Co.
(i) He issued the audit queries to client which were raised during the course of audit.
(ii) He issued production certificate to a client under Central Excise Act, 1944.
(iii) He attended the Income Tax proceedings for a client as authorized representative
before Income Tax Authorities.
Please comment on eligibility of Mr. 'Y' for conducting such jobs in name of M/s A & Co. and
liability of Mr. 'A' under the Chartered Accountants Act, 1949.
12. XYZ Co. Ltd. has applied to a bank for loan facilities. The bank on studying the financial
statements of the company notices that you are the auditor and requests you to call at the
bank for a discussion. In the course of discussions, the bank asks for your opinion regarding
the company and also asks for detailed information regarding a few items in the f inancial
statements. The information is available in your working paper file. What should be your
response and why?
Answers to Theoretical Questions
1. Advising on Portfolio Management Services: The Council of the Institute of Chartered
Accountants of India (ICAI) pursuant to Section 2(2)(iv) of the Chartered Accountants Act,
1949 has passed a resolution permitting “Management Consultancy and other Services” by a
Chartered Accountant in practice. A clause of the aforesaid resolution allows Chartered
Accountants in practice to act as advisor or consultant to an issue of securities including such
matters as drafting of prospectus, filing of documents with SEBI, preparation of publicity

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

20.128 ADVANCED AUDITING AND PROFESSIONAL ETHICS

budgets, advice regarding selection of brokers, etc. It is, however, specifically stated that
Chartered Accountants in practice are not permitted to undertake the activities of broking,
underwriting and portfolio management services. Thus, a chartered accountant in pr actice is
not permitted to manage portfolios of his clients.
Conclusion: In view of this, P would be guilty of misconduct under the Chartered
Accountants Act, 1949.
2. In terms of section 27 of the Chartered Accountants Act, 1949, if a chartered accountant in
practice has more than one office in India, each one of these offices should be in the
separate charge of a member of the Institute. There is however an exemption for the above if
the second office is located in the same premises, in which the first office is located; or the
second office is located in the same city, in which the first office is located; or the second
office is located within a distance of 50 kms from the municipal limits of a city, in which the
first office is located. Since the second office is situated beyond 50 kms of municipal limits of
Mumbai city, he would be liable for committing a professional misconduct.
3. Refer Para 7.2
4. Sharing of Audit Fees with Non-Member: As per Clause (2) of Part I of First Schedule to
the Chartered Accountants Act, 1949 a member shall be held guilty if a Chartered Accountant
in practice pays or allows or agrees to pay or allow, directly or indirectly, any share,
commission or brokerage in the fees or profits of his professional business, to any person
other than a member of the Institute or a partner or a retired partner or the legal
representative of a deceased partner, or a member of any other professional body or with
such other persons having such qualification as may be prescribed, for the purpose of
rendering such professional services from time to time in or outside India.
In the instant case, Mr. K, a practising Chartered Accountant gave 50% of the audit fees
received by him to a non-Chartered Accountant, Mr. L, under the nomenclature of office
allowance and such an arrangement continued for a number of years. In this case, it is not
the nomenclature to a transaction that is material but it is the substance of the transaction,
which has to be looked into.
The Chartered Accountant had shared his profits and, therefore, Mr. K will be held guilty of
professional misconduct under the Clause (2) of Part I of First Schedule to the Chartered
Accountants Act, 1949.
5. Sharing Fees with an Articled Clerk: As per Clause (2) of Part I of First Schedule to the
Chartered Accountants Act 1949, a Chartered Accountant in practice shall be deemed to be
guilty of professional misconduct if he pays or allows or agrees to pay or allow, directly or
indirectly, any share, commission or brokerage in the fees or profits of his professional
business, to any person other than a member of the Institute or a partner or a retired partner
or the legal representative of a deceased partner, or a member of any other professional
body or with such other persons having such qualification as may be prescribed, for the

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

PROFESSIONAL ETHICS 20.129

purpose of rendering such professional services from time to time in or outside India.
In view of the above, the objections of the Institute of Chartered Accountants of India, as
given in the case, are correct and reply of Mr. X, stating that he is paying 1 % profits of his
firm over and above the stipend to help the articled clerk as the position of the articled clerk is
weak is not tenable.
Hence, Mr. X is guilty of professional misconduct in terms of Clause (2) of Part I of First
Schedule to the Chartered Accountants Act 1949.
6. Posting of Particulars on Website: The Council of the Institute had approved posting of
particulars on website by Chartered Accountants in practice under Clause (6) of Part I of First
Schedule to the Chartered Accountants Act, 1949 subject to the prescribed guidelines. The
relevant guidelines in the context of the website hosted by M/s XYZ are:
 No restriction on the colours used in the website;
 The websites are run on a “pull” technology and not a “push” technology
 Names of clients and fees charged not to be given.
However, disclosure of names of clients and/or fees charged, on the website is permissible
only where it is required by a regulator, whether or not constituted under a statute, in India or
outside India, provided that such disclosure is only to the extent of require ment of the
regulator. Where such disclosure of names of clients and/or fees charged is made on the
website, the member/ firm shall ensure that it is mentioned on the website [in italics], below
such disclosure itself, that “This disclosure is in terms of the requirement of [name of the
regulator] having jurisdiction in [name of the country/area where such regulator has
jurisdiction] vide [Rule/ Directive etc. under which the disclosure is required by the Regulator].
In view of the above, M/s XYZ would have no restriction on the colours used in the website
but failed to satisfy the other two guidelines. Thus, the firm would be liable for professional
misconduct since it would amount to soliciting work by advertisement.
7. Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 prohibits
solicitation of client or professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means since it shall constitute
professional misconduct. The bio-data was handed over to the chairperson during the T.V.
interview by the Chartered Accountant which included details about the firm and the
achievements of the partner as an expert in the field of taxation. The chairperson simply read
out the same in detail about association with the international firm as also the achievements
of the partner and his recognition as an expert in the field of taxation. Such an act would
definitely lead to the promotion of the firms’ name and publicity thereof as well as of the
partner and as such the handing over of bio-data cannot be approved. The partner would be
held guilty of professional miscount under Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949.

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

20.130 ADVANCED AUDITING AND PROFESSIONAL ETHICS

8. (a) Publishing an Advertisement Containing Photograph: As per Clause (6) of Part I of

the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in
practice shall be deemed to be guilty of misconduct if he solicits clients or professional
work either directly or indirectly by a circular, advertisement, personal communication or
interview or by any other means.
In the given case, Mr. X published an advertisement in a Newspaper containing his
photograph on the occasion of the opening ceremony of his office. On this context, it
may be noted that the advertisement which had been put in by the member is quite
prominent. If soliciting of work is allowed, the independence and forthrightness of a
Chartered Accountant in the discharge of duties cannot be maintained.
The above therefore amounts to soliciting professional work by advertisement directly or
indirectly. Mr. X would be therefore held guilty under Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949.
(b) Soliciting Professional Work: As per Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed
to be guilty of misconduct if he solicits clients or professional work either directly or
indirectly by a circular, advertisement, personal communication or interview or by any
other means.
In the given case, Mr. X, a Chartered Accountant and proprietor of M/s X and Co., wrote
several letters to the Assistant Registrar of Co-operative Societies, requesting for
allotment of audit work. In similar cases, it was held that the Chartered Accountant
would be guilty of professional misconduct under Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949. The writing of continuous lette r to
ascertain the reasons for not getting the work is quite alright but in case such either
amount to request for allowing the work then Mr. X will be liable for professional
misconduct.
Consequently, Mr. X would therefore be held guilty under Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949.
9. Cost Accountant: As stated in the case study given in clause 7 with reference to tax
consultant, this would also constitute misconduct under section 7 of the Act read with Clause
(7) of Part I of the First Schedule to the Chartered Accountants Act, 1949. A chartered
accountant in practice cannot use any other designation than that of a chartered accountant.
Nevertheless, a member in practice may use any other letters or descriptions indicating
membership of accountancy bodies which have been approved by the Council. Thus, it is
improper for a chartered accountant to state in his documents that he is a “Cost Accountant”.
However as per the Chartered Accountants Act, 1949, the Council has resolved that the
members are permitted to use letters indicating membership of the Institute of Cost and
Works Accountants but not the designation "Cost Accountant".
10. Using Designation Other Than a CA and Providing Details of Services Offered:
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 states that a

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

PROFESSIONAL ETHICS 20.131

Chartered Accountant in practice shall be deemed to be guilty of misconduct if he solicits

clients or professional work either directly or indirectly by a circular, advertisement, personal
communication or interview or by any other means. Such a restraint has been put so that the
members maintain their independence of judgment and may be able to command respect
from their prospective clients.
Section 7 of the Chartered Accountants Act, 1949 read with Clause (7) of Part I of the First
Schedule to the said Act prohibits advertising of professional attainments or services of a
member. It also restrains a member from using any designation or expression other than tha t
of a chartered accountant in documents through which the professional attainments of the
member would come to the notice of the public. Under the clause, use of any designation or
expression other than chartered accountant for a chartered accountant in p ractice, on
professional documents, visiting cards, etc. amounts to a misconduct unless it be a degree of
a university or a title indicating membership of any other professional body recognised by the
Central Government or the Council.
Member may appear on television and films and agree to broadcast in the Radio or give
lectures at forums and may give their names and describe themselves as Chartered
Accountants. Special qualifications or specialized knowledge directly relevant to the subject
matter of the programme may also be given but no reference should be made, in the case of
practicing member to the name and address or services of his firm. What he may say or write
must not be promotional of his or his firm but must be an objective professional view of the
topic under consideration.
Thus, it is improper to use designation "Management Expert" since neither it is a degree of a
University established by law in India or recognised by the Central Government nor it is a
recognised professional membership by the Central Government or the Council. Therefore,
he is deemed to be guilty of professional misconduct under both Clause (6) and Clause (7) as
he has used the designation “Management Expert” in his speech and also he has made
reference to the services provided by his firm of Chartered Accountants at reasonable rates.
Distribution of cards to audience is also a misconduct in terms of Clause (6).
11. Delegation of Authority to the Employee: As per Clause (12) of Part I of the First Schedule
of the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be
guilty of professional misconduct “if he allows a person not being a member of the Institute in
practice or a member not being his partner to sign on his behalf or on behal f of his firm, any
balance sheet, profit and loss account, report or financial statements”.
In this case CA. ‘A’ proprietor of M/s A & Co., went to abroad and delegated the authority to
another Chartered Accountant Mr. Y, his employee, for taking care of routine matters of his
office who is not a partner but a member of the Institute of Chartered Accountants
The Council has clarified that the power to sign routine documents on which a professional
opinion or authentication is not required to be expressed may be delegated and such

© The Institute of Chartered Accountants of India

 Downloaded from castudyweb.com

20.132 ADVANCED AUDITING AND PROFESSIONAL ETHICS

delegation will not attract provisions of this clause like issue of audit queries during the
course of audit, asking for information or issue of questionnaire, attending to routing matters
in tax practice, subject to provisions of Section 288 of Income Tax Act etc.
(i) In the given case, Mr. ‘Y’, a chartered accountant being employee of M/s A & Co. has
issued audit queries which were raised during the course of audit. Here “Y” is right in
issuing the query, since the same falls under routine work which can be delegated by
the auditor. Therefore, there is no misconduct in this case as per Clause (12) of Part I of
First schedule to the Act.
(ii) Further, issuance of production certificate to a client under Central Excise Act, 1944 by
Mr. “Y” being an employee of M/s A & Co. (an audit firm), is not a routine work and it is
outside his authorities. Thus, CA. ‘A’ is guilty of professional misconduct under Clause
(12) of Part I of First Schedule of the Chartered Accountants Act, 1949.
(iii) In this instance, Mr. “Y”, CA employee of the audit firm M/s A & Co. has attended the
Income tax proceedings for a client as authorized representative before Income Tax
Authorities. Since the council has allowed the delegation of such work, the charte red
accountant employee can attend to routine matter in tax practice as decided by the
council, subject to provisions of Section 288 of the Income Tax Act. Therefore, there is
no misconduct in this case as per Clause (12) of Part I of First schedule to the Act.
12. Clause (1) of Part I of the Second Schedule to the Chartered Accountants Act, 1949 states
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 the client or otherwise than as
required by law for the time being in force. SA 200 on " Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance with Standards on Auditing" also
reiterates that, "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". In the instant
case, the bank has asked the auditor for detailed information regarding few items in the
financial statements available in his working papers. Having regard to the position stated
earlier, the auditor cannot disclose the information in his possession without specific
permission of the client. As far as working papers are concerned, working papers are the
property of the auditor. The auditor may at his discretion, make portions of or extracts fro m
his working papers available to his client". Thus, there is no requirement compelling the
auditor to divulge information obtained in the course of audit and included in the working
papers to any outside agency except as and when required by any law.

© The Institute of Chartered Accountants of India